The World Bank in the Russian Federation 35 | April 2016 The Long Journey to Recovery Russia Economic Report The Long Journey to Recovery I. Recent Economic Developments II. Economic Outlook III. In Focus: Export Competitiveness and Foreign Direct Investment This report is produced twice a year by World Bank economists in the Macroeconomics and Fiscal Management Global Practice. The team that prepared this edition was led by Birgit Hansl (Lead Economist and Program Leader in Russia, bhansl@worldbank. org) and consisted of Sergei Ulatov (Senior Economist), Olga Emelyanova (Research Analyst), Mikhail Matytsin (Consultant), Michael Edwards (Lead Financial Sector Specialist), Katerina Levitanskaya (Operations Officer), Christian Eigen-Zucchi (Senior Economist), John Baffes (Senior Economist), and Irina Rostovtseva (Program Assistant). Birgit Hansl authored the focus note on export competitiveness and foreign direct investment together with Michael Ferrantino (Lead Economist) and Gabriela Schmidt (Consultant) based on a World Bank paper titled Export Performance and Foreign Direct Investment Performance across Russia’s Regions. Peer reviewers included Eric Le Borgne (Lead Economist), Christos Kostopoulos (Lead Economist), and Praveen Kumar (Lead Economist). The report was edited by Sean Lothrop (Сonsultant), and the graphic designer was Robert Waiharo (Сonsultant). The team would like to thank Cyril Muller (Vice President of the Europe and Central Asia Region), Hans Timmer (Chief Economist of the Europe and Central Asia Region), Andras Horvai (Country Director for Russia), Miria Pigato (Practice Manager, Macroeconomics and Fiscal Management Global Practice), and the Russia teams at the European Bank for Development and Reconstruction, and the IMF for their advice and support. This report went to press on April 4, 2016. TABLE OF CONTENT ABBREVIATIONS AND ACRONYMS....................................................................................................................... i EXECUTIVE SUMMARY ........................................................................................................................................ ii I. RECENT ECONOMIC DEVELOPMENTS:............................................................................................................ 1 1.1 Growth - Economic Recovery Delayed............................................................................................................... 2 1.2 Balance of Payments – Swift Import Adjustment Supports the Current Account............................................. 8 1.3 Monetary Policy and the Financial Sector – Addressing Policy Tradeoffs ......................................................... 12 1.4 The Government Budget – Uncertainty in the Face of Unresolved Medium-Term Challenges ........................ 18 1.5 Income and Poverty Trends – The Labor Market Weakens ............................................................................... 22 II. OUTLOOK – AN UNCERTAIN PATH AHEAD ....................................................................................................... 25 2.1 Growth Outlook – A Shift in Adjustment Challenges......................................................................................... 26 2.2 Poverty and Shared Prosperity Outlook – Fortunes Reverse............................................................................. 35 2.3 Risks and Policy Challenges – Prevailing Headwinds......................................................................................... 37 III. EXPORT COMPETITIVENESS AND FOREIGN DIRECT INVESTMENT – THE COMPLEX PUZZLE OF DIVERSIFICATION ............................................................................................................................................ 45 3.1 Introduction....................................................................................................................................................... 46 3.2 Russia’s Export Profile and the Challenge of Diversification.............................................................................. 48 3.3 Attracting FDI in a Challenging External Environment ...................................................................................... 56 3.4 Foreign Investment, Export Performance and Regional Development ............................................................. 58 3.5 Conclusion......................................................................................................................................................... 61 REFERENCES.......................................................................................................................................................... 63 Annex I: Main Macroeconomic Indicators .............................................................................................................. 64 LIST OF FIGURES Figure 1: GDP growth, year-on-year, percent................................................................................................................ 2 Figure 2: Demand composition of GDP growth, year-on-year, percent ........................................................................ 3 Figure 3: GDP growth, year-on-year and quarter-on-quarter, seasonally adjusted, percent ........................................ 3 Figure 4: Global industrial production and trade growth, percent change................................................................... 4 Figure 5: Gross capital flows to developing countries, US$ billions .............................................................................. 4 Figure 6: Global energy prices, US$/mmbtu ................................................................................................................. 5 Figure 7: Crude oil supply growth, mb/d....................................................................................................................... 5 Figure 8: Contribution to GDP growth by sector, percent............................................................................................. 7 Figure 9: Growth in tradables, value, added, year-on-year, percent............................................................................. 7 Figure 10: Fixed investment growth by sector, 2015, year-on-year, percent .................................................................. 7 Figure 11: Employment growth by sector, 2015, year-on year*, percent....................................................................... 7 Figure 12: Goods imports, the REER and oil prices......................................................................................................... 8 Figure 13: The composition of the current-account balance, percent of GDP................................................................ 8 Figure 14: Oil prices and the trade, services and investment-income balances ............................................................. 9 Figure 15: Russia’s 5-year CDS spreads ........................................................................................................................... 9 Figure 16: Debt to non-residents, US$ billion ................................................................................................................. 10 Figure 17: Remittance outflows, Q1-3 2015 ................................................................................................................... 11 Figure 18: Remittance inflows, Q1-3 2015...................................................................................................................... 11 Figure 19: Exchange-rate dynamics in Russia, Kazakhstan and Azerbaijan (2014 = 100)................................................ 13 Figure 20: Changes in oil prices and the nominal exchange rate.................................................................................... 13 Figure 21: Key policy rates, percent................................................................................................................................ 14 Figure 22: CPI inflation components, year-on-year, percent........................................................................................... 14 Figure 23: Money-supply dynamics ................................................................................................................................ 15 Figure 24: Broad monetary base dynamics, 3-month moving average.......................................................................... 15 Figure 25: Credit growth, year-on-year, percent ........................................................................................................... 15 Figure 26: Profitability and credit risk, percent.............................................................................................................. 15 Figure 27: Capital adequacy ratio, end-of-period, percent ............................................................................................ 16 Figure 28: Distribution of banks by capital adequacy ratio, 2015 .................................................................................. 16 Figure 29: Federal revenue and budget balances, 2007-2015, percent of GDP............................................................. 18 Figure 30: Federal primary expenditures, 2014, percent of GDP................................................................................... 18 Figure 31: Unemployment rates in resource-rich countries, one-year moving average, percent.................................. 21 Figure 32: Labor force participation and employment, million ..................................................................................... 21 Figure 33: Net job creation and destruction rates by sector, 2008-2014 average, percent ........................................... 22 Figure 34: Real wage growth by sector, year-on-year, percent ...................................................................................... 23 Figure 35: Contribution to real income growth, total population, year-on-year, percent ............................................. 23 Figure 36: Real income growth, all income levels and bottom 40 percent, year-on-year, percent................................ 23 Figure 37: Unemployment rates by region, Q4 2015, percent ...................................................................................... 24 Figure 38: Real GDP growth projection, year-on-year, percent ..................................................................................... 26 Figure 39: Real GDP projection, 2012=100 .................................................................................................................... 26 Figure 40: Excess global oil production capacity and inventories .................................................................................. 29 Figure 41: The recent and projected growth of global oil demand................................................................................ 29 Figure 42: GDP growth composition with and without economic sanctions in 2017, percent...................................... 32 Figure 43: Poverty rate projections, percent.................................................................................................................. 36 Figure 44: Business confidence surveys in manufacturing ............................................................................................ 39 Figure 45: Key constraints to manufacturing, rosstat business survey, percent ............................................................ 39 Figure 46: The anti-crisis plan by expenditure area ....................................................................................................... 43 Figure 47: The anti-crisis plan by financing source ........................................................................................................ 43 Figure 48: Oil and gas and nonfuel exports, 1997-2015 ................................................................................................ 48 Figure 49: The sophistication of BRICS exports, 2006-2013........................................................................................... 49 Figure 50: Export growth in BRICS countries, 2006–2008 and 2011–2012 ................................................................... 50 Figure 51: Trends in key export goods ........................................................................................................................... 52 Figure 52: Russian exports by destination, 2014 ........................................................................................................... 52 Figure 53: Russian exports to non-EU countries, 2007-08 and 2013-14 ....................................................................... 53 Figure 54: HHI for Russian exports, 2012 ...................................................................................................................... 53 Figure 55: Russian nonfuel exports by product and destination, 2014 ......................................................................... 54 Figure 56: Primary non-ECU destinations for Russia’s regional exports by value .......................................................... 55 Figure 57: Net FDI inflows to Russia, 2008-2015 ........................................................................................................... 