The Russian Recovery: How Green are its Shoots? 38 Russia Economic Report November 2017 MODEST GROWTH AHEAD This report is produced twice a year by World Bank economists in the Macroeconomics, Trade and Investment (MTI) Global Practice. The team that prepared this edition was led by Apurva Sanghi (Lead Economist for the Russian Federation, asanghi@worldbank.org) and consisted of Olga Emelyanova (Economist, GMTE2), Mikhail Matytsin (Research Analyst, GPV03), Irina Rostovtseva (Research Analyst, GMTE2), Katerina Levitanskaya (Senior Financial Sector Specialist, GFCE1), Eva Gutierrez (Lead Financial Sector Specialist, GFCEE), Yoki Okawa (Economist, DECPG), John Baffes (Senior Economist, DECPG), Peter Stephen Oliver Nagle (Economist, DECPG), Xinghao Gong (Research Analyst, DECPG). Oleg Petrov (Senior Program Officer, GTD09) and the team consisted of Asya Rudkovskaya (Consultant, GTD09) and Yaroslav Eferin (Consultant, GTD09) authored the focus note on Russia’s digital economy based on a paper titled “The EAEU 2025 digital agenda: prospects and recommendations”. Peer reviewers included Yaroslav Baklazhansky (Advisor, Macroeconomic Policy Department, Eurasian Economic Commission) and Julio Revilla (Lead Economist, GMTE2). The report was edited by Christopher Pala (Consultant) and the graphic designer was Robert Waiharo (Consultant). The team would like to thank Andras Horvai (Country Director for Russia) and Maria De los Angeles Cuqui Gonzalez Miranda (Practice Manager, MTI Global Practice) for their advice and support. The team also would like to express their gratitude to the Department for Research and Forecasting of the Central Bank, Department for Macroeconomic Forecasting of the Ministry of Economic Development and Department for the budget policy and strategic planning of the Ministry of Finance for the collaboration. This report went to press on May 24, 2018. TABLE OF CONTENTS ACRONYMS AND ABBREVIATIONS ........................................................................................................................ i EXECUTIVE SUMMARY........................................................................................................................................... iii I. Recent Economic Developments .............................................................................................................. 1 1.1 Global growth: solid momentum..................................................................................................................... 2 1.2 Russia: modest 2017 growth led by non-tradable sectors............................................................................... 4 1.3 Balance of Payments: in 2017, a stronger current account and higher reserves............................................. 10 1.4 Labor Market and Poverty Trends: unemployment is stable, wages are recovering but a high share of the population remains vulnerable............................................................................................................. 12 1.5 Monetary Policy: the CBR continued monetary policy easing, moving from . ................................................ 15 a moderately tight policy to a neutral one. ...................................................................................................... 15 1.6 The Financial Sector: the banking sector’s fundamentals are largely stable; the share of state-controlled banking assets grew as a result of the continuing CBR clean-up .......................................... 17 1.7 Government Budget: the fiscal stance has improved, aided by higher oil price a recovering economy, improved tax administration and lower expenditures ..................................................................................... 21 II. The outlook for three years shows modest growth........................................................................ 25 III. Russia’s digital economy: accelerating digital transformation for economic prosperity 31 LIST OF FIGURES Figure 1: Global industrial production growth and manufacturing PMI . ...................................................................... 2 Figure 2: Inflation in selected economies ...................................................................................................................... 2 Figure 3: Following a weak first half of 2017, oil prices rose sharply in the latter half of the year. Oil prices continued to rise in the first quarter of 2018 on strong consumption growth . ............................................. 3 Figure 4: Russia’s economy has emerged from recession to recovery........................................................................... 4 Figure 5: Recovery in non-tradable sectors was the main engine of growth in 2017 . .................................................. 5 Figure 6: In 2017, tradable sectors benefitted from modest comparative advantage from REER depreciation in 2014 - 2016 ................................................................................................................................................. 5 Figure 7: In 2017, growth in manufacturing was broad-based . .................................................................................... 6 Figure 8: The production of auto vehicles, other transport vehicles, chemicals, and coke and oil products contributed to growth the most ..................................................................................................................... 6 Figure 9: Recovery of fixed capital investment began in many sectors of manufacturing in 2017. ................................ 6 Figure 10: Lower investment demand growth led to lower growth momentum in the second half of 2017.................. 7 Figure 11: Growth dynamics lost steam in the last two quarters of 2017 . ..................................................................... 7 Figure 12: Growth momentum picked up in the first quarter of 2018 ............................................................................ 8 Figure 13: The current account surplus increased on the back of a stronger trade balance, (bln US$)........................... 10 Figure 14: Labor force participation and employment remain at high levels… (in mln people) . .................................... 13 Figure 15: … while unemployment rate is at historical minimums (percent)................................................................... 13 Figure 16: Real wages are growing across all the sectors ................................................................................................ 14 Figure 17: Real incomes dynamics showed some positive signs in beginning of 2018.................................................... 14 Figure 18: Poverty in 2016 was higher than in 2010........................................................................................................ 14 Figure 19: Quarterly dynamics of poverty in 2017 is close to 2016 (cumulative)............................................................ 14 Figure 20: The CBR continued monetary policy .............................................................................................................. 15 Figure 21: Inflation is at a record-low level below the CBR’s target ................................................................................ 15 Figure 22: Food products strongly influence the headline inflation ................................................................................ 16 Figure 23: Inflation expectations continued to decline, though remained elevated compared to the inflation target ................................................................................................................................................ 16 Figure 24: The monetization of the economy increased ................................................................................................. 17 Figure 25: Compared to the previous years, the ruble’s exchange rate correlation with oil prices weakened................ 17 Figure 26: Credit growth in rubles accelerated................................................................................................................ 20 Figure 27: Overall financial sector indicators remained broadly stable . ......................................................................... 20 Figure 28: The GG Budget Primary Balance improved in 2017........................................................................................ 22 Figure 29: The Federal Budget Stance improved in 2017 ................................................................................................ 22 Figure 30: Regional budget revenues gained from the economic recovery and positive terms of trade ....................... 23 Figure 31: The growth forecast for Russia for 2018 has been slightly decreased . ......................................................... 27 Figure 32: Higher oil prices would not substantially speed up the growth..................................................................... 27 Figure 33: Non-tradable sectors are expected to drive growth in the medium-term projected growth by sector, percent........................................................................................................................................... 28 Figure 34: The poverty headcount is likely to decline in 2017 and beyond . .................................................................. 29 Figure 35: ICT use for B2B and B2C transactions ............................................................................................................ 33 Figure 36: Russia’s ICT exports growth............................................................................................................................ 33 Figure 37: Russia’s ranking.............................................................................................................................................. 34 Figure 38: Analogue (“Complements”) and digital (“Technology”) factors interplay in determining the leaders in digital transformation..................................................................................................................................... 35 Figure 39: Impact of business usage of ICT tools on the innovation and entrepreneurial environment . ...................... 35 Figure 40: Share of R&D spending in nations’ GDP......................................................................................................... 35 Figure 41: Russia in the Impact of ICT ranking by World Economic Forum Network Readiness Index 2016 .................. 41 Figure 42: Russia’s digital economy assessment summary............................................................................................. 41 Figure 43: Implementing the EAEU Digital Agenda. Additional gains per capita by 2025............................................... 43 Figure 44: Scenarios for the growth of fixed broadband per capita in the Russian Federation...................................... 44 Figure 45: The impact of the digital economy on employment growth (percent) when implementing country and regional Digital Agendas in 2018-2025.................................................................................................... 44 Figure 46: Aggregate GDP impact by 2025 of data-driven economy . ............................................................................ 45 Figure 47: Cloud computing in EAEU – potential member-country gains....................................................................... 45 Figure 48: Results of Digital Economy Assessments (DECA) in Russia vs Ulyanovsk region............................................ 46 LIST OF TABLES Table 1: External debt of the Russian Federation . ..................................................................................................... 12 Table 2: Balance of payments, 2013–2017 . ............................................................................................................... 12 Table 3: Federal budget revenue increased in 2017 . ................................................................................................. 23 Table 4: Global growth is broadly stable .................................................................................................................... 26 Table 5: Projected growth rates are modest contribution to GDP, pp . ...................................................................... 28 LIST OF BOXES Box 1: Russia must overcome structural constraints to rebalance its exports towards non-energy items.............. 8 Box 2: In April 2018, new round of U.S. sanctions increased volatility at the financial markets in Russia............... 9 Box 3: Public asset management companies: review of international experience ................................................. 18 ACRONYMS AND ABBREVIATIONS AMCs Asset Management Companies APR Annual Percentage Rate Bbl Oil Barrel B2B Business-To-Business B2C Business-To-Consumer B2E Business-To-Employee BRICS Brazil, Russia, India, China, and South Africa (emerging economies) BSCF Banking Sector Consolidation Fund CBR Central Bank of the Russian Federation CDS Credit - Default Swap CIT Corporate Income Tax CPI Consumer Price Index DECA Digital Economy Country Assessment EAEU Eurasian Economic Union EMDEs Emerging Markets and Developing Economies ERP Enterprise Resource Planning EU European Union FDI Foreign Direct Investment GDP Gross Domestic Product ICO Initial Coin Offering ICT Information and Communication Technology IEA International Energy Agency INSEAD European Institute of Business Administration IT Information Technology LFP Labor Force Participation M2 Money Supply NAMA National Asset Management Agency NPL Non-Performing Loan OFZ Federal Loan Bonds OPEC Organization of the Petroleum Exporting Countries PISA Program for International Student Assessment PMI Purchasing Managers' Index PSB Promsvyazbank R&D Research and Development REER Real Effective Exchange Rate Rosstat Russian Federal State Statistics Service RTSI Russian Trading System Index SA Seasonally Adjusted SAREB The Company for the Management of Assets proceeding from Restructuring of the Banking System SMEs Small and Medium-Sized Enterprises TOT Terms of Trade WEF World Economic Forum WTI West Texas Intermediate y-o-y Year-on-year Russia Economic Report | Edition No. 39 i EXECUTIVE SUMMARY G lobal growth continued its 2017 momentum in early 2018. Global growth reached a stronger- than-expected 3 percent in 2017 — a notable China. The impact of these measures will depend on their ultimate scope, but a rise in trade-policy uncertainty could weigh on confidence, financial- recovery from a post-crisis low of 2.4 percent in market sentiment, and eventually on economic 2016. It is currently expected to peak at 3.1 percent activity. In financial markets, prospects of a faster in 2018. Recoveries in investment, manufacturing, withdrawal of monetary policy accommodation and trade continue as commodity-exporting in advanced economies have led to rising global developing economies benefit from firming borrowing costs. commodity prices (Figure 1a). The improvement reflects a broad-based recovery in advanced Oil prices, which firmed up in 2017, are projected economies, robust growth in commodity-importing to average USD 65/bbl in 2018 and 2019, and Emerging Markets and Developing Economies USD 66/bbl in 2020, but may increase further, (EMDEs), and an ongoing rebound in commodity especially in the short term. This stems from the exporters. Growth in China – and important trading recently announced renewal of U.S. sanctions on partner for Russia – is expected to continue its Iran that have put upward pressure on oil prices gradual slowdown in 2018 following a stronger- (prior sanctions resulted in a reduction of around than-expected 6.9 percent in 2017. 1mb/d of Iranian exports). An escalation of trade tensions could also hit oil demand, particularly Global trade maintained its strength while the for fuel oil. The longer-term outlook for oil prices risk of escalating trade restrictions increased. The depends heavily on the balance between rising recovery of trade continued in early 2018, supported U.S. production and the persistence and depth of by strong demand, especially in the manufacturing OPEC production cuts. The target for OPEC’s cuts sector. On the policy front, the risk of escalating was for oil inventories to return to their five-year trade tensions increased, following tit-for-tat trade average. While this target has now been achieved, tariff announcements by the United States and both Saudi Arabia and Russia are discussing other measures to ensure the success of their production Figure 1a: Global Growth continued its momentum cuts. Saudi Arabia would also like to shift the in early 2018 existing OPEC/non-OPEC agreement cooperation Percent, 3m-o-3m, saar Index, 50>=expansion with Russia and other non-OPEC producers to 7 58 a longer-term arrangement, possibly over 10 or 6 56 20 years. At its June meeting, OPEC is scheduled 5 54 to assess market developments and to consider 4 52 extending or amending output limits in conjunction 3 50 with non-OPEC producers. An extension of the 2 48 cuts proposed by some members would further 1 46 tighten oil markets. However, higher prices would 0 44 also benefit the U.S. shale industry and may -1 2012 2013 2014 2015 2016 2017 2018 result in faster output growth despite increasingly Industrial production Manufacturing PMI (RHS) binding capacity constraints in the short-term. The Note: Seasonally adjusted quarterly growth, annualized. PMI stands for Purchasing Manager’s Index. evolution of geopolitical tensions will also play an Source: Haver Analytics, World Bank. important role in determining oil prices. Russia Economic Report | Edition No. 39 iii Executive Summary Supported by deepening macro-economic 2016). Export growth in goods was mainly fueled stability and gradual monetary loosening, Russia’s by growing exports of non-oil goods. Export growth economy continued its recovery in 2017. Growth in services also demonstrated robust growth (+14.4 momentum towards the end of 2017 slowed down, percent, y/y, in value1), driven by an increase but picked up in the first quarter of 2018. Growth in exports of transport services, business trips, in 2017 was mainly driven by non-tradable sectors. construction, ICT and other business services. Yet, The contribution of tradable sectors to GDP growth as discussed in Box 1 of the main report, at almost was limited and amounted to just 0.2 pp in 2017 59 percent, the share of oil and gas exports in total (compared to 0.3 pp in 2016). Manufacturing, exports of good remains high (Figure 4a). which stabilized in 2016, registered growth but at a marginal rate of 0.1 percent, y/y. Moreover, the Russia’s balance of payments remained stable. growth momentum was uneven. It stalled in the A favorable external environment supported the third quarter and turned negative in the fourth current account in 2017 and the beginning of 2018 quarter of 2017 due to lower investment demand, (January – March). An increase in the trade surplus before picking up again in the first quarter of 2018 due to higher energy prices was the key factor behind (Figures 2a and 3a). While real wages and pensions the strengthening of the current account. In 2017, increased on the back of low inflation, growth this was mirrored by higher net capital outflows, in real disposable incomes remained negative in mainly from the banking sector, which continued 2017, driven by a decline in income from other its external-debt repayments. In the first quarter sources, including some not directly registered by of 2018, net capital outflows slightly decreased, statistics. The poverty rate in 2017 remained at compared to the same period last year and were the levels close to 2016, and the extreme poverty largely the result of an increase in the net foreign rate remained marginal, below one percent. assets of the non-banking sector. International Unemployment declined further in the beginning reserves gained USD 15.4 billion in 2017 and 14.8 of 2018 to 5 percent. billion in January – March 2018 largely because of currency purchases by the Ministry of Finance in In 2017, robust external demand supported export the fiscal rule framework. In 2017, the government growth. Exports grew by 5.1 percent, y/y, in real further scaled up its international borrowing by terms in 2017 (compared to 3.3 percent, y/y, in issuing Eurobonds and selling OFZ bonds (coupon- Figure 2a: Russia’s economy continued its recovery Figure 3a: Growth momentum picked up in the first in 2017 quarter of 2018 (GDP growth, percent, y/y, TOT, percent, y/y) 15 3.7 4 110 108 59 10 3 106 57 5 1.5 104 1.8 2 55 0.7 102 0 53 100 -5 1 98 51 -10 96 49 0 94 -15 92 47 -1 -20 -0.2 90 45 Ja 7 16 M 6 Ju 6 No 6 Ja 6 17 M 7 Ju 7 No 7 Se 6 Se 7 18 8 -2 1 -1 -1 1 -1 -1 1 -1 l-1 1 l-1 -25 v- v- n- p- n- p- n- ar ay ar ay ar Ja M M M -2.5 -30 -3 PMI services (RHS) PMI manufacturing (RHS) 2012 2013 2014 2015 2016 2017 Industrial Production Cargo Agriculture Output in five basic sectors GDP growth (RHS) Terms of trade Construction Source: Rosstat, Haver Analytics. Source: Rosstat. Data for export volume are not available. 