56 Figure 58: Sources of Russian net incoming FDI, 2014 .................................................................................................. 56 Figure 59: Total exports per capita by region, US$ million ............................................................................................ 59 Figure 60: Intensity of resource exports, FDI and GDP per capita by region, 2012........................................................ 60 Figure 61: Average export intensity and FDI inflows, percent of nominal GRP.............................................................. 60 Figure 62: Standard deviation of log per capita income by region ................................................................................ 61 LIST OF TABLES Table 1: Contribution to growth by demand components, percentage points ............................................................ 6 Table 2: The external debt stock, 2014–2015, US$ billion ........................................................................................... 10 Table 3: Russia’s external debt-service schedule, 2015–2017, US$ billion ................................................................... 10 Table 4: Net capital flows, 2010–2015 (US$ billions) .................................................................................................. 12 Table 5: The balance of payments, 2010–2015, US$ billions........................................................................................ 12 Table 6: Federal budget outcomes, RUB billions........................................................................................................... 17 Table 7: Consolidated budget, RUB billions .................................................................................................................. 20 Table 8: Poverty trends ................................................................................................................................................. 23 Table 9: Global GDP growth, percent............................................................................................................................ 27 Table 10: Economic indicators, baseline scenario........................................................................................................... 31 Table 11: Economic indicators, lower-bound scenario.................................................................................................... 33 Table 12: Economic indicators, upper-bound oil scenario............................................................................................... 34 Table 13: Net inbound FDI by sector, 2013-2015............................................................................................................ 57 LIST OF BOXES Box 1: Global economic trends .................................................................................................................................... 4 Box 2: Global oil-price trends ....................................................................................................................................... 5 Box 3: The production structure of GDP growth in 2015 ............................................................................................. 7 Box 4: External debt trends.......................................................................................................................................... 10 Box 5: Remittance trends ............................................................................................................................................. 11 Box 6: Oil-price and exchange-rate dynamics .............................................................................................................. 13 Box 7: Drivers of CPI inflation in 2015 .......................................................................................................................... 14 Box 8: Monetary dynamics in 2015.............................................................................................................................. 15 Box 9: The 2016 budget law......................................................................................................................................... 19 Box 10: Trends in job creation and job destruction........................................................................................................ 22 Box 11: The global economic outlook............................................................................................................................ 27 Box 12: Global oil-price forecast .................................................................................................................................... 29 Box 13: Potential impact of the removal of economic sanctions on Russia’s medium-term outlook............................ 32 Box 14: The impact of fiscal policy on poverty reduction and shared prosperity since 2008 ........................................ 36 Box 15: Risks to the global outlook................................................................................................................................ 38 Box 16: The Government’s 2016 anti-crisis plan............................................................................................................ 43 Box 17: Regional differences in export composition and export destinations............................................................... 55 ABBREVIATIONS AND ACRONYMS CAR Capital Adequacy Ratio CBR Central Bank of Russia CDS Credit-Default Swap CIS Commonwealth of Independent States CPI Consumer Price Index DIA Deposit Insurance Agency ECA Europe and Central Asia ECU Eurasian Customs Union EU European Union FDI Foreign Direct Investment GDP Gross Domestic Product GRP Gross Regional Product HHI Herfindahl-Hirschman Index M2 Money Supply MENA Middle East and North Africa NPL Nonperforming Loan NWF National Welfare Fund OECD Organization for Economic Cooperation and Development OPEC Organization of the Petroleum Exporting Countries PPP Purchasing Power Parity RCA Revealed Comparative Advantage REER Real Effective Exchange Rate VAT Value-Added Tax WTO World Trade Organization i Russia Economic Report | Edition No. 35 EXECUTIVE SUMMARY R ussia’s anticipated economic recovery was delayed. In 2015 the Russian economy began its difficult adjustment to the severe the economic transition. In 2015, the average nominal ruble exchange rate depreciated by 37.4 percent against the US dollar, while oil global oil-price shock and the imposition of prices dropped by 47 percent. Meanwhile, a economic sanctions in 2014. The impact of 16.5 percent depreciation of the real effective these twin shocks drove Russia’s economy in to exchange rate drove down imports by 25.7 a deep recession, which reached its nadir in the percent, nearly doubling the current-account second quarter of 2015. Following a brief rally surplus to 5.2 percent of GDP. Relative prices now early in the year, a further decline in global oil favor Russian firms, and export performance prices in August 2015 derailed an anticipated improved in some non-energy commodity recovery, and annual real GDP contracted by a sectors such as coal, metals and chemicals. Due total of 3.7 percent. to the flexible exchange rate, the fiscal impact of the adjustment was less severe for Russia than The economic adjustment occurred primarily it was for other oil exporters, though a fiscal through a sharp drop in income. The adjustment consolidation plan remained necessary. The to the worsening external environment caused plan appears appropriate, as the accumulated an estimated 10 percent drop in gross domestic spending increases of recent years could not income, which sapped consumer demand and be sustained in an environment of slumping oil discouraged investment. The renewed decline and gas revenues, which still constitute about in oil prices put further downward pressure on 40 percent of federal revenue. While federal the ruble, and the pass-through effect pushed spending decreased in real terms, the federal the inflation rate into double digits. Rising fiscal deficit reached 2.4 percent. The Reserve inflation eroded real wages, pensions and other Fund was used to finance the deficit, which transfers, contributing to an estimated 9.6 caused it to drop by 50 percent to US$46 billion percent decline in household consumption, the at end-2015. However, a separate government first such contraction since the global financial RUB2.4 billion anti-crisis plan, which fully crisis of 2008. The authorities’ efforts to manage indexed pensions, helped mitigate the impact of inflation slowed the pace of monetary easing, the consolidation and supported financial sector and the central bank has kept its key policy rates stability through bank recapitalization. at 11 percent since August 2015. Meanwhile, economic sanctions have been extended, Opportunities have arisen to increase the limiting access to global financial markets, competitiveness of Russia’s non-resource restricting capital inflows and damaging investor sector. Falling oil prices have exposed serious confidence. High capital costs and plummeting weaknesses in Russia’s current growth model, consumer demand provided firms with little but the depreciation of the ruble has also created incentive to invest, and gross capital formation an opportunity to enhance the competitiveness dropped by 18.7 percent in 2015, contracting for of its non-resource economy through export a third consecutive year. diversification and expansion into nontraditional markets. The special focus chapter included Thus far, the government’s policy response in this edition of the Russia Economic Report has facilitated Russia’s economic adjustment. describes the complex structural and historical The central bank’s flexible exchange-rate policy challenges facing Russia’s export sector. For fostered exchange rate alignment in support of decades, the growing dominance of the natural Russia Economic Report | Edition No. 35 ii Executive Summary resource sector has undermined economy- percent, as the poor population increased by 3.1 wide competitiveness, as high commodity million to a total of 19.2 million. High inflation prices have skewed the country’s economic contributed to the erosion of real wages by 9.5 and export structure in favor of oil, gas and percent in 2015, while nonwage income sources mining. Russia’s export pattern has narrowed such as pensions and other transfers were on both the extensive and intensive margins, indexed below headline inflation. However, becoming increasingly concentrated in terms declining real wages blunted the recession’s of both products and markets as the high rate impact on the labor market, and unemployment of return offered by primary commodities increased only slightly from a record low of discouraged value addition and stifled the 5.3 percent in 2014 to 5.6 percent in 2015. development of new exports. Leveraging Nevertheless, poverty is projected to increase emerging opportunities to develop a broader further under all scenarios due to a continued and more sophisticated product and export rise in unemployment compounded by marginal mix will require a substantial increase in income growth, as the demands of the fiscal private investment. The current perhaps consolidation restrict the government’s capacity temporary price advantage generated by the for antipoverty spending. Under the baseline depreciation may be not be sufficient to attract scenario the poor population is expected to investors unless it is accompanied by sustained increase by another 1.1 million people in 2016 improvements in the investment climate. as the poverty rate rises to 14.2 percent. This would be the largest increase in the poverty rate Current projections indicate a long journey to since the economic crisis of 1998-1999, and it recovery. The conditions that pushed Russia’s would undo nearly a decade’s worth of gains. economy into recession show slow signs of However, improved growth prospects in 2017 abating, but the World Bank’s current baseline are expected to stabilize the poverty rate. scenario anticipates a further contraction of 1.9 percent in 2016. In 2017 GDP growth is projected Risks to Russia’s outlook are tilted to the to return to a positive, albeit modest, growth downside. The economy faces an uncertain rate of 1.1 percent. Oil prices are projected to global recovery, and as it gradually adapts to an average just US$37 per barrel in 2016, before adverse external environment marked by lower rebounding to around US$50 per barrel in oil prices and ongoing economic sanctions, 2017 and beyond. Commodity prices in general the focus of its economic adjustment is now will continue to dominate Russia’s medium- shifting to fiscal and financial sector challenges. term outlook, and in addition to the baseline However, the policy space for Russia’s continued projection this report includes both a lower- adjustment has narrowed as its fiscal buffers bound and an upper-bound oil-price scenario. have become increasingly depleted. As part Under the lower-bound scenario the economy of the planned fiscal consolidation, a strategic could contract by as much as 2.5 percent in expenditure restructuring that goes beyond 2016 before recovering to a modest growth general