1 iv Russia Economic Report | Edition No. 39 Executive Summary Figure 4a: The share of oil and gas exports in total export of goods by value remains high – at 58.7 percent Structure of exports in 2013 Structure of exports in 2017 1% 1% Carbo and energy minerals 0% Carbo and energy minerals 2% 3% 2% 0% 0% 1% 0% 0% (excl. electric. energy) (excl. electric. energy) 3% 0% Metals and metal products 3% Metals and metal products 3% Chemicals, rubber 6% Machinery, equipment and 6% Machinery, equipment and vehicles vehicles Chemicals, rubber Food and agricultural raw 7% Food and agricultural raw 6% materials (except for textiles) materials (except for textiles) Precious stones, metals and its products Wood, pulp and paper products Wood, pulp and paper products 59% Precious stones, metals and 70% 8% its products 8% Other goods Other goods Other minerals Other minerals Textiles, textile products and Textiles, textile products and footwear footwear Electrical energy Electrical energy 11% Leather raw materials, furs and Leather raw materials, furs and its products its products Source: Federal Customs Service of Russia. bearing federal loan bonds) to non-residents in the up. In December 2017, on the heels of the earlier secondary market (the share of non-residents in bailout of Otkritie and B&N, the CBR announced OFZ bond ownership reached 33 percent by the end the bailout of Promsvyazbank, the third large of 2017, compared to 26.9 in the end of 2016). Total private bank and the second systemically important external debt of all sectors as share of GDP reached institution to be rescued via the Banking Sector 32.9 percent in 2017 compared to 39.7 percent Consolidation Fund (BSCF). Because of the banking- in 2016. In nominal terms, adjusted for exchange sector clean-up, the share of state-controlled banks rate movements, Russia’s external liabilities in the combined assets of the Russian banking remained almost unchanged in 2017. An increase system increased to nearly 70 percent. In April 2018, in government borrowing was compensated by the CBR announced that it will create a “bad bank” to continuing debt repayments by the banking sector. transfer distressed assets in the amount of RUB 1.1 trillion from these three large private banks. Trust Monetary policy remained consistent with the Bank, a failed bank acquired by Otkritie, will act as inflation-targeting regime, and is moving from an asset management company (Box 3 in the main moderately tight to neutral. Moderately tight report provides an overview of issues to consider monetary and fiscal policies, in combination with when setting up bad banks based on international a favorable external environment and some one- Figure 5a: Inflation is at a record-low level below the off factors, let the Central Bank of Russia (CBR) to CBR’s target reach a record-low level of CPI inflation in 2017. (CPI index and its components, percent, y-o-y) CBR continued its gradual approach to monetary 25 easing, moving from a moderately tight policy to 20 a neutral one. Annual inflation now stands at a record-low level, even below the CBR’s target of 15 4 percent, while inflation expectations, though 10 trending downward, remain elevated (Figure 5a). 5 However, pro-inflationary factors are on the rise, as discussed later in the outlook section. 0 Apr-14 Jul -14 Oct -14 Apr-16 Jul -16 Oct -16 Apr-17 Jul -17 Oct -17 Apr-18 Jan -14 Jan -15 Apr-15 Jul -15 Oct -15 Jan -16 Jan -17 Jan -18 The banking sector’s fundamentals are largely Core inflation CPI inflation Food inflation Non-food inflation Services inflation stable but the share of state-controlled banking assets grew because of the continuing CBR clean- Source: CBR and Haver Analytics. Russia Economic Report | Edition No. 39 v Executive Summary experiences). More detailed operational features In 2017, both the general and federal government and financial projections on the “bad bank” have fiscal stance improved, helped by higher revenues yet to be disclosed. As discussed in the previous and lower expenditures, as the authorities RER, these funds were provided by the CBR, as adhered to a path of fiscal consolidation (Figures opposed to budget sources, which may result in 7a and 8a). The general government’s fiscal stance monetization of resolution costs and undermines improved in 2017. The overall general government fiscal transparency (Box 3, RER #38). Despite these deficit improved to a deficit of 1.5 percent of GDP developments, retail credit continued to grow at (compared to 3.6 percent of GDP in 2016). The double digits and overall financial sector indicators federal budget deficit narrowed to 1.4 percent remained broadly stable (Figure 6a). Credit growth of GDP from 3.4 percent of GDP in 2016. This to the corporate sector in rubles also accelerated: reduction was a result of growing oil and gas it grew by 4.4 percent, y/y, in the last six months, revenues, mostly because of increases in energy compared to 1.9 percent during the same period a prices, as well as declining expenditures. On the year ago. revenue side, federal budget revenues increased to 16.4 percent of GDP from 15.6 percent of GDP in Figure 6a: Overall financial sector indicators remained 2016, with oil/gas revenues higher by 0.9 percent of broadly stable (Key credit and performance indicators, percent) GDP. On the expenditure side, compared to 2016, primary expenditures decreased by 1.3 percent of 16 14 GDP, largely due to lower spending on defense, and 12 lower spending compared to the one envisaged 10 in the federal budget law (0.6 percent of GDP). In 8 2017, civil servant salaries and the savings pillar of 6 4 the pension system were frozen, as in 2015-2016 2 (2014-2016 for the savings pillar). 0 Feb -18 Mar -18 Nov -17 Dec -17 Jan -18 Jul -17 Aug -17 Sep -17 Oct -17 May -17 Jun -17 Mar -17 Apr -17 Jan -17 Feb -17 Aug -16 Sep -16 Oct -16 Nov -16 Dec -16 Apr -16 May -16 Jun -16 Jul -16 Feb -16 Mar -16 Jan -15 Oct -15 Dec -15 Jan -16 In 2017, the regions’ budget gained from the Capital adequacy ratio Return on assets continuing recovery and positive terms of trade. NPLs to total loans Return on equity Loan loss provisions to total loans The consolidated regional budget registered a Source: CBR. primary surplus of 0.1 percent of GDP in 2017, compared to 0.2 percent of GDP in 2016 (Figure Figure 7a: The General Budget Primary Balance improved in 2017 (% of GDP) 40 2016 2017 0 35 30 25 -3 20 15 10 -6 5 0 Primary expenditure Oil/gas revenue Non-oil/gas revenue -9 2016 2017 Primary balance Non-oil/gas primary balance Source: Haver Analytics. vi Russia Economic Report | Edition No. 39 Executive Summary Figure 8a: The Federal Budget Stance improved in 2017 (% of GDP) 18 2016 2017 0 16 14 -2 12 10 -4 8 6 -6 4 2 -8 0 Primary Oil/gas revenue Non-oil/gas expenditure revenue -10 2016 2017 Primary balance Non-oil/gas primary balance Source: Haver Analytics. 9a). The economic recovery increased the revenues Russia’s growth prospects for 2018 – 2020 remain of the regional budgets, with a slight increase in modest, with growth forecasted to be between primary expenditures (reasons for these increases 1.5 and 1.8 percent in the 2018 – 2020 period. are discussed in the main report). Regional debt also However, in the short-term, these forecasts may decreased to 2.5 percent of GDP from 2.7 percent in change due to changing oil prices. Relatively high 2016. However, aggregate debt dynamics concealed oil prices, continued momentum in the global substantial variations in debt levels among regions. economic growth and macro stabilization would By the end of 2017, there were 7 regions, out of support growth. Yet, the growth forecast for Russia more than 80, with a share of debt exceeding the for 2018 has been slightly decreased (to 1.5 percent region’s own revenues (the same number as at the a year) due to carry-over effect from a weak second end of 2016). In 2018, the Ministry of Finance is half of 2017 and lower than expected growth in not expected to provide new budgetary loans. To the first quarter of 2018, aggravated by some support regions with high debt burden, starting uncertainty arising from the latest sanctions (Box 2 2018, the Ministry initiated a long-term program in the main report discusses the new US sanctions for state debt restructuring. Extra-budgetary funds against Russia that were imposed on April 6, 2018). were balanced, after posting a deficit of 0.2 percent Growth projections for 2019 and 2020 stand at 1.8 of GDP in 2016. percent a year (Figure 10a). Although the fiscal rule Figure 9a: Regional budget revenues gained from the economic recovery and positive terms of trade (% of GDP) 11.8 0.2 11.7 11.6 0.1 11.5 11.4 11.3 0.0 11.2 11.1 2016 2017 -0.1 2016 2017 Primary expenditure Revenue Primary balance Balance Source: Haver Analytics. Russia Economic Report | Edition No. 39 vii Executive Summary has reduced sensitivity to oil prices, these forecasts The outlook is subject to both favorable and are subject to changing oil prices. For instance, unfavorable risks. Favorable risk factors come a simulated rise of 15 percent in oil prices (i.e, if oil primarily from higher than expected oil prices. prices rose to USD 75 /bbl in 2018 and 2019), that Unfavorable risk factors include marked escalation would increase growth to 1.7 percent for 2018 and of trade tensions and restrictions among major 2.0 percent in 2019 (Figure 32, main report). economies, which could derail the recovery in global trade and negatively impact confidence and Figure 10a: The growth forecast for Russia for 2018 has investment worldwide. Other external unfavorable been slightly decreased (real GDP growth, percent) risk factors include a further expansion of sanctions. 4 120 A sudden tightening of global financing conditions could be triggered by a reassessment of inflation 3 100 risks or by shifting expectations about monetary or 2 80 fiscal policies across major advanced economies. 1 Surges in volatility in financial markets can affect 0 60 expectations for the exchange rate and inflation. -1 40 Domestic pro-inflationary risks stem mainly from the -2 closing output gap, elevated inflation expectations, a 20 -3 tight labor market, and high food-inflation volatility. -4 0 The steep growth in nominal wages, if not followed 2012 2013 2014 2015 2016 2017 2018 2019 2020 GDP growth Oil price, average (US$ per barrel) by growing productivity, could also be a pro- Source: Rosstat, World Bank. inflationary risk in the medium-term. And although the performance of the banking sector is expected Consumer demand is expected to be the main to remain stable, the bailout of three large private engine of GDP growth in 2018-2020. In the forecast banks points to the continuing fragility in the sector, period of 2018-2020, growth in gross fixed capital while the quality of capital and assets linked to formation is expected to slow down compared related-party lending will likely remain a concern. to 2017, when most large public infrastructure projects were undertaken. While the government has set in place macro fundamentals for growth, certain micro fundamentals still need to be addressed. By The poverty rate is expected to decrease slightly switching to a flexible exchange rate regime, due to low inflation and recoveries in private introducing the fiscal rule, and continued inflation income and consumption, but remains above the targeting, the government has set important macro pre-crisis level. Driven by a rebound in disposable fundamentals for growth. Meanwhile, achievement income and consumption, the poverty headcount of the goals that were recently set by the President’s is expected to have declined marginally in 2017 to May 2018 decree (keeping economic growth above 13.2 percent in the baseline scenario, after reaching the global level, the creation of highly productive 13.3 percent in 2016 (Figure 34, main report). The export oriented sub-sectors in agriculture and poverty rate is projected to decline in the baseline manufacturing) may face challenges because of scenario in 2018, 2019 and 2020 to 12.5, 11.9 large state footprint and other structural problems. and 11.4 percent, respectively, as income and Improving micro fundamentals for growth becomes consumption grow further. Among the factors that necessary to increase productivity and put Russia could fuel real income growth are a deceleration in on a higher growth path. As analyzed in detail in inflation and a general recovery of the economy. previous reports2, this entails limiting the role of World Bank 2016: “Systematic Country Diagnostic for the 2 Russian Federation: Pathways to Inclusive Growth.” World Bank 2017: “Russia Economic Report #37. From recession to recovery.” viii Russia Economic Report | Edition No. 39 Executive Summary the state in the economy, improving institutional infrastructure to support universal broadband and and regulatory frameworks, and promoting fair mobile communications. However, for Russia to competition, among others. Achieving higher growth gain significant socio-economic benefits from digital rates and improving social assistance targeting would transformation, it will need to implement policies also allow the government to reduce poverty rates – that will accelerate the digital transformation of the another important goal set in the President’s decree. economy’s traditional enterprise sector, promote R&D, innovation and entrepreneurship and enable Part 3 of the main report discusses how Russia effective execution not only at the national level, can accelerate its transformation to a digital but also at the regional level, as well as that of the economy. A strategic focus on digital transformation Eurasian Economic Union level. Part 3 of the report has enabled Russia to build a national digital analyzes and discusses these issues. Russia Economic Report | Edition No. 39 ix PART I RECENT ECONOMIC DEVELOPMENTS I. Recent Economic and Policy Developments 1.1 Global growth: solid momentum Global growth remains robust in early 2018. Global trade remained strong, but the risk of escalating trade restrictions increased. G lobal growth continued its 2017 momentum in early 2018. Global activity remains robust. The World Bank’s January 2018 forecast is for but a rise in trade-policy uncertainty could weigh on confidence, financial-market sentiment, and eventually on activity. In the financial market, global growth to edge up to 3.1 percent in 2018, prospects of a faster withdrawal of monetary policy highest after 2011, while some high frequency data accommodation in advanced economies have led suggests momentum has eased recently. Recoveries to rising global borrowing costs and depreciation of in investment, manufacturing, and trade continue currency for emerging and developing economies as commodity-exporting developing economies since the start of 2018. benefit from firming commodity prices (Figure 1). The improvement reflects a broad-based recovery in Following a weak first half of 2017, oil prices advanced economies, robust growth in commodity- rose sharply in the latter half of the year. Strong importing EMDEs, and an ongoing rebound in oil consumption growth, geopolitical tensions, commodity exporters. Growth in China is expected and greater-than-expected compliance by the 22 to continue its gradual slowdown in 2018 following OPEC and non-OPEC producers to their agreed a stronger-than-expected 6.9 percent in 2017. production cuts helped tip the market into deficit and reduced inventories (Figure 3A). Oil Global trade maintained its strength while the inventories are now just 30 million barrels above risk of escalating trade restrictions increased. their five-year average, which was the original The recovery of trade continued in the start of goal of OPEC’s production cuts. 2018, supported by strong demand, especially in the manufacturing sector. On the policy front, the Oil prices continued to rise in the first quarter of risk of escalating trade protectionism increased, 2018 on strong consumption growth, with the following tit-for-tat trade tariff announcements by main international marker, Brent, briefly topping the United States and China. The impact of these USD 70/bbl in January. Prices rose further in May, measures will depend on their ultimate scope, with Brent reaching USD 79/bbl, its highest level Figure 1: Global industrial production growth and Figure 2: Inflation in selected economies manufacturing PMI (percent, year-on-year) Percent, 3m-o-3m, saar Index, 50>=expansion 5 7 58 6 56 4 5 54 3 4 52 3 2 50 2 48 1 1 0 46 0 -1 44 India South Brazil UK Russia USA World China Euro Japan 2012 2013 2014 2015 2016 2017 2018 Africa Area Industrial production Manufacturing PMI (RHS) Latest Jun-17 Note: Seasonally adjusted quarterly growth, annualized. PMI Source: Global Monthly, World Bank. stands for Purchasing Manager’s Index. Source: Haver Analytics, World Bank. 2 Russia Economic Report | Edition No. 39 I. Recent Economic and Policy Developments since November 2014. Rising geopolitical tensions Saudi Arabia to become the world’s second-largest threatened oil exports on several fronts, such as crude oil producer after Russia (Figure 3D). the reinstatement of U.S. sanctions against Iran, military escalation in Syria, and tensions between Crude oil prices are projected to average USD 65/ Saudi Arabia and Iran. OPEC’s supply cuts have also bbl in 2018 and 2019, and USD 66/bbl in 2020. The continued to be deeper than expected, worsened longer-term outlook for oil prices depends heavily by unplanned production losses in Venezuela, on the balance between rising U.S. production and where supply has fallen by more than half a million the persistence and depth of OPEC production cuts. barrels per day compared to last year. The target for OPEC’s cuts was for oil inventories to return to their five-year average. While this target The impact of the substantial production cuts by has now been achieved, both Saudi Arabia and these countries has been countered by continued Russia are discussing other measures to ensure increases in U.S. production (Figure 3B). The the success of their production cuts. Saudi Arabia number of rigs in the United States has increased by would also like to shift the existing OPEC/non-OPEC nearly 500 from its low in 2016 to 844 in mid-May agreement cooperation with Russia and other non- 2018 (Figure 3C). The United States has overtaken OPEC producers to a longer-term arrangement, Figure 3: Following a weak first half of 2017, oil prices rose sharply in the latter half of the year. Oil prices continued to rise in the first quarter of 2018 on strong consumption growth A. World oil balance and oil price B. Cumulative change in oil production since September 2018 mb/d, quarterly US$/bbl, quarterly mb/d 3 120 4 3 2 100 2 1 1 80 0 0 -1 60 -1 -2 -3 40 -2 -4 Sep - 16 Oct - 16 Nov - 16 Dec - 16 Jan - 17 Feb - 17 Mar - 17 Apr - 17 May - 17 Jun - 17 Jul - 17 Aug - 17 Sep - 17 Oct - 17 Nov - 17 Dec - 17 Jan - 18 Feb - 18 Mar - 18 Apr - 18 -3 20 2010Q1 2012Q1 2014Q1 2016Q1 2018Q1 Oil balance Price (RHS) Others Agreement countries Net C. U.S. oil rig count and oil prices, weekly D. Crude oil production US$/bbl Rig count mb/d 120 1,800 12 1,600 100 1,400 10 80 1,200 1,000 60 8 800 40 600 6 400 20 200 0 0 4 2010 2011 2012 2013 2014 2015 2016 2017 2018 2010 2011 2012 2013 2014 2015 2016 2017 2018 Oil price, WTI Rig Count United States Saudi Arabia Russia Note: A. Shaded area (2018Q2-2018Q4) represents IEA projections. OPEC crude oil production for 2018 is assumed at 32.0 mb/d. Sources: Energy Information Administration, International Energy Agency, World Bank. Russia Economic Report | Edition No. 39 3 I. Recent Economic and Policy Developments possibly over 10 or 20 years. At its June meeting, growth despite increasingly binding capacity OPEC is scheduled to assess market developments constraints in the short-term. The evolution of and to consider extending or amending output geopolitical tensions will also play an important limits in conjunction with non-OPEC producers. role in determining oil prices. The recently announced renewal of sanctions on Iran is likely to An extension of the cuts proposed by some have an adverse impact – prior sanctions resulted members would further tighten oil markets. in a reduction of around 1mb/d of Iranian exports. However, higher prices would also benefit the An escalation of trade tensions could also hit oil U.S. shale industry and may result in faster output demand, particularly for fuel oil. 1.2 Russia: modest 2017 growth led by non-tradable sectors In 2017, the Russian economy continued recovering from a “soft” recession that started in the third quarter of 2014 and continued for nine quarters. As for growth composition in 2017, it was mainly driven by non-tradable sectors. As for growth dynamics, momentum was uneven, stalling in the third quarter and turning negative in the fourth quarter of 2017. Growth momentum picked up in the first quarter of 2018. The pattern of growth will have implications for the growth outlook in the medium term (see Outlook section). R ussia’s economy continued its recovery in 2017, supported by a strengthening global economy, deepening macro-economic stability, firming whereas the contribution of tradable sectors was modest, limited by the OPEC+ agreement affecting oil production, along with subdued growth in energy prices, and gradual monetary loosening. manufacturing. Growth dynamics lost steam in the The GDP expanded by 1.5 percent in 2017. Prompt last two quarters of 2017 largely on the back of and adequate stabilization policies contributed lower investment demand; and growth momentum to economic growth, along with firming energy was lower than expected in the first quarter of commodity prices, gradual monetary loosening and 2018. a recovering global economy (Figure 4). The recovery in non-tradable sectors supported growth, Growth in non-tradable sectors was the main engine of recovery in 2017. Recovery in retail Figure 4: Russia’s economy has emerged from recession to recovery and wholesale trade, transportation and real (GDP growth, percent, y/y, TOT, percent, y/y) estate contributed the most to growth. Retail and wholesale trade were supported by growth in 15 3.7 4 10 household consumption, which increased on the 3 5 back of increasing real wages, macro stabilization, 1.8 1.5 0 0.7 2 a stronger ruble and reviving consumer credit. -5 1 Wholesale trade also benefitted from high growth -10 0 in gas extraction. The contribution of non-tradable -15 sectors to GDP growth totaled 1.4 percentage -1 -20 -0.2 points (pp) in 2017 (Figure 5). -2 -25 -2.5 -30 -3 2012 2013 2014 2015 2016 2017 GDP growth (RHS) Terms of trade Source: Rosstat, Haver Analytics. 