budget cuts, as well as efforts to rate of just 0.5 percent in 2017. Conversely, the strengthen the nonoil revenue base, will be upper-bound scenario projects a more modest necessary to adapt to a protracted downturn 0.7 percent contraction in 2016 followed by a in oil and gas revenues. Returning to a credible stronger recovery, with growth reaching 1.7 medium-term fiscal framework will be crucial percent in 2017. to boost consumer and business confidence by reducing fiscal uncertainty. Maintaining fiscal The recession is reversing Russia’s substantial discipline will require bold choices during the achievements in poverty reduction. In 2015, 2017 budget-planning process, as the authorities Russia’s poverty rate rose from 11.2 to 13.4 strive to determine new medium-term fiscal iii Russia Economic Report | Edition No. 35 Executive Summary policy priorities. A massive bank recapitalization not focus exclusively on emergency measures, temporarily stabilized the financial sector, but but also includes a number of medium-term managing systemic vulnerabilities will require economic development initiatives intended to constant vigilance and readiness to implement spur investment, including reforms designed to further stabilization measures. diminish regulatory uncertainty and strengthen judicial processes and law-enforcement systems. Russia’s longer-term growth trajectory will The swift and comprehensive implementation of depend on the effectiveness of its structural these measures would clearly signal the Russian reforms. Policies designed to bolster investor government’s commitment to improving the confidence could greatly enhance Russia’s long- investment climate. Without rapid and sustained term growth prospects. Administrative barriers to investment in new industries, Russia may miss doing business, high transportation and logistics the opportunity afforded by its current price costs, and the perception of an uneven playing advantage, and achieving sufficient productivity field all discourage investment, particularly growth to raise the country’s long-term economic in the non-resource sectors. Recognizing the trajectory will prove extremely challenging importance of addressing structural constraints, unless structural constraints to investment can the government’s new anti-crisis plan does be effectively addressed. Russia Economic Report | Edition No. 35 iv iii Russia Economic Report | Edition No. 34 PART I RECENT ECONOMIC DEVELOPMENTS: Searching for a Way Out of the Recession I n 2015 the Russian economy began its difficult adjustment to the combined impact of the economic sanctions regime imposed in July 2014 and the collapse of global oil prices later in the year. These twin shocks sharply decreased national income and depressed both consumer and investment demand, causing Russia’s real GDP to contract by an estimated 3.7 percent in 2015. Following a brief rally, a second drop in global oil prices in August 2015 delayed the anticipated economic recovery. Persistently low oil prices contributed to a dramatic depreciation of the ruble, but the country’s flexible exchange rate enabled a swift adjustment in imports, protected the central bank’s foreign-currency reserves and limited the negative impact on fiscal revenues. However, pass-through effects resulted in double-digit inflation, undermining household purchasing power and contributing to a rapid drop in consumption, as real wages declined sharply. The deterioration of real incomes coupled with rising food prices resulted in a significant increase in poverty in 2015. Efforts to manage inflationary pressures slowed the pace of monetary easing, and the central bank has kept its key policy rates at 11 percent since August 2015. Meanwhile, economic sanctions against Russia were extended, depressing economic confidence and cutting off Russian businesses and banks from global financial markets. A lack of affordable credit and plummeting consumer demand caused investment to contract for the third consecutive year. Despite regulatory forbearance and a massive recapitalization program, the financial sector remains vulnerable. While the government announced its commitment to fiscal consolidation, continued budget overruns will further deplete the already shrinking Reserve Fund. Russia Economic Report | Edition No. 35 1 I. Recent Economic Developments 1.1 Growth - Economic Recovery Delayed Russia’s efforts to cope with the economic and macro-fiscal impacts of oil-price shocks and economic sanctions dominated economic developments in 2015. As the adjustment began, a sharp drop in income reduced consumer and investment demand, causing Russia’s real GDP to contract by an estimated 3.7 percent in 2015. A second oil-price shock in August 2015 delayed the anticipated economic recovery. R ussia’s dependence on oil exports proved to be a serious liability in 2015, as an increasingly adverse external environment resulted in a had a negative impact on Russia’s oil-dependent economy. Russia’s economy contracted by an estimated 3.7 percent of GDP in 2015. Russia’s severe economic contraction (Figure 1). Global ongoing recession is negatively affecting other growth once again fell short of expectations, countries in the region through reduced trade, decelerating from a rate of 2.6 percent in 2014 to remittances and capital flows. an estimated 2.4 percent in 2015, as a slowdown in major emerging markets and developing As with other oil exporters, an adverse external economies offset a modest recovery in high- environment continues to threaten Russia’s income countries. Subdued global trade, bouts of economic stability, but fiscal challenges now financial market volatility and weakening capital outweigh macroeconomic issues. Key challenges flows contributed to a deteriorating external for oil exporters include weakening current- environment for most emerging economies account balances (Azerbaijan and Colombia) and (Box 1). Moreover, the decline in oil prices has depreciating exchange rates (Kazakhstan and persisted well beyond initial expectations, and Angola), which in some cases have prompted excess supply capacity in the global hydrocarbon the imposition of foreign-exchange controls market, policy decisions among major oil (Azerbaijan and Nigeria). Other challenges producers and a secular growth deceleration in include accelerating inflation, tighter monetary key emerging markets have spurred a further policies, falling government revenues, and decline in oil prices since mid-2015 (Box 2). This depleted fiscal buffers (Russia and Mexico). Risks second oil-price shock, which occurred amid a to Russia’s fiscal position may be exacerbated worsening growth outlook for emerging markets, by the oil-price assumption of US$50 per barrel used in the current budget, which significantly Figure 1: GDP growth, year-on-year, percent exceeds the World Bank’s projected average of 12 US$37 per barrel for 2016. Russia had built up 8 significant fiscal buffers that could have enabled it to cope with a transient terms-of-trade shock, 4 but the persistence of the current downturn in 0 global oil prices has already severely strained -4 its reserves. Russia will have difficulty meeting its 2016 deficit target of 3.0 percent of GDP, -8 and the necessity of financing budget overruns -12 will further deplete the country’s Reserve Fund. Q1-08 Q1-09 Q1-10 Q1-11 Q1-12 Q1-13 Q1-14 Q1-15 Q2-15 Q3-15 Q4-15 Coping with lower public revenues, continuing OECD Oil-exporters Russia Emerging the process of fiscal consolidation and managing OECD Eastern European EU lingering inflationary pressures will remain key Source: OECD. Note: Eastern European EU economies include the Czech Republic, Estonia, policy challenges over the medium term. Hungary, Poland, Slovakia and Slovenia. Emerging economies include Brazil, China, India, Indonesia, Mexico, South Africa and Turkey. OECD oil exporters include Australia, Canada, Chile, the Netherlands, Norway and the US. 2 Russia Economic Report | Edition No. 35 I. Recent Economic Developments The Russian economy adjusted to the worsening formation dropped by 18.7 percent in 2015, external environment through a sharp drop in contracting for the third consecutive year. income, which weakened consumer demand and discouraged investment. Gross domestic The difficult economic adjustment pushed income is estimated to have dropped by about Russia into a deep recession, which reached 10 percent, primarily due to negative terms-of- its nadir in the second quarter of 2015. The trade effects. Persistently low oil prices resulted contraction in seasonally adjusted quarterly GDP in a steep depreciation of the ruble. The free- accelerated from 0.7 percent in the last quarter floating exchange rate enabled imports to of 2014 to 1.2 and 1.3 percent in the first and rapidly adjust, with a 25.7 percent decline in second quarters of 2015, respectively (Figure 3). import volumes boosting net exports in 2015 However, expectations that Russia’s economy (Figure 2), yet the ruble’s depreciation also led to would bottom out in the third quarter of 2015 double-digit inflation. The consequent decline in did not materialize,1 and an unanticipated household purchasing power−as real wages and second oil-price shock that began in August 2015 incomes did not keep track with inflation trends− delayed the recovery. The renewed depreciation sharply reduced consumption by an estimated of the ruble increased inflationary pressures 7.5 percent in 2015, its first contraction since the and slowed the pace of monetary easing, global financial crisis in 2008. The authorities’ extending the slump in domestic demand. As a efforts to manage inflationary pressures slowed result, Russia’s economy remained in recession the pace of monetary easing, and the central during the second half of 2015, contracting by bank has kept its key policy rates at 11 percent a seasonally adjusted 0.6 percent in the third since August 2015. The economic sanctions quarter and an estimated 0.7 percent in the imposed on Russia have been extended, limiting fourth quarter. By end-2015 Russia’s economy access to global financial markets, restricting had contracted for six consecutive quarters, capital inflows and depressing private sector reflecting a cumulative decline in real GDP of confidence. High capital costs and plummeting about five percent since June 2014, while real consumer demand have given Russian firms little GDP fell below the level observed in the third incentive to expand, and as a result, gross capital quarter of 2011. Figure 2: Demand composition of GDP growth, Figure 3: GDP growth, year-on-year and quarter-on-quarter, year-on-year, percent seasonally adjusted, percent 15 5 10 5 3 1.2 0 0.8 0.1 1 1.2 0.1 0.5 0.4 -5 1.5 (0.6) -10 0.8 0.5 -1 0.6 0.2 0.2 0.3 (0.7) (0.6) -15 (0.7) (1.2) -20 -3 (1.3) -25 -5 Q1-08 Q2-08 Q3-08 Q4-08 Q1-09 Q2-09 Q3-09 Q4-09 Q1-11 Q2-11 Q3-11 Q4-11 Q1-12 Q2-12 Q3-12 Q4-12 Q1-13 Q2-13 Q3-13 Q4-13 Q1-14 Q2-14 Q3-14 Q4-14 Q1-15 Q2-15 Q3-15 Q4-15 Q1-10 Q2-10 Q3-10 Q4-10 Q1-11 Q2-11 Q3-11 Q4-11 Q1-12 Q2-12 Q3-12 Q4-12 Q1-13 Q2-13 Q3-13 Q4-13 Q1-14 Q2-14 Q3-14 Q4-14 Q1-15 Q2-15 Q3-15 Q4-15* Consumption Gross Fixed Capital Formation GDP growth Change in inventories Export Import Stat error GDP growth, y-o-y GDP growth, q-o-q, sa Source: Rosstat. Source: Rosstat. *World Bank staff estimates. The industrial sector was expected to benefit from a favorable adjustment in relative prices, lifting the economy out of its recession in the second half 1 of 2015. But industry growth remained negative throughout the year, while the contraction of industrial output ceased as the sector went from an 8 percent contraction in June to zero growth in October. Business-confidence surveys revealed weakening sentiments, and the Purchasing Managers’ Index for manufacturing continued to fall for most of 2015. Russia Economic Report | Edition No. 35 3 I. Recent Economic Developments Box 1 Global economic trends Global growth weakened again in 2015. Growth in the US and the Eurozone failed to meet expectations, and Japan’s economy contracted. Meanwhile, China continued its deceleration, and Brazil and Russia remained in deep recessions. In the fourth quarter of 2015 global growth is estimated to have slowed to just under 1.4 percent (quarter–on-quarter, annualized), its lowest level since the euro zone crisis of 2012. By contrast, fourth-quarter growth accelerated in parts of East Asia and Western Europe. Global manufacturing activity remained subdued. In 2015, the sector’s growth rate was less than half its 5-year average, and changes in the manufacturing Purchasing Managers’ Index in January 2016 reflected contractions across major emerging markets and weakening growth in advanced economies (Figure 4). Global trade remains weak. Despite a modest ongoing recovery in some advanced economies, global trade remained subdued throughout 2015, due largely to falling import demand among large commodity-exporting emerging markets such as Brazil and Russia. The increasingly pronounced rebalancing of the Chinese economy compounded this trend, negatively affecting both exports and imports. Given anemic global demand, exchange-rate depreciations have yielded limited benefits for exporters while contributing to rising costs and slowing import growth. The slow growth of global trade flows not only reduces export opportunities in the short term, but also inhibits the realization of productivity gains through increased specialization and technological transfer over the medium term. International capital flows have diminished and global equity markets remain at multi-year lows. Capital inflows to developing countries slowed to US$763 billion in 2015, down from US$1.3 trillion in 2014. 2015 was also the third consecutive year of net outflows from emerging market funds, as a combination of tumbling commodity prices, investment-risk rating downgrades and concerns about rising borrowing costs negatively impacted emerging-market assets. Global investors pulled a record US$76 billion (net) from emerging market bond and equity funds, exceeding the US$69 billion withdrawn during the global financial crisis. Outflows from emerging market bond and equity funds continued through early 2016 at a slightly faster pace for fixed income than for stocks. International bond sales by sovereign and corporate borrowers from developing countries dipped to the lowest January level since 2009, though spreads remained relatively high, as rising risk aversion pushed up borrowing costs (Figure 5). Global equity markets lost 5.5 percent of their value in January and remained near multiyear lows in February, especially oil and gas companies and banks, further tightening financing conditions. Currency adjustments are ongoing. Diverging monetary policies and growth prospects across advanced, emerging and developing economies are driving these adjustments. The dollar continued to strengthen as the US Federal Reserve raised its policy interest rate by 25 basis points in December, the first increase in nearly a decade, while the euro zone, Japan and China eased their monetary policies. The currencies of key commodity exporters (including South Africa, Russia, Brazil, Colombia and Malaysia) fell to multiyear lows at the start of 2016 as a result of the strong dollar and weak commodity prices. While currency depreciations can insulate countries against terms-of-trade shocks, they can also intensify balance- sheet pressures when combined with large dollar-denominated liabilities. The post-crisis credit boom has left many firms in emerging markets highly leveraged and vulnerable to a combination of weakening growth, rising borrowing costs and currency depreciation. Figure 4: Global industrial production and trade growth, Figure 5: Gross capital flows to developing percent change countries, US$ billions Percent change, 3m/3m saar 80 40 70 30 60 20 50 10 0 40 -10 30 -20 20 -30 10 -40 0 Jun -11 Jun -12 Jun -13 Jun -14 Jun -15 Feb -12 Apr-12 Feb -13 Aug-11 Apr-13 Feb -14 Aug-12 Apr-14 Feb -15 Aug-13 Apr-15 Aug-14 Dec-11 Aug-15 Oct -11 Dec-12 Oct -12 Dec-13 Oct -13 Dec-14 Oct -14 Dec-15 Oct -15 Nov-15 Dec-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Mar-15 Apr-15 Nov-14 Dec-14 Jan-15 Feb-15 Sep-14 Oct-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Feb-14 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Jul-13 Aug-13 Developing industrial production Developing country exports High income industrial production High income imports Syndicated bank lending Bond issuance New equity issuance Source: Datastream and World Bank Prospects. Source: Dealogic and World Bank Prospects Group. 4 Russia Economic Report | Edition No. 35 I. Recent Economic Developments Box 2 Global oil-price trends Global oil prices dropped from a high of over US$100 per barrel in the first half of 2014 to about US$40 per barrel in August 2015 and reached a 13-year low of less than US$30 per barrel in January 2016. Oil prices continued to decline in the second half of 2015, even as investment and output in the US shale oil sector plummeted. Low oil prices impacted other energy markets, especially the European and Asian natural gas markets (Figure 6). These spillover effects have further negative implications for Russian energy exports. By end-2015, three key World Bank commodity-market indexes— energy, metals and agricultural raw materials—were down an average of about 40 percent from their 2011 peaks. Metal prices remained low due to high inventories and weakening Chinese demand. The protracted drop in oil prices reflects a combination of supply- and demand-side factors. On the supply side, the ongoing shale oil and fracking boom in the US dramatically boosted global output, more than offsetting declines in Libya, Syria and Yemen (Figure 7). Meanwhile, Iranian exports rose more steeply than expected in the wake of the recent multilateral agreement regarding the country’s nuclear program. OPEC’s December 2014 decision to defend its market share eliminated the only plausible avenue for stabilizing supply in the short term. Instead, increasing production in Saudi Arabia and Iraq pushed OPEC’s total output to a record 33 million barrels per day in January following the group’s formal abandonment of its 30-million-barrel-per-day target. On the demand side, high OECD inventories, a mild winter in the Northern Hemisphere and slowing growth among major oil importers put further downward pressure on prices, which continued to fall through January 2016. There are signs that the slump in global oil prices may be slowly approaching its end, as overall production growth is declining, while low prices have encouraged increased consumption. US shale oil production is slowly decelerating, though efficiency gains have increased the sector’s resilience, and other global producers are also maintaining high output levels despite sharp cutbacks in overall investment. Discussions regarding a possible coordinated supply cut by Saudi Arabia, Russia and some smaller oil exporters have yet to yield an agreement. Nevertheless, global oil production growth fell by 50 percent in the fourth quarter of 2015 compared to the average for the first three quarters. Most fourth-quarter output gains came from OPEC countries (Iraq and Saudi Arabia), following ten consecutive quarters in which non-OPEC countries (especially the US) posted the largest increases in production. Finally, while slowing economic growth depressed global oil demand, the sheer magnitude of the drop in oil prices—two-thirds of which was attributable to increased supply—has spurred consumption growth, which reached a five-year high of 1.8 percent in 2015 despite weakening slightly in the fourth quarter. Figure 6: Global energy prices, US$/mmbtu Figure 7: Crude oil supply growth, mb/d US$/mmbtu Thousand mb/d 25 5 4 20 Crude oil 3 2 15 1 0 10 Natural Gas (US) -1 -2 5 -3 Q1-11 Q2-11 Q3-11 Q4-11 Q1-12 Q2-12 Q3-12 Q4-12 Q1-13 Q2-13 Q3-13 Q4-13 Q1-14 Q2-14 Q3-14 Q4-14 Q1-15 Q2-15 Q3-15 Q4-15 Q1-10 Q2-10 Q3-10 Q4-10 Coal (Australia) 0 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Iran Libya Syria Yemen United States Net Changes Source: World Bank. Source: World Bank and International Energy Agency. Note: These are relative prices of different fuels in terms of energy units to ensure comparability. Russia Economic Report | Edition No. 35 5 I. Recent Economic Developments A second terms-of-trade shock in 2015 further double its marginal impact during the global weakened the ruble and prolonged the financial crisis (Table 1). negative impact of its devaluation on household consumption. The pass-through effect combined Investment continued to decline sharply in the with restrictions on food imports in 2014 led to second half of 2015. Throughout the year, the double-digit inflation in the first half of 2015. private sector scaled down investments as demand At the same time, insignificant nominal wage slackened. Meanwhile, the economic sanctions growth in the private sector and the limited regime restricted access to global capital markets indexation of public wages and transfers2 and chocked off foreign investment, while the (Section 1.5) caused household consumption costs of domestic credit remained elevated due to plummet by an average of 7.5 percent, year- to the suspension of monetary easing (Section on-year, in the first half of 2015. The renewed 1.3). An expenditure-focused fiscal adjustment depreciation of the ruble began in August did nothing to reinforce household incomes or 2015 and intensified in November-December, stimulate investment (Section 1.4). As a result, prolonging the negative impact of the terms- gross fixed capital investment dropped by 7.6 of-trade shock on household purchasing power. percent, year-on-year, trimming 1.6 percentage The deterioration of real incomes in a context of points from overall growth. Russian producers persistently high interest rates diminished the cut inventories sharply as consumer demand capacity of households to service debt or take plummeted, particularly in the first two quarters out new loans.3 As a result, consumer demand of 2015.4 Inventory destocking reduced annual remained deeply depressed in the second half of growth by 2.3 percentage points, and its 2015, contracting by an estimated 11.4 percent, contribution was negative in all four quarters year-on-year. Exacerbated by a slight reduction of 2015. Consequently, gross capital formation in government consumption, total consumption dropped by 18.7 percent, cutting 3.9 percentage contracted by 7.5 percent and reduced growth points from GDP growth, more than in 2013 and by 5.4 percentage points in 2015, more than 2014 combined. Table 1: Contribution to growth by demand components, percentage points 2007 2008 2009 2010 2011 2012 2013 2014 2015 GDP growth, percent 8.5 5.2 -7.8 4.5 4.3 3.5 1.3 0.7 -3.7 Consumption 7.4 5.7 -2.6 2.6 3.7 4.1 2.1 1.0 -5.4 Households 6.9 5.1 -2.5 3.0 3.5 3.6 1.8 0.9 -5.1 Government 0.5 0.6 -0.1 -0.3 0.3 0.5 0.3 0.1 -0.3 Gross capital formation 4.7 2.5 -10.5 5.4 4.7 1.0 -1.8 -1.4 -3.9 Fixed capital investment 3.9 2.2 -3.2 1.3 2.0 1.3 0.2 -0.1 -1.6 Change in stocks 0.8 0.3 -7.2 4.1 2.8 -0.3 -2.0 -1.3 -2.3 Exports 2.1 0.2 -1.5 2.0 0.1 0.4 1.4 0.1 1.0 Imports -5.5 -3.2 6.7 -5.3 -4.3 -2.1 -0.5 1.3 5.4 Source: Rosstat and World Bank staff calculations. 2 Pensions were indexed by 11 percent, while public wages were not indexed at all. 3 The loan-default rate for households rose from 8.9 percent in November 2014 to 11.6 percent in November 2015, and banks limited consumer lending (Section 1.3). 4 The pace of destocking slowed in the second half of 2015, as quarter-on-quarter contractions in consumer demand decelerated and the costs of imported inputs stabilized. 6 Russia Economic Report | Edition No. 35 I. Recent Economic Developments Box 3 The production structure of GDP growth in 2015 The nontradable and tradable sectors both contributed negatively to GDP growth in 2015, as domestic demand dampened (Figure 8). Falling consumer demand hit the service sector especially hard. Trade—the Russian economy’s largest subsector—contracted by 10.0 percent, from a 1.4 percent growth rate in 2014. Other services contracted at a similar pace, and the poor performance of nontradables reduced sectoral growth by 2.6 percentage points in 2015, compared to a positive contribution of 0.4 percentage points in the previous year. Weak domestic demand also deepened the manufacturing sector’s contraction to 5.1 percent, year-on-year, compared to a positive growth rate of 0.6 percent in 2014 (Figure 9). This contraction more than offset robust agricultural growth and a slight expansion in the extractive industries, and together the tradable sectors reduced overall growth by a net 0.5 percentage points. Some industries were able to take advantage of the weaker ruble to increase output and exports, but most manufacturing sectors continued to contract in 2015. Most manufacturers—who might normally be well positioned to benefit from import substitution—continued to see demand for their products fall. Here the depreciation’s positive benefits were unable to compensate for the collapse of domestic demand. Only the agricultural sector expanded notably by 3.1 percent in 2015, benefiting largely from the Russian food import ban. The sharp relative price adjustment bolstered the competitiveness of certain exports, particularly non-energy commodities such as coal, metals and chemicals, and investment and employment statistics for 2015 indicate increased factor allocation to those sectors (Figure 10 and Figure 11). However, investment in manufacturing remained negative due to spare capacity, structural rigidities, and the surging cost of imported intermediate goods. Figure 9: Growth in tradables, value, added, Figure 8: Contribution to GDP growth by sector, percent year-on-year, percent 10 5.0 0.1 3.0 5 2.5 1.0 0.0 0.9 0.1 0.9 0.4 0.4 0.3 -0.5 0 -1.0 -2.6 -3.0 -0.2 -5 -5.0 -10 -7.0 2012 2013 2014 2015 2012 2013 2014 2015 Tradable Non -tradable Public sector Agriculture Mineral extraction Manufacturing Source: Rosstat and World Bank staff calculations. Source: Rosstat. Figure 10: Fixed investment growth by sector, 2015, Figure 11: Employment growth by sector, 2015, year-on-year, percent year-on year*, percent 20 3.0 15 14.0 2.5 12.2 10.7 10 2.0 5 2.9 3.4 1.5 0 1.0 -5 -3.4 0.5 0 -10 -9.5 -11.8 -11.7 -10.9 -0.5 -15 -16.3 -1.0 -20 Public Agriculture Trade Administration Health Transport and Education Construction Manufacturing Utilities Communications Mining Agriculture Trade Construction Food processing Pulp and paper production Manufacturing (Total) Machine building Rubber and plastic products Mining Electrotechnical equipment Chemical