4 Russia Economic Report | Edition No. 39 I. Recent Economic and Policy Developments Figure 5: Recovery in non-tradable sectors was the Figure 6: In 2017, tradable sectors benefitted main engine of growth in 2017 from modest comparative advantage from REER (contribution to growth, p.p.) depreciation in 2014 - 2016 (REER index) 3.5 110 105 3.0 105 95 2.5 100 85 2.0 95 75 1.5 90 65 1.0 85 55 80 0.5 75 45 0.0 2012 2013 2014 2015 2016 2017 70 35 -0.5 65 25 -1.0 Dec -13 Mar -14 Jun -14 Sep -14 Dec -14 Mar -15 Jun -15 Sep -15 Dec -15 Mar -16 Jun -16 Sep -16 Dec -16 Mar -17 Jun -17 Sep -17 Dec -17 Mar -18 -1.5 -2.0 Tradables Non-tradables REER, Dec 13 = 100 Oil price (Brent), Dec 13 = 100 Source: Rosstat. Source: Rosstat, Haver Analytics. The contribution of tradable sectors to GDP (Figure 7). Industries such as auto vehicles, growth was limited and amounted to just 0.2 pp in other transport vehicles, chemicals, and 2017 compared to 0.3 pp in 2016. coke and oil products contributed the most. • In 2017, strong growth in natural gas Expanding global demand also supported production (+7.8 percent, y/y) supported manufacturing, as the export of goods mineral resource extraction, which volume increased for all categories of goods, increased by 1.4 percent, y/y, despite slightly except for mineral goods, leather and furs. decreasing oil production as Russia joined However, the contraction of metallurgical production in 2017 (mainly in the fourth the OPEC+ agreement. Due to gradually quarter) dragged down manufacturing increasing compliance to OPEC+ agreement the most (Figure 8). While the volume of and high base of oil production in the fourth exports of metals and metal goods was quarter of 2016, the contribution of mineral growing in 2016-2017, domestic demand resource extraction to growth was uneven. It (from construction, for instance) remained decreased in the third quarter of 2017 and subdued and REER appreciation in 2017 turned negative in the fourth (Figure 11). led to increased competition from imports. • Manufacturing, which stabilized in 2016, A drop in the production of computers, registered growth but at a marginal rate of electronic and optic devices also contributed 0.1 percent, y/y. Despite the appreciation negatively to manufacturing growth. Lower of the Real Effective Exchange Rate (REER) government spending on national defense by 16 percent in 2017, manufacturing and also could have negatively impacted growth other tradable sectors (mineral resource in both above-mentioned industries in 2017. extraction and agriculture) benefitted from • Domestic demand bounced back by 3.6 persisting modest comparative advantage percent, y/y, in 2017, and became the main due to the REER depreciation in 2014-2016. engine of growth. Yet, the growth momentum In 2017, the REER index was about 10 percent in domestic demand was uneven: it stalled in below that of December 2013 (Figure 6). the third quarter and turned negative in the Growth in manufacturing was broad-based fourth quarter of 2017. Russia Economic Report | Edition No. 39 5 I. Recent Economic and Policy Developments Figure 7: In 2017, growth in manufacturing was Figure 8: The production of auto vehicles, other broad-based transport vehicles, chemicals, and coke and oil (percent, y/y) products contributed to growth the most (contribution to growth of the manufacturing sector, p.p.) Computers. electro/optical pr. Metallurgy Metal products Computers. electro/optical pr. Metallurgy Food products, beverages, tobacco Polygraph Metal products Food products, beverages, tobacco Polygraph Repairs Repairs Paper and pulp Paper and pulp Machines and equipment Machines and equipment Coke and oil products Textile, clothes, leather Other nonmetal products Wood processing Textile, clothes, leather Electrical equipment Electrical equipment Other nonmetal products Wood processing Rubber and plastic Chemicals Furniture Rubber and plastic Medicines Other transp vehicles Coke and oil products Furniture Chemicals Medicines Auto vehicles Auto vehicles Other transp vehicles -10 -5 0 5 10 15 20 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 Source: Rosstat. Source: Rosstat. • Both household and investment demand • Fixed capital investment in mineral resource expanded and contributed almost equally extraction (oil and gas), in transportation to GDP growth. Yet, investment demand via pipelines conducted largely by public slowed down in the second half of 2017, companies, in the financial sector and in largely due to lower restocking in the third sports (related to the 2018 FIFA World quarter and destocking in the fourth. Lower CUP) were the main support of fixed capital investment demand was the main reason for investment growth. While fixed capital weak growth momentum in the second half investment started the recovery in some of 2017 (Figure 10). Due to the high volatility manufacturing sub-sectors (Figure 9), fixed of changes in inventory, the destocking in capital investment for the manufacturing the fourth quarter of 2017 could be rather sector as a whole continued contracting (-0.8 considered as a one-off factor. percent, y/y), shrinking by about 22 percent • Private consumption, supported by a stronger for the period 2014-2017. Contracting fixed ruble, growing real wages and pensions and capital investment in metallurgy and metal by reviving credits to households, contributed goods was the biggest drag on manufacturing 1.8 pp to growth in 2017. investment dynamics. Figure 9: Recovery of fixed capital investment began in many sectors of manufacturing in 2017 Growth in manufacturing by sector, percent; fixed capital investment growth in manufacturing by sector [large and medium enterprises], percent: 2017 (left chart) vs 2016 (right chart) -30 -20 -10 0 10 20 30 40 50 -50 -30 -10 0 10 Total manufacturing Food products Total manufacturing Beverages Tobacco products Transport and transportation equipment Textile Electro-technical and optical Clothes Leather Machines and equipment Wood processing Paper and pulp Metallurgy and metal products Polygraph Coke and oil products Other nonmetal products Chemicals Rubber and plastic Medicines Rubber and plastic Chemicals Other nonmetal products Metallurgy products Coke and oil products Metal products Paper. pulp and polygraph Computers. electro and optical products Electrical equipment Wood processing Machines and equipment Vehicles Leather Other transportation equipment Textile Furniture Other finished goods Food products Production growth in 2017, % Investment growth in 2017, % Investment growth in 2016. % Production growth in 2016. % Source: Rosstat. Source: Rosstat. 6 Russia Economic Report | Edition No. 39 I. Recent Economic and Policy Developments Figure 10: Lower investment demand growth led to Figure 11: Growth dynamics lost steam in the last two lower growth momentum in the second half of 2017 quarters of 2017 (contribution to growth, p.p.) (contribution to growth, p.p.) 10 3.0 8 6 2.5 4 2.0 2 0 1.5 -2 -4 1.0 -6 0.5 -8 -10 0.0 -12 -14 -0.5 Q1 2017 Q2 2017 Q3 2017 Q4 2017 -1.0 Consumption GCF Q1 2017 Q2 2017 Q3 2017 Q4 2017 Gross fixed capital formation Change in inventories Export Import (-) Mineral resource extraction Non-tradables Stat error GDP growth Manufacturing Agriculture Source: Rosstat. Source: Rosstat. • 2017 also witnessed an increase in foreign quarter of 2016, continued in 2017, helped by direct investment (+ USD 12.4 billion)1 after macro stabilization, a relatively stronger ruble marginal levels of FDI inflows in 2015 and and growing consumer and investment demand. 2016. This inflow reflected a certain decrease Imports increased by 17.4 percent, y/y, in real in uncertainty in the business environment terms in 2017, and its negative contribution to and some revival of interest by foreign GDP growth overweighed the positive contribution investors in Russia, but it also included a good of exports. portion of capital round-tripping. In 2017, 30 percent of incoming FDI were concentrated Growth momentum picked up in the first quarter in the oil and gas sector, compared to about of 2018 (Figure 12). In the first quarter of 2018, 13 percent in manufacturing. GDP growth totaled 1.3 percent, y/y and 3.2 percent q/q, saar. This is compared with GDP In 2017, a robust external demand supported growth of 0.9 percent y/y and -1.5 percent q/q, export growth. Exports grew by 5.1 percent, y/y, saar, in the last quarter of 2017. According to high- in real terms in 2017 compared to 3.3 percent, y/y, frequency statistics, In January-March 2018, output in 2016. In 2017, the growth of exports of goods in five basic sectors3 increased by 1.3 percent, y/y was mainly fueled by growing export of non-oil (Figure 12). Industrial production output increased goods. Export of services also demonstrated robust by 1.9 percent, y/y in the first three months of growth (+14.4 percent, y/y, in value2), driven by an 2018. Yet growth momentum of both indicators increase in export of transport services, business was the strongest in January and decreased in trips, construction, ICT and other business services. February-March. In the first three months of 2018, Yet Russia still has a long way ahead to significantly construction dropped by 4 percent, y/y, pointing to increase the share of non-oil/gas exports and weak fixed-capital investment growth. Sanctions, break its dependence on hydrocarbons, which which were introduced in the beginning of April and would reduce its vulnerability to external shocks which could have caused certain distortions in the and increase sustainability of growth (Box 1). The metals and energy sector (Box 2), had a marginal effect recovery in imports, which started in the second in April on industrial production, which expanded by 1.3 percent, y/y and 0.5 percent, q/q, sa. Adjusted for one-off privatization of Rosneft in 2016 and 1 reinvestment of profits. The five basic sectors consist of agriculture, industrial production, 3 Data for export volume are not available. 2 construction, retail trade, and transportation. Russia Economic Report | Edition No. 39 7 I. Recent Economic and Policy Developments Figure 12: Growth momentum picked up in the first quarter of 2018 110 59 108 57 106 104 55 102 53 100 98 51 96 49 94 47 92 90 45 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 PMI services (RHS) PMI manufacturing (RHS) Industrial Production Cargo Agriculture Output in five basic sectors Construction Source: Rosstat. Box 1 Russia must overcome structural constraints to rebalance its exports towards non-energy items The significant depreciation of the Real Effective Exchange Figure B1-1: Some non-energy export items demonstrated robust growth in 2014 – 2017 Rate (REER) during 2014-2016 increased competitiveness and contributed to growth of non-energy exports (Figure 350 35 B1-1). 300 30 In 2017, the export value of goods in all categories 250 25 – except for energy goods, metals and wheat, other 200 20 important commodities exported by Russia – increased by 150 15 17 percent, y/y. Export value of tradable services such as ICT and business services increased by 21.6 percent, y/y 100 10 and 7.8 percent, y/y respectively.4 50 5 0 0 While this is a positive development, the share of oil and Food Minerals Oil Chemicals, Wood, Textiles Metals Machinery Other products (incl. oil) products rubber pulp gas exports in total export of goods (by value) remains Cumulative growth 2014 - 2017 (2013 = 100), left axis Average growth (2014 - 2017), right axis high at 58.7 percent (Figure B1-2). Source: Federal Customs Service of Russia. Figure B1-2: The share of oil and gas exports in total export of goods by value remains high – at 58.7 percent Structure of exports in 2013 Structure of exports in 2017 1% 1% Carbo and energy minerals 0% Carbo and energy minerals 2% 3% 2% 0% 0% 1% 0% 0% (excl. electric. energy) (excl. electric. energy) 3% 0% Metals and metal products 3% Metals and metal products 3% Chemicals, rubber 6% Machinery, equipment and 6% Machinery, equipment and vehicles vehicles Chemicals, rubber Food and agricultural raw 7% Food and agricultural raw 6% materials (except for textiles) materials (except for textiles) Precious stones, metals and its products Wood, pulp and paper products Wood, pulp and paper products 59% Precious stones, metals and 70% 8% its products 8% Other goods Other goods Other minerals Other minerals Textiles, textile products and Textiles, textile products and footwear footwear Electrical energy Electrical energy 11% Leather raw materials, furs and Leather raw materials, furs and its products its products Source: Federal Customs Service of Russia. 4 Data for export volume are not available. 8 Russia Economic Report | Edition No. 39 I. Recent Economic and Policy Developments Among tradable sectors, manufacturing remains the weak spot: compared to 2013, investment in manufacturing had contracted by 22 percent4 by end 2017, and employment in manufacturing had decreased by 2.9 percent (Figure B1-3). Despite the marginal growth of 0.1 percent in 2017, production in manufacturing fell by 4.0 percent, compared to 2013, and its share in GDP remained flat at about 13 percent. Macroeconomic policies (switching to a flexible exchange rate, low inflation, fiscal consolidation) set the stage for non-oil/gas export growth through reducing external volatility and reducing uncertainty. Yet, accumulated structural problems aggravated by sanctions negatively affect the growth of non- energy exports. Boosting manufacturing, which is crucial for further non-oil/gas robust export growth, would require addressing accumulated structural problems such as poor connectivity and inadequate competition. Figure B1-3: 2017: change in employment, compared to 2013 (percent) 15 10 5 0 -5 -10 -15 Agriculture Manufacturing Construction Public adm Health Mining Trade Education Utilities Financial Other Transport and defence activity and communication Average Source: Rosstat. Box 2 In April 2018, new round of U.S. sanctions increased volatility at the financial markets in Russia On April 6th, the U.S. imposed new sanctions on Russia—particularly on a group of oligarchs and their 12 companies, as well as 17 senior Russian government officials and a state-owned Russian weapons trading company and its subsidiary. All assets of the designated individuals and entities subject to U.S. jurisdiction were frozen, and U.S. citizens are generally prohibited from dealing with them. The imposition of sanctions, coupled with increased geopolitical tension, caused a massive sell-off of Russia’s financial assets. The RTS index dropped from 1253 on April 5 to 1083 on April 11 and the ruble depreciated from 57.7 Rub/USD on April 5 to 64.4 Rub/USD on April 11 despite increasing oil prices (Figure B2-1). The Ministry of Finance postponed its domestic debt auction on the back of the interest rate increase (it resumed the auctions on April 18) and refrained from currency purchases in the budget rule framework to stabilize the FX market (it resumed those purchases on April 17). However, by the end of April, the markets had calmed down to some extent and the ruble gained back about 30 percent of its losses with respect to the USD, and the RTS index gained back about 50 percent of its losses. The fiscal impact of the sanctions is not yet clear and it will depend on the nature and magnitude of public support for the affected firms. However, aside from a potential fiscal burden, any public intervention could increase the state footprint, further affecting competition and productivity. The performance of the banking sector is expected to remain stable. Russia’s largest bank, state-owned Sberbank, may become vulnerable to sanctions due to lending to certain Russian companies. However, according to Sberbank management, loans to companies on the new sanctions list — which are now barred from making payments in dollars or accessing western markets — total “no more than 2.5 percent” of Sberbank’s total assets. On April 23, the CBR informed banks that they are allowed not to create additional reserves and request additional collateral Data are available for large and medium enterprises. 5 Russia Economic Report | Edition No. 39 9 I. Recent Economic and Policy Developments for loans to companies on which the latest U.S. sanctions have been imposed and whose financial situation has worsened. They will just need to inform the central bank about decisions related to the loans to sanctioned entities. This is an expected measure of banks’ support on the part of the regulator, especially given that the government is now working on the plan to support the companies that are under sanctions. Figure B2-1: The imposition of sanctions, coupled with increased geopolitical tension, caused a massive sell-off of Russia’s financial assets 75 160 65 1300 64 150 1250 70 63 62 140 1200 65 61 130 60 1150 60 59 120 1100 58 55 57 110 1050 56 50 100 55 1000 1 - Mar 5 - Mar 7 - Mar 9 - Mar 13 - Mar 15 - Mar 19 - Mar 21 - Mar 23 - Mar 27 - Mar 29 - Mar 1 -Mar 3 -Mar 5 -Mar 7 -Mar 9 -Mar 11 -Mar 13 -Mar 15 -Mar 17 -Mar 19 -Mar 21 -Mar 23 -Mar 25 -Mar 27 -Mar 29 -Mar 31 -Mar 2 - Apr 4 - Apr 6 - Apr 8 - Apr 10 - Apr 12 - Apr 14 - Apr 16 - Apr 18 - Apr 20 - Apr 22 - Apr 24 - Apr 26 - Apr 3 - Apr 5 - Apr 9 - Apr 11 - Apr 13 - Apr 17 - Apr 19 - Apr 23 - Apr 25 - Apr 27 - Apr Oil price, Brent Rub/USD CDS 5Y (right hand side) Rub/USD RTSI Source: CBR, Micex. 1.3 Balance of Payments: in 2017, a stronger current account and higher reserves In 2017, positive terms of trade (higher oil/gas and metals prices) supported the current account through higher exports. An increase in energy export revenues stemming from the price effect more than compensated for the significant growth in imports that accompanied a stronger ruble and a recovering domestic demand. While short-term capital flew into the government sector on the back of continued interest in the financial assets of emerging and developing economies (EMDEs), net capital outflows from the non-government sector increased. The CBR increased its reserves, mainly conducting interventions introduced by the Ministry of Finance in the context of the fiscal rule. In 2017, the current account surplus increased on the back of a stronger trade balance. The current account surplus increased to USD 35.2 billion in Figure 13: The current account surplus increased on the back of a stronger trade balance (bln US$) 60000 2017 from USD 24.4 billion in 2016 (Figure 13). 40000 Due to positive terms of trade and a robust export 20000 demand, the surplus in goods trade increased by USD 24.7 billion despite a recovery in imports, 0 mainly supported by REER appreciation (+15,9 y/y) -20000 and recovering economy. Deficits increased in the -40000 service, investment income and secondary income -60000 accounts. The non-oil deficit of the current account remained high at USD 157.7 billion, or 9.9 percent Goods Services Compensation of employees Investment income of GDP, only slightly below the level of 10.0 percent Transfers Current account balance of GDP in 2016 (USD 129.6 billion). Source: CBR. 10 Russia Economic Report | Edition No. 39 I. Recent Economic and Policy Developments In 2017, short-term capital flew into the Russia’s external liabilities increased only slightly government sector, driven by a resilient risk in 2017. An increase in government borrowing was appetite for EMDE financial assets and supported compensated by continuing debt repayments by by the still-accommodative monetary policy in the banking sector. Russia’s outstanding external advanced economies. Net capital outflows4 from debt rose to USD 518.9 billion at end-2017, from the non-government sector increased. In 2017, the USD 511.7 at end-2016, but it remained almost government sector registered a net capital inflow of unchanged after adjusting for the exchange rate USD 12 billion that was mainly due to OFZ (federal movement. Meanwhile, with the ruble appreciating loan bonds) purchases by non-residents. Net in nominal terms during 2017, the debt burden capital outflows5 from the non-government sector decreased substantially as a share of GDP from increased as net capital outflows from the banking 39.7 percent of GDP in 2016 to 32.9 percent of sector rose. Banks continued deleveraging, but their GDP in 2017, closer to the level of 31.8 percent of net foreign assets decreased less strongly than they GDP in 2013. The government further scaled up did last year, which could be associated with the its international borrowing by issuing Eurobonds Rosneft privatization deal closing in the first quarter and selling OFZ to non-residents (the share of non- of 2017. Meanwhile in the non-banking sector, net residents in OFZ ownership reached 33 percent capital outflow turned zero in 2017, compared to by the end of 2017, compared to 26.9 in the end USD 19.6 billion in 2016. While the acquisition of of 2016). Banks continued deleveraging as their net foreign assets dropped considerably in 2017, access to international market remained restricted. an increase in net foreign liabilities of the non- Adjusted for exchange rate movement, non-banking banking sector was just slightly less than in 2016. sector debt remained flat, ceasing the downward An increase in net foreign liabilities in 2017 largely trend caused by lower oil prices and sanctions stemmed from incoming FDI, part of which was (Table 1). During the first nine months of 2017, the non-repatriated profit. bulk of the decrease of non-banking sector debt was due to the public sector, while the private The CBR increased its reserves, mainly conducting sector attracted debt, mainly ruble-denominated interventions introduced by the Ministry debt from direct investors. of Finance in the context of the fiscal rule framework. The CBR added about USD 15.4 billion A stronger trade balance supported the current to its reserves, which amounted to USD 433 billion account in the first quarter of 2018 while net at end-December 2017 (27.4 percent of GDP). capital outflow from the private sector decreased. The import cover stayed at a comfortable level, In the first three months of 2018, the current although slightly lower than as of end 2016 (15.9 account increased to USD 28.8 billion from USD months of goods and services in the end of 2017, 22.3 billion in the same period last year. An increase compared to 17 months of goods and services at in the trade surplus, due to higher exports (+20.2 the end of 2016). The central bank refrained from percent, y/y, in value) supported by higher energy intervening on its own, in line with its flexible prices, was the key factor behind the strengthening exchange-rate regime. of the current account. Despite REER depreciation in the first quarter of 2018 largely on the back of stronger euro, value of imports increased by 18.5 Adjusted for currency swaps and correspondent accounts of 4 percent, y/y. Net capital inflow to the government resident banks in the central bank, and repayments of foreign- sector decreased compared to the same period currency loans by large banks to the central bank. last year, as the Central Bank continued gradual Adjusted for currency swaps and correspondent accounts of 5 easing and the monetary stance in the advanced resident banks in the central bank, and repayments of foreign- currency loans by large banks to the central bank. economy gradually tightened. In addition, country Russia Economic Report | Edition No. 39 11 I. Recent Economic and Policy Developments Table 1: External debt of the Russian Federation (US$ billions) 1-Jan-16 1-Apr-16 1-Jul-16 1-Oct-16 1-Jan-17 1-Apr-17 1-Jul-17 1-Oct-17 1-Jan-18 Total 518.5 520.1 523.0 518.3 511.7 521.5 527.0 529.6 518.9 Government (w/t CBR) 30.5 32.1 35.9 40.4 39.1 45.8 46.5 54.3 55.8 Corporate 476.3 477.3 476.4 467.2 460.5 461.7 463.6 454.1 448.6 Banks 131.7 129.8 127.7 123.6 119.4 120.2 113.3 108.0 103.4 Short-term 25.3 25.6 28.7 28.4 26.7 32.5 32.0 27.6 30.6 Non-banking sector 344.5 347.5 348.7 343.6 341.1 341.5 350.3 346.1 345.2 Short-term 13.2 12.5 14.3 12.5 13.5 12.8 16.4 14.3 14.2 Source: CBR. risk slightly rose in the end of March on higher of January-March 2017 in the non-banking sector, geopolitical tensions. Net private capital outflows is compared now to net capital outflow of USD 12.5 in the January-March 2018 period reached USD billion in the first quarter of 2018. The international 13.4 billion compared to USD 16.4 billion from reserves gained USD 14.8 billion in the January- January-March 2017, as net capital outflow in the March 2018 period compared to an increase of USD banking sector dropped significantly compared 4.4 billion in the January-March 2017 period on the to the first quarter of 2017 when it rose due to back of foreign currency purchases by the Ministry Rosneft privatization deal. Marginal capital inflow of Finance in the fiscal rule framework. Table 2: Balance of payments, 2013–2017 (US$ billions) Q1 Q2 Q3 Q4 Q1 2013 2014 2015 2016 2017 2017 2017 2017 2017 2018 Current account balance 33.4 57.5 68.8 25.5 35.2 22.3 2.2 -3.0 13.7 28.8 Trade balance 122.3 133.7 111.5 66.4 115.0 34.5 25.2 20.8 34.5 42.3 Non-oil current account balance -315.6 -266.9 -134.5 -128.5 -154.5 -27.1 -43.7 -47.1 -36.6 -31.2 Capital and financial account -46.6 -89.0 -69.4 -11.1 -16.3 -11.7 1.5 10.3 -16.4 -8.2 Errors and omissions -8.9 8.0 2.9 -4.6 3.8 0.7 3.9 -0.8 0.0 -1.3 Change in reserves (- = increase) 22.1 107.5 -1.7 8.2 -22.6 -11.3 -7.5 -6.5 2.7 -19.3 Memo: average oil price 108.4 97.5 54.4 45.9 54.4 54.1 50.2 51.7 61.5 67.0 (Brent, US$/barrel) Source: CBR. 1.4 Labor Market and Poverty Trends: unemployment is stable, wages are recovering but a high share of the population remains vulnerable Unemployment declined further in the beginning of 2018 to a current 5 percent, while real wages and pensions increased on the back of low inflation. In 2017, wage growth was highest in the tradable sectors and above the rate of inflation in the non-tradable and public sectors. However, growth in real disposable incomes remained negative in 2017, driven by a decline in income from other sources, including some not directly registered by statistics. The poverty rate under the national definition remains at the levels close to 2016. The extreme poverty rate remained marginal, below one percent. 