production -1.5 Sectors Average Source: CBR, Haver. Source: Rosstat, Haver, Analytics and World Bank staff estimates. *Data for 2015 include Crimea, which accounts for the increase in total employment in 2014. Russia Economic Report | Edition No. 35 7 I. Recent Economic Developments Rapidly falling imports drove an increase in net estimated 9.8 percent, year-on-year, in the last exports in 2015, yet this was not sufficient to quarter of 2015, up from an average of just 1.6 compensate for the contraction in domestic percent in the first three quarters. As a result, demand. Imports dropped dramatically as the total export volumes grew by 3.6 percent in 2015,5 depreciation of the ruble increased their relative contributing 1.0 percentage points to growth. cost, adding 5.4 percentage points to overall Coupled with the sharp import contraction, this growth. Nevertheless, the import contraction pushed the positive contribution of net exports decelerated in the second half of 2015, especially to growth to 6.4 percentage points in 2015, a in the last quarter. The continued depreciation fourfold increase over the previous year. These of the ruble also boosted export performance trends made net-exports the principal driver of in certain sectors, including chemicals and oil growth dynamics in 2015. products (Box 3). Export volumes grew by an 1.2 Balance of Payments– Swift Import Adjustment Supports the Current Account The Balance of Payments remained stable despite adverse terms-of-trade shocks and restricted access to international capital markets. The current-account surplus nearly doubled from 2.8 percent of GDP in 2014 to 5.2 percent in 2015, as imports swiftly adjusted to the ruble depreciation and the investment and labor income balances improved. Meanwhile, net capital outflows moderated from 7.4 percent of GDP in 2014 to 4.4 percent in 2015. R ussia’s external balances adjusted smoothly to external shocks, as the flexible exchange rate facilitated a rapid decrease in imports. The 2014 to US$69.6 billion in 2015, almost doubling as a share of GDP6 from 2.8 percent in 2014 to 5.2 percent in 2015 (Figure 13). The nonoil flexible exchange-rate regime enabled the real current-account deficit improved from US$266.7 effective exchange rate (REER) to adjust rapidly billion in 2014 to US$129.3 billion in 2015—or to commodity-price shocks in 2015, resulting in from 13.0 percent of GDP to 9.8 percent—due a 16.5 percent depreciation and a simultaneous to the drastic reduction in imports coupled with drop in import demand (Figure 12). The current improved investment and labor income balances. account surplus rose from US$58.3 billion in Figure 13: The composition of the current-account balance, Figure 12: Goods imports, the REER and oil prices percent of GDP 120 12 110 9 100 90 6 80 3 70 60 0 50 -3 40 -6 30 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 -9 2008 2009 2010 2011 2012 2013 2014 2015 Goods Services Import of goods, Dec 13 = 100, SA Brent price, Dec 13 = 100 Compensation of employees Investment income REER, Dec 13 = 100 Transfers Current account balance Source: CBR and Haver. Source: CBR and World Bank staff estimates. 5 National accounts data reflect export growth by volume and value added. These figures may differ significantly from export values reported in the balance-of-payments data, which are based on volume and export prices. 6 The relative improvement in the current-account balance was also the result of the depreciation, which caused Russia’s GDP to drop by 35.4 percent in dollar terms. 8 Russia Economic Report | Edition No. 35 I. Recent Economic Developments The total value of goods imports dropped by for a small number of manufactures, especially 37.4 percent in 2015, from US$308.0 billion chemicals (5.6 percent) and machinery (0.4 to US$193.0 billion. This was due not only to percent). Export volumes for food products and imports becoming relatively more expensive, but textiles declined by an average of 4.3 percent also to the weakening of import demand due to and 6.2 percent, respectively. The special focus the ongoing recession and restrictions on food chapter included in this edition of the Russia imports. Ultimately, the sharp reduction in goods Economic Report examines recent export trends imports could not fully compensate for falling in greater detail. export revenues, narrowing the trade surplus from US$189.7 billion to US$148.5 billion. Oil The continued deleveraging of external debt and and gas export receipts dropped by 38.8 percent, a decline in remittance outflows also supported from US$325.0 billion in 2014 to US$198.9 the growth of the current-account surplus. A billion in 2015, reflecting a 47.0 percent decline substantial reduction in net external liabilities in the average (Brent) oil price. The value of reduced outbound interest and dividend non-energy exports decreased by 17.5 percent, payments, nearly halving the investment income from US$172.8 billion in 2014 to US$142.6 balance from US$58.0 billion in 2014 to US$31.6 billion in 2015, as global prices for non-energy billion in 2015. Russia’s net external liabilities commodities fell and manufacturing exporters had already decreased by US$58.2 billion in decreased prices in dollar terms. The services the second half of 2014 when the economic balance improved significantly, as a decline sanctions regime curbed access to international in service imports, mainly tourism abroad, capital markets, and in 2015 net external exceeded a drop in service exports (Figure 14). liabilities declined by a further US$73.4 billion. The extension of the economic sanctions regime, The volume of non-energy exports increased, coupled with low oil prices and negative growth, though the value of those exports dropped has kept external borrowing costs for Russian substantially. Customs data indicate that the firms elevated. Russia’s 5-year credit-default volume of non-energy exports increased, year- swap (CDS) spread exceeded 300 basis points for on-year, during the first three quarters of 2015, most of 2015, up from 170 basis points in early in particular for non-energy commodities such 2014 (Figure 15). In 2015 Standard & Poor and as wood and metals, which grew by an average Moody’s both downgraded Russia’s sovereign of 7.7 and 3.1 percent, respectively, as well as rating to below investment grade, while Fitch Figure 14: Oil prices and the trade, services and investment- income balances Figure 15: Russia’s 5-year CDS spreads 60 140 700 50 40 600 30 500 20 90 10 400 0 -10 300 -20 -30 40 200 Q1-13 Q2-13 Q3-13 Q4-13 Q1-14 Q2-14 Q3-14 Q4-14 Q1-15 Q2-15 Q3-15 Q4-15 100 Trade balance, bln USD (left axis) Investment income balance, bln USD (left axis) Services balance, bln USD (left axis) Crude oil, Brent, $/b (right axis) 1/2/13 7/2/13 1/2/14 7/2/14 1/2/15 7/2/15 1/2/16 Source: CBR, Bloomberg and World Bank staff estimates. Source: Bloomberg. Russia Economic Report | Edition No. 35 9 I. Recent Economic Developments Box 4 External debt trends Russia’s external debt decreased by about 10.0 percent Figure 16: Debt to non-residents, US$ billion adjusted for reevaluation effects to US$515.9 billion at end-2015 from US$599.9 billion at end-2014 (Table 2). 800 External government debt dropped from US$41.6 billion at end-2014 to US$30.6 billion at end-2015. While non- 700 residents sold off government bonds, the authorities 600 refrained from new international borrowing and continued to make scheduled debt payments (Figure 16). 500 After adjusting for the depreciation of the ruble, the total public debt stock dropped by 16.0 percent between end- 400 2014 and end-2015. 300 The banking sector’s total external debt, adjusted for 200 depreciation, shrank by 16.8 percent between end-2014 and the end of the quarter three in 2015. This followed 100 a drop of 11.6 percent in the second half of 2014, when 0 the imposition of economic sanctions prompted faster Mar-13 Mar-14 Mar-15 Dec-12 Dec-13 Dec-14 Dec-15 Sep-13 Sep-14 Sep-15 external debt reduction by stateowned banks relative to Jun-13 Jun-14 Jun-15 private banks. However, this trend reversed in 2015, as State Banks Non-banking sector higher interest rates, the rising cost of ruble-denominated debt service, and the stalled growth of foreign-currency Source: CBR. credit to the nonbanking sector forced private banks to deleverage faster than state-controlled banks. State- owned companies in the non-banking sector also deleveraged faster in the second half of 2014 than in the first three quarters of 2015, while deleveraging in private firms slowed. Large scheduled debt payments among non-financial firms in the fourth quarter of 2015 (Table 3) only modestly increased pressure on the financial account, as firms managed to roll over about 60 percent of their debt. Overall, the devaluation-adjusted external debt stock of banks and non-bank firms fell by 8.2 percent in the second half of 2014 and by 7.2 percent in the first three quarters of 2015. Table 2: The external debt stock, 2014–2015, US$ billion Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec- 13 14 14 14 14 15 15 15 15 Total debt 728.9 715.9 732.8 680.9 599.9 556.2 555.6 536.5 515.9 Corporate 651.2 646.8 659.4 615.7 547.7 510.9 509.3 494.4 474.3 Banks 214.4 214.0 208.9 192.3 171.5 154.2 148.9 140.0 131.7 of which Private Banks 81.4 76.3 73.5 69.1 63.4 53.6 51.1 47.3 Non-financial corporations 436.8 432.7 450.6 423.4 376.2 356.7 360.4 354.4 342.6 of which Private Non-fin. Corporations 271.6 264.1 279.7 260.2 230.8 224.0 228.4 212.7 Source: CBR. End of the month data. Table 3: Russia’s external debt-service schedule, 2015–2017, US$ billion Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Government 1.0 0.9 0.6 0.9 1.1 0.7 2.2 0.8 Banks 10.7 5.6 7.3 7.1 5.0 6.9 8.1 3.9 Non-banking sector 30.8 19.5 19.2 13.3 18.8 13.9 14.0 9.1 Total 43.0 26.0 27.1 21.3 24.9 21.6 24.2 13.8 Source: CBR. 10 Russia Economic Report | Edition No. 35 I. Recent Economic Developments reduced Russia’s sovereign debt rating to the liabilities dropped by US$67.0 billion—including lowest level in the investment-grade range. US$59.8 billion in the banking sector alone. A These developments amplified deleveraging dramatic decline in net acquisitions of foreign across all sectors of the Russian economy. The assets, which dropped from US$121.9 billion in value of Russia’s external debt dropped from 2014 to a negative US$3.4 billion in 2015, drove US$599.9 billion at end-2014 to US$515.9 billion the decline in net capital outflows between at end-2015 (Box 4), yet its external debt burden 2014 and 2015. The banking sector shed foreign grew in relative terms, rising from 43.3 to 46.8 assets to service external debt, while a 4.2 percent of GDP and from 12.8 to 15.7 months percent decrease in corporate profits and a 33.0 of exports. This increase in the relative size of percent decrease in household income (in dollar the debt burden also implies that deleveraging terms) limited opportunities for non-financial will continue for some time. Finally, a drop in firms and households to invest in foreign assets.7 outbound remittances halved the labor-income Outbound foreign direct investment (FDI) more deficit, which fell from US$10.1 billion in 2014 than halved to US$21.6 billion in 2015, while to US$5.1 billion in 2015, as the number of inbound FDI dropped from US$22.0 billion migrant and expatriate workers declined and the to US$4.8 billion. Finally, foreign-currency depreciation diminished the value of remittances acquisition by households and nonfinancial firms in dollar terms (Box 5). dropped by US$19.7 billion in 2015, compared to an increase of US$41.8 billion during in Moderating net capital outflows helped improve 2014, as confidence in the ruble strengthened the financial- and capital-account balances and despite its continued depreciation. Overall, net eased pressures on international reserves. capital outflows returned to their 2012–2013 Deleveraging continued, and private sector net levels, falling from US$151.6 billion in 2014 to Box 5 Remittance trends Remittance outflows declined significantly in the first three quarters of 2015 due to the ruble depreciation. Outbound remittances declined by 43.3 percent, year-on-year, to US$11.9 billion. More than two thirds of all remittances (76 percent) went to the Commonwealth of Independent States (CIS) countries, mainly to Uzbekistan (US$2.3 billion), Tajikistan (US$1.5 billion), Ukraine (US$ 1.3 billion), the Kyrgyz Republic (US$1.1 billion), and Armenia (US$0.9 billion) (Figure 17). Remittance inflows during the same period totaled US$4.9 billion, down 8.1 percent from a year earlier. CIS countries accounted for 35.4 percent of total remittance inflows, led by Kazakhstan (US$0.7 billion) and Uzbekistan (US$0.3 billion) (Figure 18). Figure 17: Remittance outflows, Q1-3 2015 Figure 18: Remittance inflows, Q1-3 2015 5.4 7.1 2.3 2.4 1.0 24.2 3.3 14.6 2.2 Azerbaijan Azerbaijan Armenia Armenia Belarus Belarus Kazakhstan Kazakhstan 9.2 Kyrgyz Republic 2.7 Kyrgyz Republic Moldova 1.2 Moldova Tajikistan Tajikistan Turkmenistan 2.4 Turkmenistan Uzbekistan 0.6 Uzbekistan 5.5 Ukraine Ukraine 10.7 Non-CIS 5.9 Non-CIS 2.2 64.6 19.5 12.8 0.1 Source: CBR. Source: CBR. The implementation of the government’s new de-offshoring law at end-2014 and the mandated reduction in net foreign assets by oil exporters and 7 other