12 Russia Economic Report | Edition No. 39 I. Recent Economic and Policy Developments T he labor force participation and employment rates remained at high levels at the beginning of 2018, while unemployment was close to Figure 15: … while unemployment rate is at historical minimums (percent) 6.5 minimum. The absolute numbers of economically 6.0 active people increased by 100,000 to 76.1 million, and those of employed people grew by 5.5 400,000 people to 72.3 million in March 2018, compared to the levels of a year earlier (Figure 14). 5.0 This led to a marginal growth of the labor force 4.5 participation and of employment rates of about 0.2-0.4 percentage points. These rates are above 4.0 62 and 59 percent respectively.6 High employment 2015 2016 2017 2018 Total SA rates, in combination with the continued decline Source: Rosstat and Haver Analytics. in the working-age population, led to a further reduction of the unemployment rate. It decreased Other labor-market indicators have not been to 5.1 percent in the first three months of 2018, overly affected. The vacancy rate7 increased compared to 5.5 percent a year earlier (Figure slightly to 2.7 percent in the fourth quarter of 2017, 15). The structure of unemployment remained the compared to 2.4 percent a year ago, reflecting a same, with the gaps between male/female and gradual recovery in the real sector. The number rural/urban unemployment remaining stable and of part-time employees decreased further in 2017 most of the unemployment still being long-term: and remained far below the levels of the 2009 30 percent of the unemployed had been looking crisis period. The average number of hours worked for a job for over a year. Unemployment by regions increased marginally for both genders. remained unequal and followed the declining national trend. With inflation low, wages continued to grow in real terms. Real wages accelerated in the second Figure 14: Labor force participation and employment half of 2017 (Figure 16). The average growth in remain at high levels… (in mln people) July-December was 4.5 percent, compared to the 78 same period of 2016. In the first three months 76 of 2018, growth sped up to 9.3 percent, while in 2017, the fastest wage growth was in the tradable 74 sector, especially in agriculture (18.2 percent) and 72 manufacturing (11.6 percent). In the beginning of 2018, the fastest wage growth rates were recorded 70 in the health and education sectors as well as in financial services. 68 2015 2016 2017 2018 Labor force Employment Labor force, SA Employment, SA Real disposable-income dynamics remain Source: Rosstat and Haver Analytics. volatile. Real disposable incomes continued declining in 2017. The growth rate of pensions and wages did not compensate for the contraction of other components of household incomes, The numbers are not comparable to the ones reported in the 6 including incomes from business as well as informal previous issues due to changes in the methodology by Rosstat. The old rates were for age 15-72, while the new ones are for 15+ and that is why lower. Ratio of vacancies to the total numbers of jobs. 7 Russia Economic Report | Edition No. 39 13 I. Recent Economic and Policy Developments Figure 16: Real wages are growing across all Figure 17: Real incomes dynamics showed some the sectors positive signs in beginning of 2018 (percent, year on year) (percent, year on year) 20 15 15 10 10 5 5 0 0 -5 -5 -10 -15 -10 -20 -15 2015 2016 2017 2018 2015 2016 2017 2018 Tradables Non-Tradables Public Wages Pensions Disp income Source: Rosstat and World Bank staff estimates. Note: Pension and disposable income dynamics adjusted for January 2017’s one-time payment. Source: Rosstat and World Bank staff estimates. activities, which continued to decline in 2017. reported by Rosstat, decreased marginally in 2017 However, in early 2018, real disposable income compared to a year ago (Figure 19). The poverty dynamics showed some positive signs. Adjusting rate fell despite the contraction of real disposable for the one-time pension payment made in January income because of the decrease in the poverty 2017, disposable incomes in January 2018 were at boundary in real terms in 2017. The subsistence the same level as in January 2017 and they grew at minimum of 10,008 Rub on average in 2017, used 4.2 percent y/y in March 2018 (Figure 17). Average as the poverty line in Russia, is calculated separately pensions also increased by 2.2 percent in January- from the CPI. It increased in nominal terms by 2.6 March 2018. percent, which is below the inflation rate of 3.7 percent in the same period. Thus, those households The official poverty rate in 2017 was slightly lower whose nominal incomes increased by more than than in 2016. Despite the continued contraction 2.6 percent, escaped from official poverty, but their of real disposable income, the official poverty real incomes might have contracted if they grew rate, measured as the share of the population less than CPI. with incomes below the subsistence minimum as Figure 18: Poverty in 2016 was higher than in 2010 Figure 19: Quarterly dynamics of poverty in 2017 is close to 2016 (cumulative) 25 25 20 20 15 15 10 10 5 5 0 0 Q1 Q2 Q3 Q4 2010 2011 2012 2013 2014 2015 2016 2017 Poverty rate 2016, percent Number of poor 2016, million people Poverty rate, percent Number of poor, million people Poverty rate 2017, percent Number of poor 2017, million people Source: Rosstat. Source: Rosstat. 14 Russia Economic Report | Edition No. 39 I. Recent Economic and Policy Developments 1.5 Monetary Policy: the CBR continued monetary policy easing, moving from a moderately tight policy to a neutral one Monetary policy remained consistent with the inflation-targeting regime. Moderately tight monetary and fiscal policies, in combination with a favorable external environment and some one-off factors, let consumer inflation reach a record-low level in 2017. The nominal ruble exchange rate appreciated in 2017 and early 2018 against the US dollar. T he Central Bank of Russia (CBR) has continued its gradual approach to monetary easing, moving from a moderately tight policy to a from 7.1 percent in 2016, due to the combination of a strengthening ruble, a bumper harvest, weak consumer demand and relatively tight monetary neutral one. In 2017, the CBR cut the key rate by and fiscal policies (Figure 21). Lower inflation in 225 basis points (Figure 20). Between January and services contributed the most to a decrease in March 2018, it lowered the key rate twice by 25 inflation in 2017. Core inflation dropped from 7.5 basis points, thus bringing it down to 7.25 percent percent in 2016 (year-on-year, 12-month average) in annual terms. After an increase in geopolitical to 3.5 percent in 2017. In January-February 2018, tensions in April 2018, the CBR affirmed its the 12-month Consumer Price Index stayed at the intention to complete the transition to a neutral record-low level of 2.2 percent y/y. However, in monetary policy8 in 2018. Yet, the Central Bank March and April, it slightly increased to 2.4 percent, noted that the estimated neutral interest rate has y/y, still far below the target. An increase in food shifted closer to its upper bound within the range inflation mostly contributed to the CPI growth. In of 6 to 7 percent, due to the increased country risk April, food inflation edged up to 1.1 percent, y/y, premium and an upward revision of interest rates from 0.7 percent, y/y, in January 2018, due to in advanced economies. the dynamics of fruit-and-vegetable pricing. Core inflation decreased to 1.9 percent, y/y, in January- Annual inflation stands at a record-low level, April 2018, from 2.1 percent, y/y, at the end of even below the CBR’s target of 4 percent, while 2017, indicating low inflation pressures. Inflation inflation expectations continue their downward expectations continued to decline,9 though they trend. In 2017, consumer inflation reached 3.7 remained elevated compared to the inflation target percent (year-on-year, 12-month average), down (Figure 23). Figure 20: The CBR continued monetary policy Figure 21: Inflation is at a record-low level below the (percent) CBR’s target (CPI index and its components, percent, y-o-y) 18 25 16 20 14 15 12 10 10 8 5 6 0 Apr-14 Jul -14 Oct -14 Oct -16 Apr-17 Jul -17 Oct -17 Apr-18 Jan -14 Jan -15 Apr-15 Jul -15 Oct -15 Jan -16 Apr-16 Jul -16 Jan -17 Jan -18 4 Oct-17 Dec-17 Feb-18 Mar-18 Apr-18 Mar-17 May-17 Jun-17 Sep-17 Dec-15 Jan-15 Mar-16 Apr-16 Jun-16 Jul-16 Sep-16 Oct-16 Dec-16 Feb-17 Dec-14 Feb-15 Mar-15 May-15 Jun-15 Aug-15 Sep-15 Core inflation CPI inflation Food inflation Non-food inflation Services inflation Source: CBR. Source: CBR and Haver Analytics. 8 A neutral key rate would not either decelerate or accelerate 9 Data on inflation expectations do not include the period after a inflation, relative to the target level of 4 percent. new round of sanctions. Russia Economic Report | Edition No. 39 15 I. Recent Economic and Policy Developments Figure 22: Food products strongly influence the Figure 23: Inflation expectations continued to headline inflation decline, though remained elevated compared to the (contribution to inflation by component, percent) inflation target (percent) 18 20 16 18 14 16 12 14 10 12 8 10 6 8 4 6 2 4 2 0 0 Jan -14 Apr -14 Jul -14 Oct -14 Jan -15 Apr -15 Jul -15 Oct -15 Jan -16 Apr -16 Jul -16 Oct -16 Jan -17 Apr -17 Jul -17 Oct -17 Jan -18 Apr -18 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 Food Non-food Services CPI CPI inflation Expected Inflation Source: Rosstat, World Bank staff calculations. Source: CBR. The monetization of the economy continued its on the ruble in 2017. Relatively favorable external upward trend. The monetary conditions were conditions supported the ruble in the first gradually eased further, primarily due to the quarter of 2018 as well. Meanwhile, currency transfer of less-tight monetary policy to market interventions conducted by the Central Bank on interest rates. The ratio of the money supply (M2) behalf of the Ministry of Finance (about USD 14.8 to GDP increased to 42.8 percent at the end of 2017 billion in the first quarter of 2018), combined from 41.5 percent in 2016 (Figure 24). with prospects of a faster withdrawal of monetary policy accommodation in advanced economies and Relatively favorable external conditions, together episodes of increased geopolitical tension, exerted with a moderately tight monetary policy in downward pressure on the ruble. The nominal Russia amidst accommodative monetary ruble exchange rate strengthened by about 2.7 policies in advanced economies, supported the percent with respect to the US dollar in the first strengthening of the ruble exchange rate in 2017. quarter of 2018, q/q. Compared to the previous With help from these factors, the nominal ruble years, the ruble’s exchange rate correlation with exchange rate strengthened by about 15 percent oil prices weakened (Figure 25). New sanctions with respect to the US dollar in 2017. Meanwhile, imposed by the U.S. on April 6th led to a sell-off of currency interventions conducted by the Central Russian financial assets and a depreciation of the Bank on behalf of the Ministry of Finance (about ruble. In April, the ruble lost 6.5 percent against the USD14 billion in 2017) and episodes of increased U.S. dollar compared to March. geopolitical tension, exerted downward pressure 16 Russia Economic Report | Edition No. 39 I. Recent Economic and Policy Developments Figure 24: The monetization of the economy increased Figure 25: Compared to the previous years, the ruble’s (percent) exchange rate correlation with oil prices weakened (changes in oil prices and the nominal exchange rate, logarithmic scale) 14 44 5 3.5 43 4.8 3.6 12 42 4.6 3.7 10 4.4 3.8 41 8 40 4.2 3.9 4 4 6 39 3.8 4.1 38 4 3.6 4.2 37 3.4 4.3 2 36 3.2 4.4 0 35 3 4.5 Q2 14 Q3 14 Q4 14 Q1 14 Q2 15 Q3 15 Q4 15 Q1 15 Q2 16 Q3 16 Q4 16 Q1 16 Q2 17 Q3 17 Q4 17 7 Jan -16 Mar -16 Jul -16 Sep -16 Nov -16 Jan -17 Mar -17 May -17 Jul -17 Sep -17 Nov -17 Jan -18 Mar -18 May -18 Jan -14 Mar -14 Jul -14 Sep -14 Nov -14 Jan -15 Mar -15 May -15 Jul -15 Sep -15 Nov -15 May -16 May -14 01 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 Q1 Average Money Supply growth, y-o-y, sa, percent (LHS) Average Money Supply, percent of GDP (RHS) Oil price (Brent), ln Rub/USD, ln (rhs, reverse order) Source: CBR and World Bank staff calculations. Source: CBR, World Banks staff calculations. 1.6 The Financial Sector: the banking sector’s fundamentals are largely stable; the share of state-controlled banking assets grew as a result of the continuing CBR clean-up The Central Bank of Russia (CBR) continued the banking sector clean-up. On December 15, 2017, it announced a bailout of Promsvyazbank, the third large private bank and the second systemically important institution to be rescued via the Banking Sector Consolidation Fund (BSCF). As a result of the banking-sector clean-up, the share of state-controlled banks in the combined assets of the Russian banking system increased to nearly 70 percent. On April 2, 2018, the CBR announced that it will create a “bad bank” to transfer distressed assets in the amount of RUB 1.1 trillion from the three large private banks that were bailed out in 2017 via the BSCF. Trust Bank, a failed bank acquired by Otkrytie, will act as an asset management company. More detailed operational features and financial projections on the “bad bank” have yet to be disclosed. Retail credit continued to grow at double digits and overall financial sector indicators remained broadly stable. In the absence of severe external shocks, the performance of the banking sector is expected to remain stable. T he CBR continued the banking sector clean-up by removing insolvent banks and recapitalizing systemically important ones, thus (BSCF).10 BSCF was put in place in the second half of 2017 as a new resolution mechanism that allows the CBR to inject capital into insolvent banks. The further increasing the public sector’s share of the central bank has already injected RUB 626 billion banking system. Since November 2017, 30 banks (approximately USD 10 billion) into the capital of had their licenses revoked for failing to comply Otkritie, B&N and Promsvyazbank. Following this with regulations. On December 15, 2017, the CBR recapitalization, Otkritie and B&N will be merged announced a bailout of Promsvyazbank (PSB). It was the third large private bank and the second In total, three major privately held Russian banks (nearly 6% 10 systemically important institution to be rescued by market share by assets) went under the control of the CBR last year: Otkrytie, Binbank (B&N Bank) and Promsvyazbank. They all the CBR via its Banking Sector Consolidation Fund had earlier taken on other problematic banks for restructuring. Russia Economic Report | Edition No. 39 17 I. Recent Economic and Policy Developments in 2018, while their toxic loans will be transferred 1.45 trillion and it will spend RUB 1.1 trillion into a separate “bad bank,” yet to be established. to hold and manage their problem assets in a As a result of the banking-sector cleanup, the “bad bank”. The funds were provided by CBR, as share of state-controlled banks in the combined opposed to budget sources, which may result in assets of the Russian banking system increased monetization of resolution costs and undermines to 69 percent,11 most of them under central bank fiscal transparency (Box 3, RER #38).12.13 ownership. This may affect the levelness of the playing-field and create conflicts of interest between In January 2018, the government announced that CBR’s regulatory and ownership functions. Promsvyazbank would become a special state- controlled bank for servicing Russia’s defense To provide liquidity support and recapitalize the sector. Loans from other large Russian lenders three large private banks — Otkritie, B&N and currently servicing the sector will be transferred Promsvyazbank, the CBR has already spent RUB to PSB. It is expected that Promsvyazbank would Box 3 Public asset management companies: Review of international experience13 Asset Management Companies (AMCs), known as “bad banks,” were set up as independent financial institutions to hold and manage problematic assets of banks. A bad bank is a corporate structure created to hold and manage problem assets of a financial institution or a group of institutions. Bad banks can be set up in a variety of ways, ranging from an internal unit within the bank that holds the problem assets to a separate financial institution.14 When set up as independent financial institutions, bad banks are typically known as AMCs. AMCs may be created to manage the assets of failed institutions that are under liquidation or to acquire the problem assets of operating financial institutions. In the former case, assets are transferred for management by the AMC and there is no purchase involved. In the latter, the sale of the assets to the AMC involves recognizing losses in the value of the transferred assets. While the bank receives cash or interest-bearing securities in exchange for the problem assets, the price at which assets are sold is below the asset book value. The segregation of the problem assets facilitates the valuation of the remaining part of the bank by potential investors, so the bank can raise capital or funding to strengthen its financial position and resume lending, or be privatized, if it was nationalized to maintain viability. Hence, AMCs set to purchase problem assets from operating institutions are used as tools to restore financial health to the system. AMCs have been set up in most major recent financial crisis episodes with public support. Examples of AMCs set to manage assets from institutions under liquidation include Resolution Trust Corporation in the US during the saving and loan crisis of the late 1980s; Securum in Sweden in the early 1990s; the Indonesian Bank Restructuring Agency during the Asian financial crisis of the late 1990s or Turkey’s Savings Deposit Insurance Fund. Examples of AMCs set up as purchasing asset entities include the Korea Asset Management Corporation and Malaysia’s Danaharta. Several purchasing assets AMCs were also set up in Europe in the aftermath of the global financial crisis, including the Company for the Management of Assets proceeding from Restructuring of the Banking System (SAREB) in Spain, the National Asset Management Agency (NAMA) in Ireland or BACMA in Slovenia. AMC initial capital primarily came from governments because the banking sector was very weak. In Ireland and Spain, efforts were made to enhance the private sector’s “skin in the game.” In Ireland, NAMA issued 5% of the purchase price of its assets in the form of subordinated debt payable only if performance target were met. The banks were required by the supervisor to write this debt off. In Spain, SAREB’s capital is owned at 55 percent by international and local banks and insurance companies. 12 This Box is based on Cerruti, Caroline and Ruth Neyens (2016), Public Asset Management Companies: A Toolkit. World Bank Studies. Washington, DC: World Bank. 13 Gabriel Brenna; Thomas Poppensieker & Sebastian Schneider (December 2009), “Understanding the Bad Bank,” McKinsey & World Bank staff calculations. 11 Company. 18 Russia Economic Report | Edition No. 39 I. Recent Economic and Policy Developments AMCs present advantages as tools to rescue financial institutions. AMCs provide a mechanism to improve the valuation of operating financial institutions when there is no market for distressed assets. The sale of problem assets provides banks with much-needed income, improves transparency and confidence and allows banks to focus on resuming lending. AMCs can also help maximize recovery value. For example, by representing several of the lenders of a troubled corporation, the AMC is in a better position to negotiate an out-of-court corporate debt workout. Coordinated asset disposal may prevent fire sales that occur when many banks try to simultaneously dispose of their assets, pushing market prices downward. Also, by concentrating assets, AMCs have bargaining power in price negotiations with asset buyers. However, setting up AMCs to purchase assets poses substantial risks and their overall performance record is mixed. The prospect that the state will take over non-performing loans may encourage banks to take undue risks (i.e. moral-hazard behavior). Also, it may induce corporations to default (“strategic defaulters”) so they can repurchase their obligations at a deeply discounted price. AMCs are costly to establish and operate, as they require substantial public equity and funding guarantees to raise funds to purchase the assets. Asset purchases at inflated prices may end up building contingent liabilities for the government. Public AMCs may also be subject to political interference and be slow to dispose of assets in order to ensure their continuity. Furthermore, few AMCs have managed to repay their liabilities and at least part of their initial equity. A review of experiences with AMCs indicates that certain preconditions should be in place to ensure their success. The preconditions include (i) a strong consensus and political will with respect to the approach, and willingness to recognize losses; (ii) a comprehensive and coordinated reform program to strengthen financial-sector regulation and supervision, risk management and workout practices within the banks; (iii) corporate restructuring and legal and regulatory reforms to remove impediments to restructuring; (iv) a solid diagnostic of the critical mass of impaired assets; (v) a strong tradition of institutional independence and public accountability and (vi) a robust legal framework for bank resolution, debt recovery, and creditors’ rights. Experience shows that a strong commercial focus is a key success factor. AMCs should have a focused and narrow mandate and be given the necessary powers to accomplish their task. AMCs’ legal mandate should provide a lifespan that avoids “fire sales” but prevents warehousing of problem assets and protects the AMC against political interference. The AMC should be managed by private-sector professionals with expertise on asset resolution. The transfer price should be based on market value established through a transparent, market-based, due-diligence process conducted with the assistance of an independent third-party experienced in valuation. Strong levels of governance, with frequent reporting including annual financial statements, should help to gather public support and to exert oversight over the AMC.16 Adequate funding should be provided up front to cover operating expenses until the proceeds of asset sales are received. receive up to RUB 1 trillion in defense sector’s loans about 1.3 percent of the total assets of the Russian to be transferred mainly from Sberbank and VTB, banking sector) from the three large private banks along with the corresponding amount of capital that were bailed out in 2017 via the BSCF. The CBR against those loans. PSB is being re-capitalized by the estimates that 40−60 percent of the bad loans could CBR in the amount of RUB 243 billion (approximately be recovered. Trust Bank, a failed bank initially USD 4 billion), out of which RUB 113 billion has acquired by Otkrytie for restructuring and recently been already provided. Then it will be transferred to transferred to BSCF, will hold and manage those government ownership later in 2018. distressed assets, acting as an asset management company after surrendering its banking license. The CBR has also announced the creation of a The funding to the company will be provided by the “bad bank” to manage the distressed assets of the CBR in the amount of RUB 1.1 trillion as a loan at failed banks as part of its bank resolution efforts. the preferential rate of 0.5 per cent. More detailed On April 2, 2018, the central bank announced that it operational features and financial projections on will create a “bad bank” to transfer distressed assets the “bad bank” have yet to be disclosed, including in the amount of RUB 1.1 trillion (USD 17 billion or its capital position and the price at which distressed Russia Economic Report | Edition No. 39 19 I. Recent Economic and Policy Developments assets are to be transferred. Box 3 provides an broadly stable at 12.5 percent, while non-performing overview of issues to consider when setting up bad loans slightly increased to 10.6 percent, compared banks based on international experiences. to 10.2 six months before (Figure 27). Profitability, affected by the ongoing financial recovery process Despite these developments, retail credit for the three rescued banks since the second half of continued to grow at double digits and overall 2017, continued its declining trend from 2016 and financial sector indicators remained broadly return on assets and the return on equity stood at stable. In the last 6 months, credit to households 0.9 percent and 8 percent, respectively. in rubles grew at 13.6 percent, y/y, compared to 2.5 percent during the same period a year ago (Figure To support financial-sector development, the CBR 26). To address the risks linked to accelerated approved two important strategic documents on consumer lending growth in recent months, the CBR financial technology and financial inclusion. Both tightened risk-weighting requirements for consumer documents promote the use of technology to loans with an annual percentage rate (APR) of 15-25 decrease transaction costs for financial institutions percent, which account for the bulk of unsecured and their customers and to improve access to consumer loans. The new requirements apply to financial services for consumers and SMEs. On consumer loans issued after May 1, 2018. This February 7, 2018, the central bank published regulatory measure follows the recent tightening the framework “Main Directions for Financial of risk-weighting requirements for mortgage loans Technology Development in 2018-2020,” along with low down payments (below 20 percent), which with a detailed implementation roadmap. This came into effect on January 1, 2018. Credit to the document is fully aligned with the government corporate sector in rubles grew by 4.4 percent, y/y, program on the digital economy15 and provides the in the last six months, compared to 1.9 percent foundation for the CBR to establish a regulatory during the same period a year ago (Figure 26). As of framework for digital technologies and set up the March 1, 2018, the sector’s average capital ratio was related financial infrastructure. Most proposed Figure 26: Credit growth in rubles accelerated Figure 27: Overall financial sector indicators remained (Y-o-y, percent) broadly stable (Key credit and performance indicators, percent) 18 16 15 14 12 12 9 10 8 6 6 3 4 0 2 -3 0 -6 Jan -18 Feb -18 Mar -18 Sep -17 Oct -17 Nov -17 Dec -17 Aug -17 May -17 Jun -17 Jul -17 Feb -17 Mar -17 Apr -17 Sep -16 Oct -16 Nov -16 Dec -16 Jan -17 Aug -16 Apr -16 May -16 Jun -16 Jul -16 Feb -16 Mar -16 Jan -15 Oct -15 Dec -15 Jan -16 -9 Jan -15 Apr -18 Mar -15 May -15 Jul -15 Sep -15 Nov -15 Jan -16 Mar -16 May -16 Jul -16 Sep -16 Nov -16 Jan -17 Mar -17 May -17 Jul -17 Sep -17 Nov -17 Jan -18 Mar -18 Capital adequacy ratio Return on assets NPLs to total loans Return on equity Companies Household Loan loss provisions to total loans Source: CBR, World Bank staff calculations. Source: CBR. 14 The European Commission’s recently published AMC blueprint provides a comprehensive discussion of reporting requirements to meet both EU and national standards as well as practical guidance for setting up public AMCs. EU Commission Staff Working Document AMC Blueprint, Com 2018 133 final, March 2018. 15 Digital Economy of the Russian Federation. 20 Russia Economic Report | Edition No. 39 I. Recent Economic and Policy Developments initiatives are likely to be implemented in 2018- more than 2.5 percent” of Sberbank’s total assets. 2019. The adopted framework, infrastructure and Furthermore, the current state of the Russian regulations should encourage competition, reduce banking system, with its ample liquidity and fairly risks and costs, increase the availability – and strong capital base, makes it less vulnerable to the improve the quality – of financial products and consequences of the latest US sanctions. services. The CBR outlined a number of high-priority innovative technologies that it encouraged the In the absence of severe external shocks, the sector to develop. These include big data and smart performance of the banking sector is expected to data, mobile technologies, artificial intelligence, remain stable. However, the quality of capital and machine learning, biometry, blockchain and open- assets, and related-party lending will likely remain a application programming interface. On March concern for some time. As the economy accelerates, 26, 2018, the CBR’s board of directors approved a NPLs, which are still high in comparison to other Financial Inclusion Strategy for 2018-2020 aimed BRICs and large emerging countries, are expected at improving financial inclusion for people living in to decline. Further banking-sector consolidation remote areas, socially vulnerable groups and SMEs. will continue due to the ongoing CBR clean-up and The strategy also emphasizes the use of technology to restructuring and transitioning towards a tiered in improving the quality and speed of access to banking system. While the immediate impact from financial services for businesses and consumers. the most recent US sanctions has been muted so far, and CBR granted a regulatory forbearance to the The new U.S. sanctions against Russia imposed banks whose clients have fallen under the sanctions, on April 6, 2018 may have a muted effect on the their longer-term effects remains to be seen. banking sector. Russia’s largest bank, state-owned The banking system has sufficient liquid foreign Sberbank, may become vulnerable to sanctions currency assets to repay its maturing external against the Russian companies to which it lends. debt and rubble liquidity is at an all-time high. However, according to Sberbank management, High international reserves, a positive net external loans to companies on the new sanctions list — creditor position, a current account surplus, low companies now barred from making payments in public-sector debt and moderate financing needs dollars or accessing Western markets — total “no continue to provide important buffers. 1.7 Government Budget: the fiscal stance has improved, aided by higher oil prices, a recovering economy, improved tax administration and lower expenditures In 2017, both the federal and general government fiscal stance improved, helped by higher revenues and lower expenditures, as the Russian Government adhered to a path of fiscal consolidation. The government changed the formula for currency interventions, increasing the volume of interventions for a one-dollar change in the price of a barrel. This suggests that a higher share of windfall oil/gas revenues will be absorbed by the National Welfare Fund, which potentially decreases the exchange rate volatility caused by oil price fluctuations. T he general government’s16 fiscal stance improved in 2017 (Figure 29). In 2017, the general government registered a primary deficit of 0.6 percent of GDP, compared to a primary deficit of 2.8 percent in 2016. The overall general government deficit of 3.6 percent of GDP in 2016 improved to a deficit of 1.5 percent of GDP in 2017. The general government budget includes the federal budget, 16 The fiscal stance improvement happened mostly at the subnational budgets and extra-budgetary funds, i.e. pension, the federal level. mandatory medical insurance and social security funds. Russia Economic Report | Edition No. 39 21 I. Recent Economic and Policy Developments Figure 28: The GG budget primary balance improved in 2017 (% of GDP) 40 2016 2017 0 35 30 25 -3 20 15 10 -6 5 0 Primary expenditure Oil/gas revenue Non-oil/gas revenue -9 2016 2017 Primary balance Non-oil/gas primary balance Source: Haver Analytics. Figure 29: The federal budget stance improved in 2017 (% of GDP) 18 2016 2017 0 16 14 -2 12 10 -4 8 6 -6 4 -8 2 0 Primary Oil/gas revenue Non-oil/gas -10 expenditure revenue Primary balance Non-oil/gas primary balance 2016 2017 Source: Haver Analytics. In 2017, buoyed by higher revenues and lower to 2016, primary expenditures decreased by 1.3 expenditures, the federal budget registered a percent of GDP, partly due to lower spending primary deficit of 0.7 percent of GDP17 compared compared to the one envisaged in the federal to a primary deficit of 2.7 percent of GDP in the budget law (0.6 percent of GDP). In addition, in same period last year (Figure 28). Federal budget 2017, civil servant salaries and the savings pillar of revenue increased to 16.4 percent of GDP from the pension system were frozen, as in 2015-2016 15.6 percent of GDP in 2016, with oil/gas revenues (2014-2016 for the savings pillar), and spending higher by 0.9 percent of GDP (Table 3). Despite the on defense decreased by 1.3 percent of GDP. In appreciation of the ruble in nominal terms, oil and 2017, the non-oil/gas primary deficit narrowed to gas revenues grew, mostly because of increases in 7.2 percent of GDP (compared to 8.3 percent in energy prices. Non-oil/gas revenues decreased by 2016 and 8.9 percent in 2013). Overall, the federal 0.1 percent of GDP, compared to 2016.18 Compared budget deficit narrowed to 1.4 percent of GDP from 3.4 percent of GDP in 2016. 17 On a cash basis. Accounting for the Rosneft privatization deal in 2016 and a 18 Ruble-denominated debt issuance and Reserve higher share of CIT receipts transferred to the federal budget, Fund spending were the main sources of deficit non-oil/gas revenues increased by about 0.5 percent of GDP, also financing in 2017. In addition, the government used because of improved tax administration and higher excise and VAT receipts from a recovering domestic demand. 0.7 percent of GDP from the National Welfare Fund 22 Russia Economic Report | Edition No. 39 I. Recent Economic and Policy Developments and issued euro bonds.19 In 2017, the federal debt USD 14 billion) is to be transferred to the National stock dropped to 12.6 percent of GDP from 12.9 Welfare Fund by October 1, 2018. As of January 1, percent of GDP in 2016 on the back of a decrease 2018, the National Wealth Fund stood at USD 65.15 in external debt, partly due to a price effect and a billion (3.9 percent of GDP). Starting on January decrease in ruble-denominated state guarantees. 1, 2018, the government changed the formula for currency interventions. The new formula uses the Table 3: Federal budget revenue increased in 2017 actual exchange rate to determine oil/gas revenues (percent of GDP) in excess of the benchmark price, as opposed to   2016 2017 forecasted exchange rate in the previous version. It Revenues 15.6 16.4 also increases the volume of interventions for a one- Oil and gas revenues 5.6 6.5 dollar change in the price of a barrel. This suggests Non-oil/gas revenues 10.0 9.9 a that higher share of windfall oil/gas revenues will Expenditures 19.1 17.8 be absorbed by in the National Welfare Fund, and Primary expenditures 18.3 17.1 it potentially decreases exchange rate volatility caused by the oil price fluctuations. Interest payments 0.7 0.8 Balance -3.4 -1.4 In 2017, the regional budgets gained from the Primary balance -2.7 -0.7 economic recovery and positive terms of trade. Non-oil/gas primary balance -8.3 -7.2 The consolidated regional budget registered a Source: Federal Treasury of the RF. primary surplus of 0.1 percent of GDP in 2017, compared to 0.2 percent of GDP in 2016 (Figure Starting February 1, 2018, the government closed 30). The economic recovery increased the revenues the Reserve Fund, which was exhausted by the end of the regional budgets, yet primary expenditures of December 2017. Currency purchased by the CBR increased only slightly more. Expenditures on behalf of the Ministry of Finance in 2017 (about expanded for the national economy (+0.2 percent Figure 30: Regional budget revenues gained from the economic recovery and positive terms of trade (% of GDP) 11.8 0.2 11.7 11.6 0.1 11.5 11.4 11.3 0.0 11.2 11.1 2016 2017 -0.1 2016 2017 Primary expenditure Revenue Primary balance Balance Source: Haver Analytics. In June 2017, the government issued USD 1.0 billion in 10- 19 year Eurobonds with an effective rate of 4.25 percent and USD 2.0 billion in 30-year Eurobonds with an effective rate of 5.25 percent. In addition, the Finance Ministry issued permission to swap up to $4 billion of debt maturing in 2018 and 2030 into new notes. It conducted a swap of USD 1.4 billion issuing notes maturing in 2027 and USD 2.5 billion notes maturing in 2047 with interest rate of 4 percent and 5.2 percent respectively. Russia Economic Report | Edition No. 39 23 I. Recent Economic and Policy Developments of GDP, partly related to the renovation program Extra-budgetary funds were balanced, after in Moscow), housing and communal services (+0.1 posting a deficit of 0.2 percent of GDP in 2016. percent of GDP) and culture (+0.1 percent of GDP). Overall regional budgets balance worsened to a 0.1 In early 2018, higher oil prices continued to help percent deficit from a balanced stance in 2016. The the budget. In the first four months of 2018, aided number of regions that registered budget surpluses by higher oil revenues and lower expenditures, increased to 39 in 2017 from 27 in 2016. The the federal budget primary surplus strengthened Ministry of Finance continued to ease the regional to 1.5 percent of GDP from a primary deficit of 1 debt burden, providing budgetary loans with low percent of GDP in the same period last year. Higher interest rates to regions. The share of budget oil prices prompted an increase in federal budget credits increased to 43.6 percent of total debt of oil revenues to 8.3 percent of GDP in January-April regions, from 42 percent by the end of 2016. In 2018, compared to 7.2 percent in the same period 2017, the regional debt decreased to 2.5 percent of last year. Federal budget primary expenditures GDP from 2.7 percent in 2016 or by 1.6 percent in decreased to 16.9 percent of GDP in January-April value. Yet the aggregate debt dynamics concealed 2018 from 18.5 percent of GDP in the same period substantial variations in debt levels among regions. last year, mainly due to lower spending on social By the end of 2017, there were 7 regions, out of policy due to a one-off pension payment in January more than 80, with a share of debt exceeding the 2017. The overall federal budget stance improved region’s own revenues (the same number as at the to a surplus of 0.6 percent of GDP in January-April end of 2016).20 In 2018, the Ministry of Finance 2018 compared to 1.9 percent of GDP deficit in is not expected to provide new budgetary loans. the same period last year. The general government Starting 2018, the Ministry initiated a long-term budget surplus improved to 2.2 percent of GDP in program for state debt restructuring. January-February 2018 from 0.2 percent of GDP in the same period last year. 20 In 2018, federal authorities took over the budget spending in two regions (Kostromskaya oblast and Republic of Khakassia). Due to the large volume of accumulated debt, budget spending decisions in these regions will be controlled by the federal treasury. 24 Russia Economic Report | Edition No. 39 PART II THE OUTLOOK FOR THREE YEARS SHOWS MODEST GROWTH Russia Economic Report | Edition No. 39 25 II. Outlook and Risks The global economic upturn is expected to peak in 2018 and gradually decelerate to 2020. Oil prices are anticipated to average USD 65/bbl in 2018 and 2019, based on robust demand and continued production restraints by OPEC and non-OPEC producers, notwithstanding increases in U.S. shale oil production. Russia’s growth prospects for 2018 – 2020 remain modest, with growth forecasted to be between 1.5 and 1.8 percent in the 2018 – 2020 period. However, in the short-term, these forecasts may change due to changing oil prices. G lobal growth is expected to peak in 2018. With global growth exceeding potential growth for the second consecutive year, 2018 is expected to be in U.S. shale oil production. Higher oil prices are expected to eventually feed into higher natural gas prices while coal prices will continue to decline the first year since the financial crisis that the global as energy demand shifts towards less polluting economy will be operating at or near full capacity. sources. Upside risks to the forecasts include Supply-side constraints will become more binding, potential supply losses arising from geopolitical suggesting that global inflation should pick up events, a deterioration of the situation in gradually while growth slows. After reaching a five- Venezuela, deeper cuts by OPEC and non-OPEC year peak of 3.1 percent in 2018 based on current countries or an extension of the agreement to a projections, it is projected to moderate in 2019- longer-term horizon. Conversely, a weakening of 20, edging down to 2.9 percent by the end of the the agreement, or further efficiency gains among forecast period as monetary policy stimulus is pared U.S. shale producers, could depress prices. down, and the effect of the U.S. fiscal expansion wanes. A projected deceleration of capital spending Relatively high oil prices, continued momentum in these economies, combined with that in China, in the global economic growth and macro will contribute to a more moderate global trade stabilization would support growth in the medium growth in 2019 and 2020. term, but its rate will be only modest. (Figure 31). In 2018, a decrease in mineral resource Oil prices are anticipated to average USD 65/ extraction, mostly because of OPEC+ cuts, would bbl in 2018 and 2019 based on robust demand stop weighing down on growth starting the second and continued production restraint by OPEC and quarter, while such one-off negative factors that non-OPEC producers, notwithstanding increases influenced economic performance in late 2017 as Table 4: Global growth is broadly stable (GDP Growth Projections, percent)   2016 2017 2018f 2019f 2020f World 2.4 3.0 3.1 3.0 2.9 Advanced economies 1.6 2.3 2.2 1.9 1.7 United States 1.6 2.3 2.5 2.2 2 Euro Area 1.8 2.4 2.1 1.7 1.5 Emerging and developing economies 3.5 4.3 4.5 4.7 4.7 China 6.7 6.9 6.5 6.3 6.2 Russia -0.2 1.5 1.5 1.8 1.8 Crude oil (Brent, WTI and Dubai average, US$/bbl) 42.8 53 65 65 66 Source: WDI, World Bank staff projections. 