state-owned companies further curtailed net foreign-asset acquisition. Russia Economic Report | Edition No. 35 11 I. Recent Economic Developments Table 4: Net capital flows, 2010–2015 (US$ billions) Q1 Q2 Q3 Q4 2010 2011 2012 2013 2014 2015 2015 2015 2015 2015 Total net capital inflows to the -30.8 -81.4 -53.9 -61.6 -151.6 -58.5 -33.1 -18.6 3.1 -10.0 private sector Net capital inflows to the 22.8 -27.5 7.9 -17.3 -86.0 -34.0 -14.2 -12.6 -10.9 3.7 banking sector Net capital inflows to the non- -53.6 -53.8 -61.8 -44.4 -65.6 -24.5 -18.9 -6.0 14.0 -13.6 banking sector Source: CBR. Table 5: The balance of payments, 2010–2015, US$ billions Q1 Q2 Q3 Q4 2010 2011 2012 2013 2014 2015 2015 2015 2015 2015 Current account balance 67.5 97.3 71.3 33.4 58.3 69.6 30.0 16.6 8.0 15.0 Trade balance 147.0 196.9 191.7 180.6 189.7 148.5 45.5 43.7 28.9 30.3 Non-oil current account balance -186.6 -244.5 -275.5 -316.1 -266.7 -129.3 -24.1 -38.3 -37.9 -29.0 Capital and financial account -21.6 -76.0 -30.9 -46.6 -173.8 -72.9 -37.5 -19.6 -2.6 -13.2 Errors and omissions -9.1 -8.7 -10.4 -8.9 8.0 5.0 -2.6 0.8 4.4 2.5 Change in reserves (- = increase) -36.8 -12.6 -30.0 22.1 107.5 -1.7 10.1 2.2 -9.7 -4.3 Memo: average oil price 79.7 111.1 112.0 108.9 98.9 52.4 53.9 62.1 50.0 43.4 (Brent, US$/barrel) Source: CBR. US$58.5 billion in 2015 (Table 4). This reduced billion in reserves in January 2015, international the financial- and capital-account deficit by two- reserves remained at a comfortable level of thirds, from US$173.8 billion to US$72.9 billion. US$368.4 billion at end-2015 (15.7 months of As the Central Bank of Russia (CBR) refrained imports), compared to US$385.5 billion (10.5 from intervening in foreign-currency markets, months of imports) at end-2014 (Table 5). with the exception of a one-time sale of US$2.3 1.3 Monetary Policy and the Financial Sector – Addressing Policy Tradeoffs The Central Bank of Russia faced the difficult policy challenge of lowering inflation in line with its medium-term target without completely stifling credit growth in a struggling economy. The authorities addressed this challenge through a measured monetary-easing strategy. Regulatory forbearance continues to prevent a thorough analysis of macro-prudential indicators, and financial sector risks linger despite a massive recapitalization program. A dherence to the flexible exchange-rate regime helped to shield the country’s foreign currency and fiscal reserves. The exchange rate the key determinant of exchange-rate dynamics (Box 6). The ruble depreciated by 37.4 percent against the US dollar in 2015, while the average remained well-aligned with prevailing economic (Brent) oil price dropped by 47 percent. conditions, facilitating the process of structural This led to a sharp REER depreciation which transformation. As foreign-exchange-liquidity supported Russia’s transition to a context of pressures eased in 2015, oil prices again became lower oil prices by allowing relative prices 12 Russia Economic Report | Edition No. 35 I. Recent Economic Developments to favor Russian producers and exporters. Figure 19: Exchange-rate dynamics in Russia, Kazakhstan Meanwhile, the free float helped to keep the and Azerbaijan (2014 = 100) country’s foreign currency reserves intact and 120 120 the depreciation prevented a drain on fiscal 100 100 reserves by limiting the negative impact on fiscal balances. By end-2015, the CBR’s foreign- 80 80 currency reserves remained strong at about 16 60 60 months of imports. This stands in contrast to the experience of other regional oil exporters 40 40 such as Kazakhstan and Azerbaijan, which 20 20 maintained fixed exchange rates throughout 2014 and most of 2015 despite falling oil prices, 0 0 01-14 02-14 03-14 04-14 05-14 06-14 07-14 08-14 08-14 09-14 10-14 11-14 12-14 01-15 02-15 03-15 04-15 05-15 06-15 07-15 08-15 09-15 10-15 11-15 12-15 01-16 thereby depleting their reserves and running up large fiscal deficits8 before allowing their USD/RUB USD/AZN USD/KZT currencies to depreciate9 (Figure 19). Source: CBR. tariff increase in July and restrictions on food Throughout 2015, Russia’s monetary policies imports, boosted inflationary pressures in the reinforced macroeconomic stability by second half of the year. This kept inflation slowly reigning in inflation. A combination expectations stubbornly high. As a result, of monetary and nonmonetary factors kept inflation slowed but remained in double digits. inflationary pressures elevated throughout The 12-month consumer price index (CPI) 2015. Nonmonetary factors, including the pass- decreased from 15.0 percent in January 2015 through effect of the ruble’s depreciation, the to 12.9 percent in December (Box 7), yet it Box 6 Oil-price and exchange-rate dynamics As liquidity pressures eased in the second quarter of 2015, oil prices once again became the main driver of Figure 20: Changes in oil prices and the nominal exchange-rate dynamics. The CBR restricted itself to a exchange rate single US$2.3 billion intervention in January, when oil 5 3.5 prices reached record lows and the nominal exchange rate approached 70 RUB/US$. From February to June, the 4.8 3.6 free-floating ruble benefited as oil prices rallied. By May, 4.6 3.7 it had appreciated by around 30 percent against the dollar 4.4 3.8 and the exchange rate rebounded to around 50 RUB/US$ (Figure 20). The ruble’s appreciation allowed the CBR to 4.2 3.9 launch a medium-term reserve-replenishing program in 4 4 May, which called for daily purchases of US$200 million to 3.8 4.1 reach a goal of US$500 billion by 2018. Between May and July, the CBR purchased a total of US$10.1 billion in new 3.6 4.2 reserves. However, depreciation pressures intensified in 3.4 4.3 August and especially at the end of 2015, when oil prices declined further and geopolitical tensions increased. In 3.2 4.4 December, the average oil price fell below US$38 a barrel, 3 4.5 and between May and December the ruble depreciated 01-14 02-14 03-14 04-14 05-14 06-14 07-14 08-14 09-14 10-14 11-14 12-14 01-15 02-15 03-15 04-15 05-15 06-15 07-15 08-15 09-15 10-15 11-15 12-15 01-16 02-16 by 28 percent against the US dollar. In January 2016, oil prices dipped under US$30 per barrel and the nominal Oil price (Brent), ln Rub/USD, ln (rhs, reverse order) exchange rate reached a record low of 83 RUB/US$, yet the CBR refrained from intervening in the foreign- Source: CBR and Haver Analytics. exchange market. 8 Azerbaijan’s reserves dropped from US$13.8 billion (8.4 months of imports) at end-2014 to US$5 billion (3.6 months of imports) at end-2015, while its fiscal balance deteriorated from a surplus of 2.7 percent of GDP to a deficit of 1.1 percent. Kazakhstan spent about 15 percent of its total reserves, including foreign assets in its sovereign wealth fund, which dropped from US$100.8 billion at end-2014 to US$91.3 billion at end-2015. At the same time, its fiscal balance deteriorated from a surplus of 0.9 percent of GDP to an estimated deficit of 6.6 percent. 9 Kazakhstan moved to a flexible exchange rate regime in August 2015, while Azerbaijan introduced a flexible exchange-rate regime in December 2015 following a one-off depreciation of 25 percent in February. Russia Economic Report | Edition No. 35 13 I. Recent Economic Developments continued to exceed the CBR’s target range Figure 21: Key policy rates, percent of 8.2-8.7 percent established in December 18 2014. To manage inflationary pressures, the CBR slowed the pace of monetary easing in the 16 second quarter of 2015 and discontinued the 14 easing cycle altogether in August. 12 In January 2015, the CBR launched a monetary- 10 easing cycle designed to negotiate the tradeoff 8 between successful inflation targeting and 6 lower interest rates. The CBR cut its key policy 4 rate from a record high of 17 percent−a legacy Feb-2015 Jun-2015 Mar-16 of the currency crisis in December 2014−while keeping a close eye on inflation dynamics. In Source: CBR. the first half of 2015, the CBR lowered the key policy rate by 600 basis points in five modest and a rising share of nonperforming loans (NPLs) incremental adjustments (Figure 21), gradually negatively affected bank balance sheets. NPLs easing monetary conditions (Box 8). Monetary increased from 6.7 percent of total loans in easing substantially reduced financing costs on January 2015 to 8.3 percent in December. Banks’ the interbank market, but the impact on credit profit margins fell close to zero (Figure 26) despite growth was negligible. Credit growth continued regulatory forbearance. Many banks adjusted by to slow throughout the year, dropping from reducing their credit portfolio, especially credit 25.9 percent, year-on-year, in December 2014 to households, which dropped by 5.7 percent, to 7.6 percent in December 2015 (Figure 25).10 year-on-year, in December 2015, compared to Dwindling credit growth also reflected greater an increase of 13.8 percent in December 2014. risk aversion among banks, as falling asset values Box 7 Drivers of CPI inflation in 2015 Rising food prices drove CPI inflation in the first half of Figure 22: CPI inflation components, year-on-year, percent 2015, while persistently high core inflation was the key factor in the second half of the year. Food-price inflation 25 outpaced all other CPI components and proved highly sensitive to both the pass-through effect of the ruble’s depreciation and the impact of restricted food imports. 20 Annual food-price inflation rose from over 20 percent in January 2015 to 23.3 percent in February, pushing headline 15 inflation to a record high of 16.9 percent in March 2015 (Figure 22). Food-price inflation fell during the second half of the year, as the pass-through effect diminished 10 and consumer demand weakened. As a result, 12-month food-price inflation slowed to 14 percent in December 5 2015. Through the second half of 2015 prices for non-food goods and services kept CPI inflation elevated. These two consumer price components climbed steadily through 0 the third quarter due to the delayed impact of the ruble’s Feb-16 Feb-15 Sep-15 Feb-14 Sep-14 Jan-16 Jan-15 Jan-14 Mar-15 Mar-14 Dec-15 Dec-14 Jun-15 Jun-14 Jul-15 Aug-15 Jul-14 Aug-14 Oct-15 Oct-14 Apr-15 May-15 Apr-14 May-14 Nov-15 Nov-14 depreciation, keeping core inflation above 16 percent until November. Non-food inflation increased from 11.2 percent Core inflation CPI inflation Food inflation in January to a peak of 15.7 percent in November before Non-food inflation Services inflation sliding to 13.7 percent in December. The midyear tariff increase boosted service-price inflation, which rose from Source: Rosstat. 12.3 percent in January to 14.1 percent in August before falling to 10.2 percent in December. This can be largely attributed to the reevaluation effect on foreign-currency credit extended to nonfinancial firms. 10 14 Russia Economic Report | Edition No. 35 I. Recent Economic Developments Box 8 Monetary dynamics in 2015 The CBR’s monetary-easing cycle began to measurably loosen monetary conditions beginning in the second quarter of 2015.11 High interest rates adopted in late 2014 kept monetary conditions tight through the first quarter of 2015. The growth of the money supply (M2) decelerated, while broad money contracted sharply (Figure 23 and Figure 24). Monetary easing continued in the second half of 2015, but was suspended in August 2015 as a further decline in oil prices brought with it renewed depreciation pressures and inflationary risks. Average M2 growth accelerated in annual terms from 4.7 percent in the first quarter of 2015 to 9.5 percent in the fourth quarter. The monetization of the economy increased, with the M2-to-GDP ratio rising to 44.2 percent in the fourth quarter of 2015, a year-on-year increase of 1.4 percentage points. The CBR considers current monetary dynamics to be consistent with the achievement of its medium-term inflation target of 4.0 percent by end-2017. Figure 24: Broad monetary base dynamics, Figure 23: Money-supply dynamics 3-month moving average 25 45 11,000 44 20 10,500 43 42 15 10,000 41 40 9,500 10 39 38 9,000 5 37 8,500 0 36 Q1-12 Q2-12 Q3-12 Q4-12 Q1-13 Q2-13 Q3-13 Q4-13 Q1-14 Q2-14 Q3-14 Q4-14 Q1-15 Q2-15 Q3-15 Q4-15 8,000 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Average Money Supply growth, y-o-y, sa, percent (LHS) Average Money Supply, percent of GDP (RHS) Source: CBR and World Bank staff calculations. Source: CBR and World Bank staff calculations. Figure 25: Credit growth, year-on-year, percent Figure 26: Profitability and credit risk, percent 60 20 3 18 50 2.5 16 40 14 2 30 12 20 10 1.5 8 10 1 6 0 4 0.5 -10 2 -20 0 0 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 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 Apr-15 Oct-15 Apr-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Jul-15 Apr-10 Oct10 Apr-11 Oct-11 Jan-12 Jul-12 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Jul10 Jan-11 Jul-11 Nonfinancial Organisations Households Total Credits Return on Equity Share of NPLs (total) Return on Assets (RHS) Source: CBR and World Bank staff calculations. Source: CBR. The use of the Reserve Fund for budget financing was money supply neutral as it was sterilized by the central bank. 11 Russia Economic Report | Edition No. 35 15 I. Recent Economic Developments The banking sector’s financial indicators remain at between 12.5 and 13.0 percent (Figure 27), difficult