26 Russia Economic Report | Edition No. 39 II. Outlook and Risks Figure 31: The growth forecast for Russia for 2018 has Figure 32: Higher oil prices would not substantially been slightly decreased speed up the growth (Real GDP growth, percent) (GDP growth, percent) 4 120 106 3 100 2 80 104 1 0 60 -1 102 40 -2 20 -3 100 -4 0 2017 2018 2019 2020 2012 2013 2014 2015 2016 2017 2018 2019 2020 GDP growth (baseline) GDP growth low (-15%) GDP growth Oil price, average (US$ per barrel) GDP growth high (+15%) Source: Rosstat, World Bank. Source: World Bank staff calculations. negative contributions from change in inventories In 2018-2020, growth in gross fixed capital and one-off manufacturing low performance would formation is expected to slow down slightly dissipate. Yet, the growth forecast for Russia for compared to 2017. Some large public infrastructure 2018 has been slightly decreased (to 1.5 percent a projects were finished, and the latest round of year) due to carry-over effect from a weak second sanctions increased uncertainty somewhat. In half of 2017 and lower than expected growth in addition, the latest sanctions announced on April the first quarter of 2018, aggravated by some 6 could dampen FDI inflow and reduce Russia’s uncertainty arising from the latest sanctions. access to technology. Growth projections for 2019 and 2020 stand at 1.8 percent a year. As in 2017, non-tradable sectors will drive growth in 2018 -2020. Non-tradable sectors will gain from The fiscal rule suggests reduced sensitivity of growing domestic demand and growing incomes Russia’s GDP growth to oil price volatility. A (Figure 33). The performance of the banking simulated decrease of 15 percent in oil prices would sector is expected to remain stable. However, the reduce growth in Russia to 1.3 percent in 2018 and bailout of three large private banks points to the 1.6 percent in 2019 and 2020. A simulated rise of continuing fragility in the sector, while the quality 15 percent in oil prices would increase growth to of capital and assets linked to related-party lending 1.7 percent for 2018 and 2.0 percent in 2019 and will likely remain a concern. Further banking- 2020 (Figure 32). sector consolidation will continue, due to the ongoing CBR clean-up and restructuring and the Consumer demand is expected to be the main transition towards a tiered banking system. While engine of GDP growth in 2018-2020. With relatively the immediate impact from the most recent US low inflation and continued economic recovery, real sanctions has been muted, and the CBR granted a wages are expected to be on a growth trajectory. regulatory forbearance to the banks whose clients A resumption of the indexation of public employee have fallen under the sanctions, their longer-term salaries, frozen in 2015-2017, will also support real effects remain to be seen. Due to an anticipated incomes and consumption. In 2018, consumption is flat oil production in 2018, industrial production likely to benefit further from the soccer World Cup growth is expected to pick up in 2019 and 2020 as hosted by 11 Russian cities. Credit growth will be oil production increases. another factor supporting consumption growth. Russia Economic Report | Edition No. 39 27 II. Outlook and Risks Figure 33: Non-tradable sectors are expected to drive growth in the medium-term Projected Growth by Sector, percent Contribution to GDP, pp 2.2 1.8 1.6 1.9 1.4 1.6 1.2 1.3 1 1.0 0.8 0.6 0.7 0.4 0.4 0.2 0.1 0 2018 2019 2020 2018 2019 2020 Agriculture Industrial production Services Agriculture Industrial production Services Source: WB staff calculations. The current account surplus is set to increase in income and consumption, but still remain above the 2018, compared to 2017. An increase in the current pre-crisis level. Driven by a rebound in disposable account surplus is expected as strengthening oil income and consumption, the poverty headcount prices support exports and growth of imports slows is expected to decline marginally in 2017 to 13.2 down in 2018-2020 (Table 5). percent in the baseline scenario, after reaching 13.3 percent in 2016 (Figure 34). The poverty rate The poverty rate is expected to decrease slightly is projected to decline in the baseline scenario due to low inflation and recoveries in private in 2018, 2019 and 2020 to 12.5, 11.9 and 11.4 Table 5: Projected growth rates are modest (major macroeconomic Indicators)   2016 2017 2018 2019 2020 Oil price (US$ per barrel, WB average) 42.8 53 65 65 66 GDP growth, percent -0.2 1.5 1.5 1.8 1.8 Consumption growth, percent -1.9 2.6 2.6 2.2 2.1 Gross capital formation growth, percent -1.9 7.4 2.0 2.0 3.1 Gross fixed capital formation growth, percent 0.8 4.3 3.0 3.0 3.2 General government balance, percent of GDP -3.6 -1.5 0.2 0.7 0.7 Current account (US$ billions) 24.4 35.2 81.9 74.5 75.5 Current account, percent of GDP 1.9 2.2 5.0 4.4 4.3 Exports (GNFS), bln US$ 332.4 410.8 487.2 511.5 547.6 Imports (GNFS), bln US$ 266.2 326.9 353.1 379.7 408.1 Trade balance (GNFS), bln US$ 66.2 83.9 134.1 131.8 139.5 Trade balance (GNFS), percent of GDP 5.1 5.3 8.2 7.8 7.9 Capital and financial account (US$ billions) -26.0 -19.8 -32.1 -25.1 -25.1 Capital and financial account, percent of GDP -2.0 -1.3 -2.0 -1.5 -1.4 CPI inflation (average) 7.1 3.7 3.1 4.0 4.0 Source: WB staff calculations. 28 Russia Economic Report | Edition No. 39 II. Outlook and Risks percent, respectively, as income and consumption expectations, a tight labor market, and high food- grow further. Among the factors that could fuel inflation volatility. The steep growth in nominal real income growth are a deceleration in inflation wages, if not followed by growing productivity, and a general recovery of the economy. Figure 33 could also be a pro-inflationary risk in the medium- also shows the sensitivity of poverty projections term. And although the performance of the banking to the minus/plus 15-percent change in oil prices sector is expected to remain stable, the bailout of (scenarios 2 and 3) compared to the baseline. three large private banks points to the continuing fragility in the sector, while the quality of capital Figure 34: The poverty headcount is likely to decline in 2017 and beyond and assets linked to related-party lending will likely (in percent) remain a concern. 14 0.422 13 0.420 While the government has set in place macro 13 0.418 fundamentals for growth, certain micro fundamentals still need to be addressed. By 12 0.416 switching to a flexible exchange rate regime, 12 0.414 introducing the fiscal rule, and continued inflation 11 0.412 targeting, the government has set important macro 11 0.410 fundamentals for growth. Meanwhile, achievement 10 0.408 of the goals that were recently set by the President’s 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Poverty rate, % Scenario 1 (baseline) May 2018 decree (keeping economic growth above - Scenario 2 (lower-bound) Scenario 3 (upper-bound) Gini (RHS) the global level, the creation of highly productive Source: Rosstat, WB staff calculations. export oriented sub-sectors in agriculture and manufacturing) may face challenges because of The outlook is subject to both favorable and large state footprint and other structural problems. unfavorable risks. Favorable risk factors come Improving micro fundamentals for growth becomes primarily from higher than expected oil prices. necessary to increase productivity and put Russia Unfavorable risk factors include marked escalation on a higher growth path. As analyzed in detail in of trade tensions and restrictions among major previous reports21, this entails limiting the role of economies, which could derail the recovery in the state in the economy, improving institutional global trade and negatively impact confidence and and regulatory frameworks, and promoting fair investment worldwide. Other external unfavorable competition, among others. Achieving higher risk factors include a further expansion of sanctions. growth rates and improving social assistance A sudden tightening of global financing conditions targeting would also allow the government to could be triggered by a reassessment of inflation reduce poverty rates – another important goal set risks or by shifting expectations about monetary or in the President’s decree. fiscal policies across major advanced economies. Surges in volatility in financial markets can affect expectations for the exchange rate and inflation. 21 World Bank 2016: “Systematic Country Diagnostic for the Russian Federation: Pathways to Inclusive Growth.” Domestic pro-inflationary risks stem mainly World Bank 2017: “Russia Economic Report #37. From from the closing output gap, elevated inflation recession to recovery.” Russia Economic Report | Edition No. 39 29 PART III RUSSIA’S DIGITAL ECONOMY: ACCELERATING DIGITAL TRANSFORMATION FOR ECONOMIC PROSPERITY III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity A strategic focus on digital transformation has enabled Russia to build a national digital infrastructure to support universal broadband and mobile communications. However, for Russia to gain significant socio-economic benefits from digital transformation, it needs to implement policies that will accelerate the digital transformation of the economy’s traditional enterprise sector, promote R&D, innovation and entrepreneurship and enable effective execution not only at the national level, but also at the regional level, as well as that of the Eurasian Economic Union. D igitization affects all aspects of economic and social development as the digital revolution spans the entire globe, with half of the world’s Digital public service delivery is on the right track, with citizens reporting high levels of user satisfaction, though commercial customers are population already connected to the Internet. less pleased. According to a 2016 Rosstat survey, Today, digital transformation is becoming one 66.1 percent of citizens are fully satisfied with the of the key factors of global economic growth, quality of public and municipal digital services, redefining not just business models but entire with another 32.4 percent partly satisfied.25 industries and economic sectors, and changing the way people work, live, learn and play. Success in A 2015 Rosstat survey of businesses determined digital transformation brings significant additional that 23.8 percent were fully satisfied with the GDP growth, creates new jobs and services, quality of digital public and municipal services, improves productivity and boosts local, regional whereas for large enterprises employing more and global competitiveness. Winners in today’s than 250 people, the figure was 30.7 percent.26 race for digital transformation will reap the largest economic and social dividends and become the A new national education platform called global leaders of tomorrow. ‘Open Education’ (www.openedu.ru) has been established to deliver open online courses. Russia has made significant strides in its digital transformation process In B2B transactions, Russia is on par with the Today, 72.6 percent of Russian households enjoy ASEAN region. E-commerce is growing fast as broadband internet access, with active mobile Russia pulls ahead of the EU, the ASEAN region, broadband penetration at 74.9 percent.22 Internet its Eurasian Economic Union neighbours and others access is affordable and high-speed. Russia like Korea, Brazil, Mexico, South Africa in B2C sales has the highest number of fibre connections in (Figure 35).27 Europe. Over 60 percent of the population now owns smartphones – more than in most other ICT Exports are growing steadily transitioning economies. The number of users of Over the last six years, ICT exports have more than online government and municipal services has doubled, reaching over USD 8.5 billion in 201728 doubled in just one year to reach 40 million.23 In the (Figure 36), while several Russian ICT companies overall ranking of citizens’ electronic participation conducted by the United Nations Department of 25 Results of federal statistical monitoring of the use of information Economic and Social Affairs in 2016, Russia shared technologies for the public in 2016, Rosstat 14th place with four other countries.24 26 Rosstat. Official statistics ITU June 2017 22 27 htt p : / / re p o r t s .wefo r u m . o rg / t rave l - a n d - to u r i s m - The same source. 23 competitiveness-report-2017/ranking/#series=EOSQ365 United Nations E-Government Survey, 2016 files/RUSSOFT_Survey_14.0_rus.pdf 32 Russia Economic Report | Edition No. 39 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity Figure 35: ICT use for B2B and B2C transactions (WEF scores 1-7, where 7 is the highest) Internet use for B2C transactions ICT use for B2B transactions Russia 5.3 Russia 4.7 Kazakhstan 4.7 Armenia 4.5 Armenia 4.5 Kazakhstan 4.4 Kyrgyzstan 4.0 Kyrgyzstan 3.5 USA 6.4 USA 5.8 UK 6.4 Japan 5.9 UAEU 4.5 UAEU 4.5 ASEAN 4.7 ASEAN 4.8 EU 5.2 EU 5.3 OECD 5.4 OECD 5.4 Source: WEF Travel and Tourism Competitiveness Report 2017. have emerged as global players. They include data analysts are in demand, universities and both well-established ones, such as Yandex and private sector companies are offering courses on Kaspersky Lab, as well as relative newcomers the subject and the two local internet giants – in ICT services, business process automation Yandex and Mail.ru – have launched companies in and security. this space. Figure 36: Russia’s ICT exports growth (2003-2017, billion USD) Cryptocurrencies are receiving a lot of attention 9 8.5 as well. The government has recently made a 8 7.6 decision to complete cryptocurrencies regulation 6.7 7 legislation by July 2018, to consider the launch of a 6 6 5.4 national cryptocurrency (CryptoRuble) and to pilot 5 4.6 4 the establishment of the first crypto-advisory and 4 3.3 crypto-detective agencies in the city of Vladivostok. 3 2.6 2.75 2.15 For now, however, cryptocurrencies are mostly 2 1.41 0.95 used in the grey areas of the economy, even though 1 0.530.74 0.345 lately many young companies in Russia have been 0 actively discussing ICOs (Initial Coin Offerings).29 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Yet ICO growth is currently constrained by still- Source: Russoft 2017. unresolved technology and legal issues. The use of emerging technologies is quickly 3D printing is being introduced in manufacturing, gaining ground medicine and construction with local companies The gains in usage are especially rapid in data appearing in this space, notably RusAt. Mobile analytics, cloud computing, the Internet operators (MTS, Megafon) are driving the adoption of Things, 3D printing, robotics, artificial of Internet of Things technologies (eg. the Platon intelligence and blockchain. toll system for trucks), while blockchain is gaining Data analytics is used in the financial sector, in Investments through bitcoins: what is the ICO and should it 29 telecommunications, trade, e-commerce and be used? Russia Economic Report | Edition No. 39 33 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity ground across multiple sectors, for example, in In the 2016 ITU’s ICT Development Index, Russia fintech (Sberbank, Central Bank, QIWI), real estate scored 43rd,30 and in the World Economic Forum (Rosreestr property registration), and patents Networked Readiness Index 2016, it scored 41st (Rospatent intellectual property registration). 31 while in INSEAD’s32 Global Innovation Index, it scored 43rd 33 (Figure 37). Artificial intelligence is used in image processing Figure 37: Russia’s ranking (NTechLab, VisionLabs, Alice by Yandex), computer vision and speech recognition. Robotics are gaining ground in education, unmanned aviation 43 43 (Rosneft, Gazprom), unmanned agricultural machinery and especially in the defense industry. Croatia Unmanned vehicles are under development by 41 Turkey Yandex and Kamaz. Yet, despite the buzz around Portugal Cyprus these technologies, their commercial utilization Chile in Russia is still in its infancy. For instance, the Poland number of industrial robots in Russia is less than ITU’s ICT Development WEF/INSEAD Network INSEAD’s Global 1 percent of the world total. The adoption of the Index Russia Readiness Index Innovation Index TechNet Roadmap by the President’s Council in Source: ITU 2016, WEF 2016, Global Innovation Index 2016. 2017 aims to accelerate the implementation and commercialization of new technologies through launching the so-called Factories of the Future In the World Bank’s Reaping Digital Dividends in based on digital and smart manufacturing. Europe and Central Asia Report,34 countries are divided into three groups, depending on their level Digital transformation is a priority at the of development of digital technologies: emerging, highest level of government transitioning, and transforming (Figure 38). As digitization remains a top priority at the highest level of government, Russia is driving digital Today Russia is in the “transitioning” group of transformation across the Eurasian space, leading countries due to inadequate progress in what the digital initiatives at the international, national, World Bank defines as the analogue foundations regional and local levels. The Russia Digital of the digital economy, such as effective leadership Economy Program adopted in July 2017, the EAEU and management institutions, a solid regulatory Digital Agenda passed in 2017, and a variety of base and relevant digital skills. digital initiatives at the regional/oblast level are all elements in this vision. 30 Measuring the Information Society Report 2016. – Geneva: In recent years, the Russian government has International Telecommunication Union objective and it aspires to become one of the 31 The Global Information Technology Report 2016. – Geneva: World Economic Forum and INSEAD 32 L’Institut européen d’administration des affaires or European Yet challenges in joining global digital leaders Institute of Business Administration. remain. 33 The Global Innovation Index 2016: Innovation Feeding the World 34 Reaping Digital Dividends in Europe and Central Asia Report, More work needs to be done for Russia to 2017 34 Russia Economic Report | Edition No. 39 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity Figure 38: Analogue (“Complements”) and Digital Figure 39: Impact of business usage of ICT tools on the (“Technology”) factors interplay in determining the innovation and entrepreneurial environment leaders in digital transformation (World Economic Forum 2016) 7 Business and innovation environment (1-7) SNG 6 USADNM UAE IRE UK FIN POR EST MAL BEL SWE GER 5 FRA LUX AUT ARM RUSSIA KYR 4 PHI CHN KAZ MYA CAM IND 3 2 1 1 2 3 4 5 6 7 Business ICT usage score (1-7) Source: World Bank staff calculations. Source: WEF Networked Readiness Index 2016. Factors affecting the pace of Russian Digital to drive economic growth. Russia’s share of Transformation national R&D expenditure is 1.13 percent of There are several factors at play here. Business GDP, which corresponds to the 34th place in the usage of ICT tools by Russian companies still lags Global Innovation Index for 2017.35 By comparison, behind that of global leaders Singapore, Finland, Canada spends 1.61 percent, China 2.09 percent, Denmark and the US (Figure 39). Germany 2.88 percent, and the global leader, Israel, spends 4.3 percent36 (Figure 40). The share Despite the solid technical education foundation that Russian businesses contributed to the total remaining from Soviet times, broad high-level national R&D expenditure is low, standing at digital skills are still lacking, and aligning the 26.5 percent in 2015. This indicates a lack of education system with industry needs calls for commitment to innovation in the commercial improvement. sector. By comparison, in Canada, this index Weak linkages between academia, centers of Figure 40: Share of R&D spending in nations’ GDP scientific research and key economic players have historically been a hindrance in the 4,3% implementation and commercialization of new technologies in Russia. Specific initiatives are required to address this issue with the emergence 2,88% of new technologies today. 2,09% 1,61% The lack of alignment between the government, 1,13% 66% the private sector and the scientific community 75% 37% 45% in turn negatively affects the innovation and 26% Russia Canada China Germany Israel entrepreneurial environment. Source: Global Innovation Index 2017. Research and development is the backbone of 35 Global Innovation Index, 2017 required to develop new products and services 36 The same source. Russia Economic Report | Edition No. 39 35 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity is at 45 percent, in Germany 65 percent Overall, enterprise digital transformation in and in China almost 75 percent.37 Internal Russia lags behind that of the public sector Russian enterprise spending on information and In terms of broadband usage, only 24.2 percent telecommunications systems R&D was worth 77.9 of Russian businesses use broadband (with billion rubles in 2016, just 8.3 percent of the total download speeds of 30 Mbps and higher), with internal R&D spending.38 large enterprise broadband usage at 40 percent,41 in spite of the general availability of broadband access. Enterprise demand for technology innovation is a According to Rosstat, the share of R&D expenditure key driver of digital transformation. The aggregate of the business sector in the field of ICT is 9.98 level of innovation activity of Russian enterprises percent42 as compared to 54/59 percent globally.43 (the share of enterprises engaged in innovation activity in the reporting year) was 9.3 percent in According to the World Economic Forum 2015, with technological innovation carried out Global Competitiveness Index 2016-2017,44 the by only 8.3 percent of the organizations. This is availability of venture capital in Russia is also very considerably less than in both developed and most low as Russia scores below 89th place in the global developing countries: in Switzerland, 75.3 percent ranking. Despite general support from the state, of companies were innovative (52.7 percent the creation of start-ups and innovative enterprises were implementing technological innovation), in in Russia based in educational or research Brazil 73.1 percent, and in Germany 67 percent institutions is weak. Half of university start-ups (52.6 percent were implementing technological do not generate revenue, and existing revenue is innovation). In terms of this indicator, Russia lags generated by universities priming the work.45 The behind all EU countries with the exception of volume of investment in university-funded start- ups in Russia in 2015 totalled just USD 9.8 million, Romania, which stands at 6.3 percent.39 out of the USD 22 billion invested globally.46 According to the Global Entrepreneurship To better understand the intricacies of the gap Monitor Index of Innovation, 40 which is calculated between Russia’s stated goals and aspirations as the proportion of first-time entrepreneurs and its international scores, the World Bank has who are entering the market with new products conducted a Digital Economy Country Assessment and services, Russia holds the second-to-last (DECA) for the Russian Federation by doing the place among 64 countries participating in the first global pilot of this holistic benchmarking tool survey with 5.4 percent, far behind the leaders being developed under the Digital Development in this space. Partnership initiative.47 Rosstat, Data of the Main Interregional Center for 2015. 41 Rosstat, Data of the Main Interregional Center for 2015. 42 The same source. 37 PWC: Companies will redistribute most of the costs of R & D 43 Science and Technology Indicators: 2018: Data Book / N. 38 in favor of software and services development. University Higher School of Economics. - Moscow: HSE, 2018. The Global Competitiveness Report 2016-2017 and_Technology_Indicators_2018.pdf Monitoring the effectiveness of innovation Russian universities 45 The Global Competitiveness Report 2016-2017, The World 39 in 2016. - M .: Russian Venture Company, 2017 the-global-competitiveness-report-2016-2017-1> The same source. 46 Global Entrepreneurship Monitor. Global Report 2016/17, 2017 40 http://www.worldbank.org/en/programs/digital-development- 47 partnership 36 Russia Economic Report | Edition No. 39 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity Russia Digital Economy Country Assessment Legislation and Regulation. Hard work on the legal framework in the last decade has led to In 2017, the World Bank conducted a DECA in the development of updated regulations on Russia. The approach to DECA was based on the digital payment systems, digital infrastructure digital development vision initially presented in and cybersecurity policy. Moreover, according the World Bank’s World Development Report to the 2016 World Bank Global Indicator of 2016: Digital Dividends.48 The report examined the Regulatory Governance, Russia was graded 4 out socio-economic effects of digital transformation of 6 in transparency and general public inclusion – the digital dividends – and the conditions for in the legislative process.49 In 2018, Russia’s top achieving them. The assessment focused on standard-setting agency, Rosstandart, ordered evaluating the key conditions for the development the expansion of responsibilities of the technical of a digital economy: its non-digital foundations; committee for standardization in “cyber-physical the use of digital technologies to transform key systems” to cover the Internet of Things, Smart sectors of the economy and the society at large; Cities, Big Data, Smart Manufacturing and Artificial and the impact of digital technologies on socio- Intelligence.50 More work needs to be done in the economic development (economic growth, jobs, area of protecting the rights of online users and quality of services). The assessment yielded regulation of digital transactions. several important findings. Another area for development is creating the Non-Digital Foundations: mechanisms to stimulate the use of digital goods Public Policy and Strategic planning. While the and services. Existing gaps in the regulations Russian Federation has developed a clear vision create barriers for the implementation of digital and strategy for its digital transformation and has technologies in the enterprise sector, which in turn set ambitious goals, more work needs to be done slows down its digital transformation. in devising detailed action plans and creating road- maps for the implementation of this strategy. In terms of human capital, in 2016 Russia scored a fairly high 28th place out of 130 countries on the More effort needs to be invested into optimizing the World Economic Forum Index of Human Capital governance of this process (e.g. creating strategic 2016.51 High scores in international rankings in foresight units to improve agility) and into the human capital development have been a reflection development of monitoring and evaluation tools of Russia’s strength in this area since Soviet times. to access the effectiveness of the implementation PISA rankings in reading, science and math skills of the strategy. remain high to this day. However, most current educational programs have not been updated in line Leadership and Institutions. While there is a with digital economy requirements and training in very high level of leadership commitment to and digital competencies remains insufficient, so there responsibility for the implementation of digital is a lack of skilled digital-economy graduates. Most transformation in Russia, the engagement of the educational programs have not been updated traditional enterprise and commercial sector is not and do not provide for the development of core as strong. Incentives may be required to stimulate a competencies in digital transformation. more active adoption of digital tools and strategies by the business sector and the public at large. Global Indicator of regulatory Governance < http://rulemaking. 49 worldbank.org/> Rosstandart Order of 27 March 2017 #642 World Development Report 2016: Digital Dividends Russia Economic Report | Edition No. 39 37 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity Boosting innovation and R&D is a key objective high level of cybersecurity. This infrastructure has that requires focused efforts to enable digital enabled the growth of strong domestic and localized economy growth. While Russia has a reasonably digital platforms and should now be used to launch well-developed innovation infrastructure, the 4.5 and 5G mobile networks to create a more innovation mentality and the institutional efficiently distributed network of data centers, to commitment to innovation are lacking. This is develop local companies in the data analytics space, evident from a low overall share of R&D spending, and to introduce new/emerging technologies such low levels of enterprise R&D spending, low share as the Internet of Things, artificial intelligence, of R&D in ICT spending, weak links between robotics, and blockchain. The interest in the new/ businesses and universities, insufficient research emerging digital technologies in Russia is very in the digital economy field, and low availability of high, with Russian products starting to appear in venture capital resulting in few start-ups. A joint the artificial intelligence and robotics space. More effort by the government, business leaders and broadly, however, this interest has yet to translate the scientific community is required to overcome into specific strategies, new products and services, the barriers to effective R&D, entrepreneurship commercialization models and national projects and innovation. that could bring Russia into a leadership positions in this field. This situation is exacerbated by the continuing challenges in Russia’s overall business In the development of digital government, the environment. While the country scored 35th in Russian Federation has achieved some successes the World Bank’s 2018 Ease of Doing Business in recent years, most notably an increase in the Rating,52 up 17 spots since 2016, some key number of state and municipal services providers challenges need to be addressed. For example, using the e-government infrastructure and an a relatively high total taxation rate impedes increase in the number of registered users of the business innovation. In the World Economic Forum Unified Public Services Portal.53 Global Competitiveness Report 2017-2018, Russia ranked 101st at 47.4 percent total tax rate, which is a The impact of Digital Government combination of profit tax (percent of profits), labor implementation has been felt by citizens tax and contribution (percent of profits), and other and corporate users alike and the former taxes (percent of profits), compared to 44 percent have reported particularly high levels of user in the U.S., 30.9 percent in the UK and 21 percent in satisfaction. Russia has also done well in setting Canada. Access to new technologies remains limited, the stage for open government. Disparities still the protection of intellectual property rights is exist in the use of digital technologies at the federal, insufficient, the perception of corruption remains regional and municipal levels of government, high and judiciary independence is seen as low. with only 10 percent of local self-government organizations in line with national digitization Digital Foundations: requirements. To move to the next stage of In the past years, Russia has focused on developing maturity of digital development, a significant broadband access and has built a fairly strong transformation of the current e-government and advanced digital infrastructure marked by a architecture will be required, including the re- competitive telecommunications market, high rates engineering of administrative processes and the of mobile penetration, affordable broadband and a emphasis on the use of national databases, the Doing Business 2017: Equal Opportunity for All 2017 38 Russia Economic Report | Edition No. 39 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity sharing of digital services by local governments, the growing demands of the digital economy. The and the provision of interactive digital government continuing lack of highly qualified teachers and platform services to citizens and businesses. trainers has yet to be addressed. In cybersecurity, Russia is among the global A lot has been done to develop a digital culture leaders, ranking 10th in the 2017 ITU Global in terms of the use of digital technologies to Cybersecurity Index.54 Still, two-thirds of Russian transform arts and culture-related organizations companies believe that in the last three years, the like libraries, museums, archives and theaters. number of cybercrimes has risen by 75 percent55 Here again, the digital infrastructure is in place, which suggests that cybersecurity should become complete with the necessary regulations and a focus for the private sector as well. Also, further program documents. The digital transformation is work is required to educate the public about taking place in a number of cultural institutions, cybersecurity threats as more Russians become with new databases and formats of interaction active online. defined. Still, digital platforms in this field are underdeveloped, partly due to unresolved conflicts E-health implementation is still in its early stages. between copyright owners and ICT firms. While the digital infrastructure required for e-health transformation is largely in place, and The digital transformation of the private sector is legislation has been adopted to enable the use progressing slowly. Apart from some automation of electronic medical records nationally as well initiatives, including the implementation of ERP as for providing telemedicine services, the use of systems in some large enterprises, there are few digital and innovative technologies in healthcare examples of digital-transformation successes in remains low and requires further effort. There the private sector. The government-led digital are also significant regional disparities in e-health transformation has focused on top-down public- adoption. While large cities are making progress, sector digitization, while the private sector, for most of the country is still far behind. the most part, has suffered from a lack of relevant knowledge and management experience among In e-education, the digital infrastructure is also in enterprise managers and employees, as well as place, available to educational institutions of all a lack of competitive pressures caused by a high levels. There is a strong focus on training teachers degree of market consolidation in key sectors and and administrative staff in digital education high barriers to entry for new players. Private- skills and on creating new education materials sector innovation is stagnating due to limited and curricula. Digital education platforms are corporate R&D budgets and taxation regulations emerging, with more opportunities for course that do not provide incentives to invest in R&D. selection and personalization. Distance learning Links with the academic community locally and and digital exams and certifications are gaining internationally are weak, and little has been popularity. The private sector is an active provider done to set industry standards for data analysis of a variety of digital education services, though and integration. the budget allocated to digital services in public educational institutions is low. Still more needs These trends are observed across large emerging to be done in increasing the quantity, quality and economies, notably the so-called BRICs. According variety of online education content in line with to the World Bank’s Digital Adoption Index, public sector transformation in Brazil, China, India Global Cybersecurity Index 2017 technologies adoption by the private sector. Russia Digital Economy Program, July 2017. 55 Russia Economic Report | Edition No. 39 39 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity Despite the challenges the private sector is 2016,58 Russia ranks 41st on reaping social and facing, there are nevertheless enterprise leaders economic benefits from digital transformation. pioneering digital technologies in a number of The lowest rankings for Russia are on the impact sectors and competing with foreign players in of ICT on the creation of new business models, their fields. Overall, according to the McKinsey goods and services (97th place), on the impact digitization-level assessment,56 ICT, education and of ICT on the accessibility of basic services like finance are ahead. But in key industrial sectors healthcare, education, etc. (88th), on the impact of such as mining, manufacturing, transport and ICT on new forms of organization such as remote agriculture, Russia is behind global leaders. working, telecommuting, etc. (75th), and on the impact of ICT on government effectiveness, i.e. the The e-commerce market is growing, despite quality of government services and government the relatively low purchasing power of the transparency (61st).59 It rates higher in the impact population, underdeveloped logistics channels of new forms of financial services related to throughout the country and competition from digital technology (FinTech) developed in Russia, cross-border players. mainly due to two widely used products in the country: online payments and transfers of funds60 The national focus on digital transformation in (Figure 41). Russia and the roll-out of digital services has caused a rapid rise in the numbers of online users and In 2011-2012, both McKinsey and BCG the participation of the population in the digital estimated the contribution of the internet to economy. This is particularly visible in large cities, Russia’s economic growth to be between 1 less so in rural areas. İt is worth noting that there and 2 percent.61,62 The Economist proposed the are no gender disparities vis-a-vis the utilization existence of a “threshold effect,” whereby the of digital services, and in the rural areas, women use of ICT starts to positively influence economic outnumber men in most areas of Internet use.57 growth after reaching a certain level of penetration More and more households enjoy broadband of technologies into the economy and/or after connectivity, including on mobile devices. Expert a certain period of time.63 In 2015, McKinsey assessments point to a growing confidence of the estimated that the share of the digital economy in Russian population in digital government, digital Russia’s GDP rose to 3.9 percent (compared to 8.2 participation, the sharing economy and the use of percent in the EU, 10 percent in China and 10.9 payment cards. The Global Information Technology Report 2016. Geneva: 58 In terms of the social and economic impacts World Economic Forum and INSEAD Russia is gradually beginning to experience certain The same source. 59 Fintech Adoption Index Russia: Key Trends. – Ernst & Young 60 benefits and gains. According to a composite sub- Valuation and Advisory Services LLC., 2016 Internet matters: The Net’s sweeping impact on growth, jobs, 61 Digital Russia: New Reality, McKinsey Report 2017. Ourpercent20Insights/Digitalpercent20Russia/Digital-Russia- The Internet Economy in the G-20: The $4,2 Trillion Opportunity. 62 report.ashx> Boston Consulting Group, 2012 information technologies by the population for 2016, Rosstat Reaping the benefits of ICT: Europe’s productivity challenge. 63 com/files/ad_pdfs/microsoft_final.pdf> 40 Russia Economic Report | Edition No. 39 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity Figure 41: Russia in the Impact of ICT ranking by World Figure 42: Russia’s Digital Economy Assessment Economic Forum Network Readiness Index 2016 Summary State Policy and Strategic Ranking for Russia of the impact of ICT planning WEF network readiness index Social and Economic Leadership and Impact 5 Institutions 61 75 Uruguay Vietnam Digital 4 Laws, Regulations & 88 Poland Cyprus Citizens/Customers 3 Standards (Legislation) 97 Gambia Egypt Mali Itali Digital Transformation 2 Human Capital of Private Sector 1 0 Digital R&D and ICT Government Innovations Digital Sector Business of Economy Environement New/Emerging Trust and Security in the Digital Technologies Digital Economy On business On accessibility On new On government Shared Digital Digital model of basic services organizational effectiveness Infrustructure forms Platforms Source: WEF Networked Readiness Index 2016. Source: World Bank staff calculations. percent in the U.S.),64 whereas BCG suggested the digital transformation of the public sector 2,1 percent65 – a significant increase over five (government, education, health, and culture) years, yet still not on par with global leaders. and especially the transformation of business Russia’s business-climate shortcomings continue through the application of digital technologies to negatively affect potential digital-dividend needs to be accelerated. R&D, innovation and gains. As noted earlier, in its Reaping Digital entrepreneurship are underdeveloped by global Dividends Report, the World Bank emphasizes standards. Adoption of digital technologies by the need to strengthen non-digital foundations the general public outside the large cities is quite for digital transformation, as well as to promote low, all of which explains the lack of significant broad education and inclusion to obtain social and quantifiable social and economic effects – the economic dividends. digital dividends – from the digitization process. Russia Digital Economy Assessment Results The work ahead requires specific policies and Summary steady dedication to accelerate the pace of private The DECA analysis results (Figure 42) confirmed and public-sector transformation, to raise public awareness of the use of digital technologies, to the World Bank’s earlier assessment of Russia as a foster links between the scientific community country that is transitioning to a digital economy, and private and public sectors, and to focus having created a solid platform for the digital leap on developing a business climate conducive to in terms of both analogue and digital factors. innovation, R&D and entrepreneurship – all of which are key elements of a digital economy culture now It has built on its traditional strengths such in short supply in Russia. Improving the regulatory as human capital, scientific excellence, strong and taxation environment, boosting investment in leadership and security, while its recent focus innovation and fostering entrepreneurship should on digital infrastructure, strategic planning become top policy priorities. and regulation has started to pay off. However, 64 Digital Russia: A New Reality. Digital McKinsey, July 2017. 