to assess due to the CBR’s regulatory with almost all banks meeting the statutory 10 forbearance.12 The return on equity among percent requirement (Figure 28). However, the Russian banks dropped from 7.9 percent to CBR withdrew its forbearance in January 2016, 2.3 percent during the year, and decreasing and rising pressure on bank capital is expected profitability had an especially damaging effect to result in falling CARs among affected banks. on medium-to-large banks.13 Thanks to a massive Meanwhile, the CBR intensified its supervision state recapitalization program14 combined with of the banking sector,15 and its delicensing of regulatory forbearance, Russian banks appear to 93 financially unviable banks reduced the total be adequately capitalized. The aggregate capital- number of banks from 834 to 733. adequacy ratio (CAR) remained stable in 2015 Figure 28: Distribution of banks by capital adequacy Figure 27: Capital adequacy ratio, end-of-period, percent ratio, 2015 14 24 3.7 13 13.5 13.0 12.9 12.9 12.5 12.7 12 33.2 11 508 10 9.1 9.0 9.1 8.9 8.9 49.3 9 8.5 8 93 7 100 13.7 6 Dec-13 Dec-14 Sep-15 Oct-15 Nov-15 Dec-15 Number of banks Share of banking sector assets (%) Capital to risk-weighted assets Core capital to risk-weighted assets 10%-12% 12%-14% Above 14% Below 10% Source: CBR. Source: CBR. 1.4 The Government Budget - Uncertainty in the Face of Unresolved Medium-Term Challenges The federal budget deficit shot up from 0.4 percent of GDP in 2014 to 2.4 percent in 2015, prompting the authorities to draw down the Reserve Fund by almost half. The government declared a fiscal consolidation plan primarily focused on the expenditure side. Russia’s fiscal position for 2016 remains uncertain as lower than projected oil prices are expected to lead to a broader revision of budgetary parameters during 2016. T he federal deficit increased dramatically in 2015 due to the large drop in revenues, driven by rapidly shrinking oil and gas revenues. In 2014, the ruble’s depreciation largely offset falling oil prices. However, the further depreciation of the exchange rate in 2015 could 12 The CBR’s forbearance includes allowing banks to use the original book value of assets rather than requiring them to use market value, meaning that they are not required to recognize asset losses. Banks were thus able to avoid having to recapitalize their balance sheets immediately, obviating the decline in their solvency margins. 13 Medium-to-large banks refers to those ranked 21st to 50th by assets. By end-2015 the banking system assets had increased moderately to 103.2 percent of GDP (RUB83 trillion), up from 99.7 percent (RUB78 trillion) at the end of 2014 and 80.8 percent (RUB57 trillion) at end-2013. 14 In December 2014 the government began the RUB1.0 trillion recapitalization program by issuing treasury bonds to be invested in the capital of systemically important banks. At the same time, the State Duma approved a law allowing up to 10 percent of the National Wealth Fund to be invested in subordinated deposits and bonds of Russian banks. In May 2015 the government approved the recapitalization of four banks: Rossia, Severnii Morskoi Put, Sodeistvie Obshestvennim Initsiativam and Rossiiski Natsionalni Kommercheski Bank through the provision of subordinated loans in the total amount of RUB20.1 billion. In August the government approved RUB8.5 billion to recapitalize 10 regional banks. 15 The CBR appointed authorized representatives to 156 banks following new legislation on bank oversight. In most cases these appointments are for banks which received government or CBR support in 2014-2015. 16 Russia Economic Report | Edition No. 35 I. Recent Economic Developments not compensate for plummeting oil and gas the consolidation on key economic sectors and prices, as a decline in the effective tax rate for oil vulnerable households.16 Part of the anti-crisis exports weakened federal revenues. Oil and gas measures, including social and regional support, revenues shrank from 9.5 percent of GDP in 2014 were financed through the 2015 budget. to 7.3 percent in 2015, a 21.1 percent decline in nominal terms, while overall federal revenues The government’s consolidation program fell from 18.6 percent of GDP to 17.0 percent, a 6 appears appropriate, as the accumulated percent drop in nominal terms (Table 6). Nonoil spending increases of recent years could not be revenues increased from 9.1 percent of GDP in sustained in an environment of slumping oil and 2014 to 9.7 in 2015, boosted by higher VAT and gas revenues. Oil revenues still constitute about corporate income tax receipts, but this increase 40 percent of overall federal revenue (Figure 29). was not sufficient to offset the drop in oil and By end-2015, annual federal spending fell by 2.5 gas revenues. A combination of rising nonoil percent in real terms, half the original target of revenues and expenditure consolidation slightly 5 percent.17 Social and defense spending were narrowed the nonoil deficit from 10 percent of the main spending items in 2015 (Figure 30). GDP in 2014 to 9.7 percent in 2015. Defense spending rose by 18.8 percent in real terms, and social spending increased by 14.4 In 2015 the government announced an percent in real terms. The bulk of the increase expenditure consolidation target of 5 percent in social spending (11 percent) went to pension in real terms and launched a separate RUB2.4 indexation as part of the government’s anti-crisis trillion anti-crisis plan to mitigate the adverse plan. Spending on subsidies to the economy effects of the expenditure cuts. The 2015 and intergovernmental transfers decreased by anti-crisis plan was designed to support the 29.7 percent18 and 22.6 percent in real terms, financial and real sectors, regional budgets followed to a lesser extent by education and and social programs, buffering the impact of public health spending. Table 6: Federal budget outcomes, RUB billions 2014 2015 2015 2015 2014-2015 2014 2015 Amended Original Budget Budget Law April Execution Real Execution Execution Law (2014 2015 (2014 (2014 Growth (Percent of (Percent of Execution prices) prices) prices) Percent GDP) GDP) Expenditures 14,831.6 14,336.1 14,088.0 14,454.5 -2.5 19.0 19.4 Interest payments 415.6 415.7 541.7 480.3 15.6 0.5 0.6 Revenues 14,496.9 13,937.0 11,611.1 12,644.1 -12.8 18.6 17.0 Oil revenues 7,434.0 7,140.7 5,265.7 5,428.4 -27.0 9.5 7.3 Non-oil revenues 7,062.9 6,292.9 5,875.3 6,681.3 -5.4 9.1 9.7 Non-oil balance -7,768.7 -7,447.4 -7,604.3 -7,197.5 -10.0 -9.7 Primary balance 80.9 970.2 -862.7 -273.1 0.1 -1.8 Balance -334.7 -369.5 -2,293.4 -1,676.3 -0.4 -2.4 Government debt 13.2 13.5 Source: CBR. 16 The plan included support to the financial sector (RUB1.3 trillion), state-owned and systemically important companies (RUB365 billion), as well as to regional budgets (RUB160 billion) and social programs (RUB296 billion). 17 An 8 percent deflator is based on national accounts data for government consumption and fixed capital investment. 18 At end-2014 the government transferred RUB1 trillion in bonds to the Deposit Insurance Agency to recapitalize the banking sector. This increased spending on support to the economy by 66 percent from 2013. Adjusting 2014 expenditures to reflect this anti-crisis measure, real budget spending increased by 4.5 percent in 2015. Russia Economic Report | Edition No. 35 17 I. Recent Economic Developments Figure 29: Federal revenue and budget balances, 2007-2015, Figure 30: Federal primary expenditures, 2014, percent of GDP percent of GDP 25 10 25 24.4 5.9 21.4 20.2 19.6 20 4.1 5 20 19.1 18.5 18.8 17.6 18.0 0.8 -0.1 0.6 -0.5 -0.4 0 15 15 -2.4 -4.1 10 10 -5.9 -5 -6.4 -9.6 -10.4 -10.3 -12.7 -10.9 -9.7 5 5 -10 -13.5 0 -15 2007 2008 2009 2010 2011 2012 2013 2014* 2015* 0 Social policy (inc. transfers to Pension Fund) National economy 2007 2008 2009 2010 2011 2012 2013 2014* 2015* National defense National security State administration Intergovernmental transfers Oil revenues, percent of GDP Non-oil balance, percent of GDP (RHS) Education Health & sports Non-oil revenues, percent of GDP Total balance, percent of GDP (RHS) Other Federal budget primary expenditures Source: Roskazna, Rosstat. Source: Roskazna, Rosstat. Note: *Due to methodological changes in nominal GDP, figures for 2014 and Note: *Due to methodological changes in nominal GDP, figures for 2014 and 2015 are not comparable with those shaded for 2013 and earlier. 2015 are not comparable with those shaded for 2013 and earlier. During 2015 the authorities drew down the exclude defense and social spending. The Reserve Fund to finance the federal budget government is also considering an ambitious deficit and used the National Welfare Fund privatization plan to finance a larger-than- for off-budget stimulus to the economy. As expected deficit, the process for which could a result, the total value of the Reserve Fund begin as early as the second half of 2016.20 In plunged from US$87.9 billion in December 2014 March 2016 the government approved the to US$46 billion at end-2015. The government Plan of Government Action for Stable Social- used the National Welfare Fund as an off-budget Economic Development in 2016, which calls for mechanism to support large banks and provide spending of RUB684.8 billion (0.8 percent of investment stimulus, investing it in assets with GDP) primarily on support to selected industries relatively high market risk. In 2015, it invested and regional governments (Box 9). In addition, RUB440 billion (US$7.3 billion) from the National the federal budget is subject to contingent Welfare Fund in ruble-denominated domestic liabilities arising from the external obligations financial assets.19 The National Welfare Fund of Vneshekonombank (VEB), which has a total decreased modestly from US$78 billion at end- outstanding external debt of US$9 billion. 2014 to US$71.7 billion at end-2015 due to the depreciation of the ruble. The consolidated government budget deficit widened from 1.1 percent in 2014 to 3.5 Russia’s fiscal position for 2016 remains percent in 2015 due to imbalances in both uncertain; a further decline in oil prices in the federal budget and extrabudgetary funds. January 2016 forced the government to The consolidated budget encompasses all consider cutting the budget by an additional 10 public spending, including the federal budget, percent, and lower prices are expected to lead subnational budgets and extra-budgetary funds to a broader revision of budgetary parameters (Table 7). Trends in general government revenue during 2016 (Box 9). The January budget cuts followed developments in federal budget 19 The majority of the RUB376.1 billion (US$6.2 billion) is being invested in bonds and shares of large state companies, including Yamal SPG (natural gas), ZapSibNeftechim (oil products), Russian Railway (transport), and Atomenergoprom (nuclear energy). A smaller part, RUB64.4 billion (US$1.1 billion) went into deposits of large state banks (VTB and Gazprombank) to stimulate credit growth. In December 2015, the government extended VEB’s payback period for a deposit of US$6.25 billion from the National Welfare Fund, lowered the interest rate to 0.25 percent, and granted a grace period for interest rate payments until September 2018. 20 Privatization may include the sale of stakes in the banking group VTB, the oil company Rosneft, the airline Aeroflot, the diamond-mining company ALROSA, the shipping company Sovcomflot, the oil-pipeline monopoly Transneft and the telecom operator Rostelecom. 