65 Russia Online: Сatch Up Impossible to Fall Behind. BCG, June 2016. Russia Economic Report | Edition No. 39 41 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity Russia Digital Economy Program 2025 implementation and innovation, focusing on transparency, quality of services and In July 2017, Russia adopted the Russia Digital leveraging shared data assets. Economy Program with an expected annual budget of USD 1.8 billion until 202566 to address - Focus on the digital transformation of the the current weaknesses preventing the country traditional economy, not just the ICT sector. from joining global digital economy leaders. Prioritize the creation of new hybrid segments of the economy and incentivize traditional The program is quite comprehensive, focusing industries to accelerate the adoption of on both analogue and digital foundations of digital solutions. digital transformation and addressing the legal, - Implement business models focusing technical, organizational and financial aspects of on commercial gains from the use of this process. In preparing this program, its authors e-commerce, digital platforms, big data were able to draw upon international best practice analytics and emerging technologies. in digital transformation. - Develop effective project management tools and new business models for the They prioritized changes in the legal and implementation of the program, focusing on regulatory framework, addressed key aspects coordinated execution, alignment with other of building digital skills, education and R&D, development priorities and programs, the proposed investments in digital infrastructure role of the private sector and PPPs. and cybersecurity, emphasized strict program - Develop a concise list of result-oriented management requirements and proposed specific project metrics and evaluation tools initiatives in e-government, Smart Cities and aimed at assessing the success of each e-health. Given the high priority assigned to this implementation stage. program at the most senior levels of government, along with the funding allocated through the - Ensure the availability of funds and sources federal budget, there are reasons to believe that if of financing (including approved government properly implemented (see sidebar), this program funding) for the entire length of the program. will allow Russia to make significant progress in its - Focus on addressing the regional challenges digital transformation process. in implementing the program, such as bridging the digital technology gaps, attracting private- Russia Digital Economy Program Implementation sector investment and participation, building Success Factors local skills and education and countering brain In collaborating with the Russian Government on drain and emigration from poorer areas. its Digital Economy Program, World Bank experts emphasized the following points: The Eurasian Economic Union Digital Agenda - Ensure a common vision of the program’s The program also provides for Russia’s participation mission and its strategic goals, expected in the Digital Agenda of the Eurasian Economic results and definitions of success, including Union (EAEU), another key digital transformation quick wins. Induce the office of the initiative announced in 2017, aimed at the government CIO to drive cross-government creation of a single digital space across the Eurasian Union. According to the joint study by the Eurasian Economic Commission and the Program “Digital Russian economy.” Approved by the Federal 66 Government on July 28, 2017 № 1632 integration agenda, focusing on the use of digital 42 Russia Economic Report | Edition No. 39 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity technologies to eliminate obstacles to economic broadband penetration and a related GDP growth cooperation across Eurasia, will yield economic of between 0.3 and 1.8 percent.67 benefits such as GDP growth, job creation and services transformation to all EAEU members, with Similarly, for mobile penetration, the joint study Russia as the Union’s largest economy standing estimates that Russia alone may achieve a 95 to gain significant competitive advantages, and percent penetration rate by 2023, whereas its population benefiting from sizable economic following the EAEU Digital Agenda may enable it gains. (Figure 43). to achieve that rate as early as 2020.68 Figure 43: Implementing the EAEU Digital Agenda. Digital transformation of the services sector in Additional Gains Per Capita by 2025 the EAEU space should become another key area Maximum, medium, minimum of focus for the Russian Federation, including Additional GDP gains per capita by 2025 the development of cross-border e-government 1,500 and open government services, e-commerce, and e-procurement. According to the joint study, 1,000 the development of e-commerce in Russia may add 0.53 percent to the GDP by 2025, whereas 500 the growth of e-commerce between the EAEU member states may add 1.06 percent to Russian Armenia Belarus Kazakhstan Kyrgyz Russia GDP alone.69 Critically, the value of removing Republic barriers to digital trade is estimated at almost 3 EAEU digital scenario Individual country scenario percent of Russian GDP.70 Source: World Bank staff calculations. McKinsey estimates that by 2025, the economic Reaping Digital Dividends across the EAEU: the impact of digital transformation in Russia will reach multiplier effect an impressive 19-to-34 percent of GDP.71 The World The Joint Study determined that the digital Bank indicates that by 2025, digital transformation dividends gained from the implementation of may lead to the creation of between 7 and 13 digital transformation across the EAEU are likely million new digital-economy jobs in the country to be multiplied compared to those that may be (Figure 45), and potential productivity gains of achieved if countries were to focus on implementing over USD 38 billion.72 their digital strategies at the national level alone under the individual-country scenario. 67 Joint study by the Eurasian Economic Commission and the World Bank “The EAEU Digital Agenda 2025: Prospects and Recommendations.” For example, the joint study estimates that in 68 Joint study by the Eurasian Economic Commission and the terms of fixed broadband per capita penetration World Bank “The EAEU Digital Agenda 2025: Prospects and Recommendations.” (Figure 44), in following the country digitization 69 Same source. scenario, Russia may achieve a fixed broadband 70 Same source. penetration rate of 28.7 percent by 2025 (28.7 71 Digital Russia: New Reality, McKinsey Report 2017 transformation scenario, in the same time frame, 72 Joint study by the Eurasian Economic Commission and the World Bank “The EAEU Digital Agenda 2025: Prospects and Russia could achieve a 35.9 percent rate of fixed Recommendations.” Russia Economic Report | Edition No. 39 43 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity Figure 44: Scenarios for the growth of fixed broadband Figure 45:The impact of the digital economy on per capita in the Russian Federation employment growth (percent) when implementing country and regional Digital Agendas in 2018-2025 40 3 Fixed broadband penetration (percent) 35 2.5 30 2 25 1.5 20 1 15 0.5 0 10 Armenia Belarus Kazakhstan Kyrgyz Republic Russia 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 EAEU Digital agenda scenario Individual country scenario Country-specific scenario EAEU digital agenda scenario Source: World Bank staff calculations. Source: World Bank staff calculations. These forecasts imply not only the digitization of Addressing Regional Disparities in Digital existing business processes, but also the adoption Adoption of new business models, platforms and ecosystems, While Eurasian integration through the use as well as the use of emerging technologies, such of digital technologies presents compelling as data analytics, artificial intelligence, robotics, opportunities to benefit from the multiplier effect 3D printing, blockchain and the Internet of Things. in obtaining digital dividends, it is critical for Russia to address the disparities in digital adoption at For example, in assessing the transformation to the regional level, which could slow the progress a data-driven economy, the joint study estimates of its digital transformation. Differences in the that its value in Russia may reach 1.9 percent of economic development of the different parts of GDP by 2025. If, however, the implementation of the Federation are likely to be reflected at the digital technologies and solutions is driven across digital level too. the EAEU, then the value of the data-driven economy in Russia may reach 2.36 percent of GDP To better understand the challenges Russian – the highest in the Union (Figure 46).73 regions are facing in implementing digital transformation, the World Bank has conducted Similarly, the value of the rapidly emerging a Digital Economy Assessment (DECA) of the technology of cloud computing may reach 0.40- Ulyanovsk region of Russia by applying the same 0.46 percent of Russian GDP by 2025. If, however, methodology principles used in the assessment this technology is implemented across the EAEU, of Russia at the national level. This was the first its value in the Russian GDP may reach 1.09 global pilot of DECA at the subnational level. percent74 (Figure 47). Ulyanovsk Oblast Digital Transformation The Ulyanovsk oblast is located in the heart of the Volga region, in the south-east of European Russia. It has a population of 1.3 million and an 73 Joint study by the Eurasian Economic Commission and the World Bank “The EAEU Digital Agenda 2025: Prospects and area of 37.2 sq km – 0.22 percent of the Russian Recommendations.” territory. Its location at the heart of the Volga 74 Joint study by the Eurasian Economic Commission and the Federal region puts it advantageously at the World Bank “The EAEU Digital Agenda 2025: Prospects and Recommendations.” crossroads of transport and logistics links between 44 Russia Economic Report | Edition No. 39 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity Figure 46: Aggregate GDP impact by 2025 of data-driven Figure 47: Cloud computing in EAEU – potential economy member-country gains Value in GDP added by data driven economy by 2025 Value in GDP added by cloud computing by 2025 as a % of current GDP as a % of current GDP 2.50 0.80 0.70 2.00 0.60 1.50 0.50 0.40 1.00 0.30 0.50 0.20 0.10 0.00 0.0 Armenia Belarus Kazakhstan Kyrgyz Russia Armenia Belarus Kazakhstan Kyrgyz Russia Republic Republic Individual Country Scenario: Value in GDP added by data - driven economy by 2025 (% of 2015 GDP) Individual Country Scenario: Value added by cloud computing technologies by 2025 per current GDP (%) EAEU Digital Agenda Scenario: Value in GDP added by data - driven economy by 2025 (% of 2015 GDP) EAEU Digital Agenda Scenario: Value added by cloud computing technologies by 2025 per current GDP (%) Source: World Bank staff calculations. Source: World Bank staff calculations. the Volga region and Europe, Central Asia, China The regional government’s commitment to and the Middle East. Industrial development driving digital transformation and attracting historically focused on mechanical engineering, investment has translated into a relatively well- hosting Europe’s largest aircraft factory, Aviastar- developed digital infrastructure, a competitive SP, and the Ulyanovsk car factory, which traces its telecommunications market, high mobile- roots back to WWII with the production of the UAZ penetration rates, affordable broadband access off-road vehicles. In 2018, Ulyanovsk announced a and high user awareness of cybersecurity issues. plan to open а competence center for unmanned Municipal services are provided electronically, and systems set in the “Ulyanovsk-Avia” cluster. The 5th 98.9 percent of users are completely or partially International Air Transport Forum will be held in satisfied with online government services.76 The Ulyanovsk in August 2018.75 region also has a reasonably well-developed infrastructure for innovation: it ranks 16th out of The region is also active in tool-making 85 and is among the most innovative regions in and machine-tools, as well as textiles, food Russia, while the share of R&D expenditure in the processing, construction, woodworking and GRP is quite high.77 The region’s government lends forestry. A nuclear innovation cluster has been strong support to the development of the digital created in the city of Dimitrovgrad. Innovation in sector of the economy, specifically encouraging Dimitrovgrad and at Ulyanovsk Avia has led to the SMEs and offering taxation and other preferences formation of the region’s Innovation Cluster that to the ICT sector. The region was among the first made it to the national list of the top 11 advanced in Russia to do this. As a result, 3.3 percent of the development territories of the country. Industrial local workforce is employed by the region’s almost development zones and special economic zones 200 ICT companies (compared to 2 percent in the have been established to attract investment ICT sector in Russia overall).78 by Russian and foreign companies. More recently, the city has adopted a Smart Region development program aimed at transforming Estimates provided by the government of Ulyanovsk oblast. 76 the region by using digital technologies. Rating of High School of Economics. 77 Expert RA. Ranking of the largest groups and companies in the 78 field of information and communication technologies following AeroNet agreement with Ulyanovsk Oblast < https://aeronet. 75 the results of 2016 main> Russia Economic Report | Edition No. 39 45 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity Nevertheless, despite the relatively well- satisfaction, 100 percent of doctors have access to developed infrastructure, there is a lack of online medical information, 25 percent of students innovation in traditional industry and few start- have used distance learning courses to improve up successes. Persistently weak links within their qualifications, and the rate of growth of the the innovation cluster may be a cause, with digital sector of the economy is five times higher insufficient communication and few partnerships than that of the real economy of the region. In between businesses, the R&D scientific terms of social dividends, Ulyanovsk is already community, the public sector and other players. ahead of the national Russian impact, according to The business environment, which is reflective of statistics related to the provision of basic services Russia’s general business climate challenges such (medical, educational, financial, etc.).79 as corruption, limited access to new technologies and insufficient protection of intellectual property Results of the Digital Economy Assessment of rights, is also a constraint. In line with the general the Ulyanovsk Oblast of Russia trend in Russia, emerging technology services The Ulyanovsk DECA results (Figure 48) are broadly such as cloud computing and data analytics are in line with the World Bank’s findings in the Russia underdeveloped. DECA, and the differences, especially with respect to weaknesses, are indicative of the situation at In terms of private-sector transformation, the the regional level across Russia. situation is also reflective of that in Russia, as examples of digital transformation leadership Overall, both the digital and non-digital foundations in the private sector and of resulting changes in required to succeed in the digital transformation business models are limited to a few individual process of the region are in place. In Ulyanovsk, enterprises. Moreover, the share of enterprises the commitment of the region’s leadership to engaged in innovations related to digital digital transformation is perceived as even higher transformation is half the Russian average, despite than at the national level, as is the strength of the fact that the share of business expenditure on public policy and strategic development plans. R&D is more than double the Russian and even global average. This should be cause for concern Figure 48: Results of Digital Economy Assessments (DECA) in Russia vs Ulyanovsk Region and a call to action for the region’s leaders, who possess sufficient authority to formulate policy and Public Policy and Strategic Planning 5 Social and Economic Impact Leadership and Institutions implement meaningful reforms without waiting 4 Digital Citizens/Customers Laws, Regulations & for solutions from the federal level. 3 Standards Digital Transformation 2 Human Capital of Private Sector 1 As elsewhere in Russian regions, a shortage of 0 ICT specialists and of ICT training is a key factor Digital Transformation of Public Sector R&D and ICT Innovations holding back the Ulyanovsk region’s digitization. Digital Sector of Economy Business Environement This is another issue that can be addressed locally, without waiting for a solution at the federal level. Emerging Digital Technologies Trust and Security Digital Platforms Digital Infrustructure Ulyanovsk Russia As the case of Ulyanovsk oblast demonstrates, Source: World Bank staff calculations. the impact of digital transformation may be more tangible at the regional than at the national level. Today 98.9 percent of users of online government 79 Analysis of current status of digital economy in Ulyanovsk services in the region report high levels of oblast, World Bank, 2017. 46 Russia Economic Report | Edition No. 39 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity More work needs to be done to overcome the Secondly, there is a need to accelerate the pace challenges posed by the business environment and of the digital transformation of the traditional- to address the digital literacy and skills gap of the industry sector where the application of ICT and population. It is critical to find ways to counteract new digital technologies can yield significant the brain drain from the region and attract and dividends across all parts of the value chain, thus keep qualified personnel, as well as to build trust improving the competitiveness of key industry in the digital economy and encourage the public sectors. Engaging the private sector in digital to actively engage in economic activity online, transformation partnerships, fostering connections through shared digital platforms, digital content with the scientific and R&D community, creating creation and other digital mechanisms. favourable taxation regulation to incentivize investments into digital technologies and R&D Specific incentives are required to accelerate are all mechanisms that need to be leveraged. Current industrial policy should be closely aligned the back-end digital transformation of public with the digital economy policies and programs. and private sector entities and to encourage It is also critical to invest into back-end digital innovation. The government, business and non- transformation and organizational restructuring of profit sectors in the region will have to work both private and public-sector entities. closely together to overcome these challenges and achieve further dividends inherent in digital Thirdly, boosting R&D into new technologies transformation success. and understanding their potential to transform traditional industries and create new ones should Conclusions and Recommendations be high on the government and private sector The dividends of building a competitive digital agendas. Understanding the impact of emerging economy in Russia are high, and tightly focused technologies on existing business models is key policies are required to accelerate the pace of this to gaining competitive advantage. A high level transformation. of coordination is required between industrial development objectives and digital transformation Firstly, it is key to maintain the high-level goals, so it can accelerate the creation of clusters government focus and strategic prioritization of of innovative companies and new drivers of economic growth. the national digital transformation so as not to lose the existing momentum and concentrate on Fourth, specific policies should be implemented effectively reaching the 2025 goals set out in the to encourage innovation and entrepreneurship Russia Digital Economy Program, the EAEU Digital in the digital transformation context. Sustainable Agenda and other relevant policy documents. innovation requires close coordination between the government, the private sector and the Effective project management is of the essence. academic community. Public sector investment Detailed roadmaps need to be developed and should not only support fundamental research and implemented, project portfolios prioritized to drive the development of world-class R&D units in identify quick wins as well as longer-term strategic Russia, but also implement policies to encourage initiatives. New governance mechanisms the commercialization of R&D outputs, while should be introduced to accelerate the pace the private sector should focus on go-to-market of transformation in line with stated goals. strategies and new business-model development. Budgets and financing mechanisms need to be An efficient regulatory system encouraging firmly in place. innovation should be further developed, with a special focus on intellectual property rights protection and patent regulation. Russia Economic Report | Edition No. 39 47 III. Russia’s Digital Economy: Accelerating Digital Transformation For Economic Prosperity Fifth, digital transformation in Russia requires And finally, policies should be aimed at the the development of a highly trained workforce. development of a receptive domestic market Policies should be put in place for training and that values the processes and outputs of digital upskilling the existing workforce, as well as retaining transformation. These include specific steps talent. The brain drain has to be addressed and aimed at improving the local business climate, strategies should be put in place to attract the best focused market-development initiatives to and the brightest back into the country. boost local demand, public-sector technology procurement preferences and incentives for Sixth, the government needs to focus on ways market players to procure locally. Initiatives to leverage digital technologies to alleviate aimed at building the public’s trust in the digital disparities in the development of Russia’s economy are also important. regions and municipalities and to enable the less-advanced regions to take advantage and In summary, the ongoing Russian government effectively localize the implementation of the focus on digital transformation as a national national digital economy programs. Policies priority, if complemented by effective policies should focus on local digital skills development, and a results-oriented focus on implementation, management training, local PPPs and innovation will position the country to make the leap from cluster-building, local market development and the group of transitioning economies to that of funding mechanisms. Special attention should be transforming economies and join the world’s given to the development of digital infrastructure digital economy leaders while reaping all the in remote and rural areas and to educating rural economic and social benefits this implies. populations about the benefits of digital services. 48 Russia Economic Report | Edition No. 39 Russia Economic Report #39, May 2018 © 2018 International Bank for Reconstruction and Development / The World Bank Modest Growth Ahead Some rights reserved 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is available under the Creative Commons Attribution 3.0 IGO license (CCBY 3.0 IGO) http://creativecommons.org license/by/3.0/igo