18 Russia Economic Report | Edition No. 35 I. Recent Economic Developments Box 9 The 2016 budget law In December 2015 the government approved a federal budget law for 2016 based on the following projections: an average oil price (Urals) of US$50 per barrel, an inflation rate of 6.4 percent and a GDP growth rate of 0.7 percent. The government instituted a 1-year planning horizon for 2016 after it suspended the legally mandated 3-year planning horizon in 2015. The fiscal rule was also suspended in 2016. The budget deficit was projected to reach 3 percent of GDP, with a nonoil deficit of 10.7 percent of GDP to be financed primarily through the Reserve Fund, which was expected to decrease by RUB 1 trillion, from 3.5 percent of GDP to 1.3 percent. Public borrowing was anticipated to reach 0.5 percent of GDP, including up to US$3 billion in external borrowing. Both federal budgetary revenues and expenditures were projected to increase slightly as a share of GDP. However, large nominal expenditure cuts were planned in public health (7.8 percent), education (8.4 percent) and community and housing services (39 percent), while subsidies to the economy were expected to rise by 12.8 percent, and defense and national security spending by 2 percent. For the second year in a row, no wage increases were planned for public sector employees. While the government did not change the pension age, it did index pensions by 4 percent. The second pillar of pension funding will continue to be frozen, reserving those funds for special needs and leaving room for additional pension increases. revenue, with falling oil prices putting downward both ease expenditure pressures on subnational pressure on overall revenues. Consolidated governments and finance subnational deficits. government spending decreased by 1.7 percent First, regional governments were not requested in real terms compared to 2014. Social policy to increase teacher and health personnel and national defense, the two priority spending salaries as per a presidential decree dating from categories, increased by 5.8 percent and 18.8 May 2012. The largest expenditure cuts at the percent in real terms, respectively. Significant regional level were in education, which fell by cuts were made in real spending on subsidies 7.5 percent in real terms, and community and to the economy, social security, culture and housing services, which fell by 12.7 percent, education. The federal budget deficit of 2.4 but real spending decreased in all expenditure percent of GDP and the increasing imbalances categories. Second, the Ministry of Finance in extra-budgetary funds, which registered a increased budgetary loans to regions with lower deficit of 0.8 percent of GDP for the first time in interest rates in order to ease the regional debt years, led to the worsening of the consolidated burden, including additional lending provided balance. The rising deficit in extra-budgetary as part of the 2015 anti-crisis plan. Budgetary funds, which stems primarily from the Pension lending increased by RUB161.2 billion to a total Fund, constitutes a significant fiscal risk. of RUB808.7 billion. The share of budgetary loans in subnational debt increased from 26.9 The concentration of resource revenues at percent at end-2014 to 30.4 percent at end- the federal level, coupled with anti-crisis 2015. Overall, subnational debt continued to measures, have shielded subnational budgets grow, rising from 3.1 percent of GDP in 2014 to from the impact of falling oil prices. Two 3.3 percent in 2015. temporary policies adopted in 2015 helped to Russia Economic Report | Edition No. 35 19 I. Recent Economic Developments Table 7: Consolidated budget, RUB billions 2015 2014 (in 2014 prices) 2014-2015 2014 2015 Execution Execution Real Growth (Percent of (Percent of Execution Execution Percent GDP) GDP) Consolidated Budget Expenditures 27,611.7 27,136.8 -1.7 35.4 36.4 Revenues 26,766.1 24,531.6 -8.3 34.4 32.9 Interest payments 537.3 612.0 13.9 0.7 0.8 Balance -845.6 -2,605.3 -1.1 -3.5 Government debt 15.5 15.8 Consolidated Subnational Budget Expenditures 9,353.3 8,777.5 -6.2 12.0 11.8 Interest payments 121.7 137.9 13.3 0.2 0.2 Expenditures w/t int. payments 9,231.6 8,639.6 -6.4 11.9 11.6 Revenues 8,905.7 8,618.7 -3.2 11.4 11.6 Revenues w/t extrabudgetary 7,234.9 7,060.3 -2.4 9.3 9.5 transfers Balance -447.6 -158.9 -0.6 -0.2 Government debt 3.1 3.3 Extrabudgetary Funds Expenditures 8,005.0 8,793.4 9.8 10.3 11.2 Revenues 7,979.4 8,164.0 2.3 10.2 11.0 Balance -25.6 -629.4 0.0 -0.8 Federal Budget Expenditures 14,831.6 14,454.5 -2.5 19.0 19.4 Interest payments 415.6 480.3 15.6 0.5 0.6 Expenditures w/t int. payments 14,416.0 13,974.3 -3.1 18.5 18.8 Revenues 14,496.9 12,644.1 -12.8 18.6 17.0 Oil revenues 7,434.0 5,428.4 -27.0 9.5 7.3 Non-oil revenues 7,062.9 7,215.8 2.2 9.1 9.7 Primary balance -7,768.7 -7,238.8 0.1 -1.8 Balance 80.9 -1,330.1 -0.4 -2.4 Government debt 13.2 13.5 Source: Roskazna. Extrabudgetary funds include the Pension Fund, the Social Security Fund, and the Federal Fund for Mandatory Health Insurance. 20 Russia Economic Report | Edition No. 35 I. Recent Economic Developments 1.5 Income and Poverty Trends – The Labor Market Weakens Labor-market indicators have begun to weaken, and the unemployment rate is slowly rising. However, falling wages remain the primary mechanism through which the labor market is adjusting to the recession. Nonwage income declined due to the limited indexation of public transfers, which, along with rising food prices, was responsible for a significant increase in the poverty rate. T he recession began to weaken labor demand during the second half of 2015. Falling real wages, large and stable public employment and percent in 2008 to 8.2 percent in 2009 (Figure 31). The structure of unemployment remained unchanged in 2015. A significant gap persists a steady outflow of migrant workers have largely between the unemployment rates for male and mitigated the recession’s effect on domestic female workers, but women were slightly more employment, but since mid-2015 employment likely to become unemployed in 2015. Male data have begun to reflect the worsening economic unemployment rose from 5.5 percent in 2014 to downturn. While the overall employment rate 5.8 percent in 2015, while female unemployment remained at 65.7 percent, unchanged from the rose from 4.8 percent to 5.3 percent. The previous year, the number of employed workers gap between urban and rural unemployment decreased by 300,000, year-on-year, in the second narrowed as urban unemployment rose faster half of 2015. than rural unemployment. Urban unemployment increased from 4.3 percent in 2014 to 4.8 The number of unemployed workers rose percent in 2015, while rural unemployment only from 3.8 million in the second half of 2014 to inched up to 8.0 percent from 7.9 percent in 4.1 million in the second half of 2015, as the 2014. The large share of long-term unemployed, unemployment rate increased from 5.0 to 5.5 defined as workers who had been searching for percent. However, the increase in unemployment a job for more than a year, is troublingly high at remained moderate compared to the trends 30 percent. Moreover, regional unemployment observed during the global financial crisis, rates remain very unequal, reflecting the limited when the unemployment rate soared from 6.2 mobility of labor (Figure 37). Figure 31: Unemployment rates in resource-rich countries, Figure 32: Labor force participation and one-year moving average, percent employment, million 9 77 8 76 7 75 6 74 5 73 4 72 3 71 2 70 1 69 0 2011 2012 2013 2014 2015 2008 2009 2010 2011 2012 2013 2014 2015 Labor Force Employed Australia Canada Mexico Russia Labor Force, MA Employed, MA Source: ILO, Rosstat, Haver Analytics and World Bank calculations. Source: Rosstat, Haver Analytics and World Bank staff estimates. Note: 2015 data does not include Crimea. Russia Economic Report | Edition No. 35 21 I. Recent Economic Developments Russia’s aging population has affected its workers also corresponds with a slight decrease labor market since 2012, but in 2015 the total in the average number of weekly hours worked, labor supply remained stable. Labor force which fell from 38.1 in the first three quarters participation rose slightly to 69.5 percent in the of 2014 to 37.9 in the first three quarters of second half of 2015, a year-on-year increase 2015. Taken together, these data indicate that a of 0.3 percentage points, offsetting the decline rising number of workers are struggling to find in the working age population due to aging and retain full-time employment. At the same and leaving the total size of the economically time, the sharp drop in real wages may require active population unchanged at 75.5 million people to work longer hours or hold multiple (Figure 32).21 Labor-force participation part-time jobs. increased primarily among workers over the age of 40, while declining among young adults. The erosion of real wages has enabled the labor Underemployment is also on the rise, with market to adjust to a deepening recession with the number of part-time workers growing by a only a modest impact on employment dynamics. third (from 100,000 to 133,000) between 2014 After rising by 1.2 percent in 2014, real wages fell and January-October 2015. Yet the increase in by 9.5 percent in 2015, with declines recorded part-time workers remains far below the peak across all sectors as inflation remained in double of 500,000 during the global financial crisis digits (Figure 34). The deterioration of real wages (Box 10). The significant increase in part-time accelerated in the second half of the year, rising Box 10 Trends in job creation and job destruction Job destruction has outpaced job creation since 2008. On average, the rate of job destruction in large and medium-sized enterprises has outpaced the rate of job creation by 2 percentage points, corresponding to 500,000 jobs annually. This trend reflects the growing informality in the Russian economy, as the share of jobs in large and medium-sized enterprises (which are mostly formal) is falling relative to the number of jobs in small enterprises (which are more likely to be informal). Average job turnover in the nontradable sectors outpaced turnover in the tradable sectors. The highest rates of newly created jobs were in the trade (17.8 percent), construction (15.2 percent) and financial services sectors (12.2 percent), all of which are nontradables. Construction had the highest rate of job destruction (17 percent), followed by agriculture (13.5 percent) (Figure 33). Only the trade and financial services sectors registered significantly positive rates of net job creation. The number of jobs in these sectors increased by 4.8 and 3.3 percent, respectively. Far more modest rates of net job creation were also observed in public administration and defense (0.4 percent). Net job creation rates were negative in all other sectors. The highest rates of net job destruction were in agriculture (6.1 percent) and manufacturing (3.9 percent). Figure 33: Net job creation and destruction rates by sector, 2008-2014 average, percent 0 2 4 6 8 10 12 14 16 18 20 Total Trade Construction Financial services Hotels and restaurants Real Estate Mining Other services Utilities Public administration & defence Education Transport and communications Agriculture Manufacturing Health and social services Creation Destruction Source: Rosstat and World Bank staff calculations. These figures are in seasonally adjusted terms. Crimea is excluded to maintain comparability with previous years. 21 22 Russia Economic Report | Edition No. 35 I. Recent Economic Developments Figure 34: Real wage growth by sector, Figure 35: Contribution to real income growth, total year-on-year, percent population, year-on-year, percent 25 10 20 8 6 15 4 10 2 5 0 0 -2 -5 -4 -10 -6 -15 -8 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 -20 2009 2010 2011 2012 2013 2014 2015 2009 2010 2011 2012 2013 2014 2015 Others Business and property Total Total Tradables Non-Tradables Public Public wages and transfers Market wages Source: Rosstat and World Bank staff estimates. Source: Rosstat and World Bank staff estimates. from 8.7 percent year-on-year during the first as the average income of the total population. six months to 10.1 percent during the second This means that the incomes of the poorest 40 half. Not only did wages decline, all components percent of the population were not converging of disposable income continued to decrease with the average. For that the income growth of in real terms, weighing heavily on household the poorest 40 percent of the population would consumption. Nonwage income sources such need to outpace average income growth. As as pensions and other transfers also declined, lower-income households also tend to have less as they were indexed below headline inflation. in savings, the pressure to reduce consumption Real pensions contracted by 4 percent in 2015, was likely most intense among the country’s compared to an increase of 0.9 percent in 2014 most vulnerable households (Figure 36). (Figure 35). The overall decline in real disposable Figure 36: Real income growth, all income levels and bottom income was a key factor behind the steep drop in 40 percent, year-on-year, percent consumption observed during 2015. 15 10 The decline in real income has had a significant impact on poverty. In 2015, the number of poor 5 people rose from 16.1 million, or 11.2 percent of 0 the population, to 19.2 million, or 13.4 percent of the population (Table 8). The increase in -5 poverty was driven by the erosion of real income -10 combined with rising prices for food and services, -15 which pushed many people back below the 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 poverty line. Since the fourth quarter of 2014 the 2009 2010 2011 2012 2013 2014 2015 Average Bottom 40 average real income of the bottom 40 percent of the population has grown at exactly the same rate Source: Rosstat and World Bank staff estimates. Table 8: Poverty trends Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2010 2011 2012 2013 2014 2014 2014 2014 2015 2015 2015 2015 Poverty rate, cumulative 12.5 12.7 10.7 10.8 13.8 13.1 12.6 11.2 15.9 15.1 14.1 13.4 Number of poor, million people 17.7 17.9 15.4 15.5 19.8 18.9 18.0 16.1 22.9 21.7 20.3 19.2 Source: Rosstat. Russia Economic Report | Edition No. 35 23 24 Figure 37: Unemployment rates by region, Q4 2015, percent LIST OF REGIONS 1 Yaroslavl 7 Tula 13 Chuvashia 21 Volgograd 27 North Ossetia 2 Kaluga 8 Nizhniy Novgorod 14, 16 Tatarstan 22 Kalmykia 28 Chechnya 3 Vladimir 9 Ryazan 15 Penza 23 Adygea 29 Ingushethia 4 Ivanovo 10 Mari El 17 Ulyanovsk 24 Stavropol 5 Perm 11 Udmurtia 18 Saratov 25 Karachaevo-Cherkessia 6 Moscow-city 12 Mordovia 19, 20 Samara 26 Kabardino-Balkaria LEGEND 1.7,4.2 4.2,5.2 5.2,5.9 5.9,7.2 7.2,8.7 Russia Economic Report | Edition No. 35 8.7,30.8 Source: Rosstat and World Bank staff calculations. I. Recent Economic Developments PART II ECONOMIC OUTLOOK: An Uncertain Path Ahead T he Russian economy faces a long journey to recovery. While the conditions that pushed Russia’s economy into recession may be gradually abating, the World Bank’s current baseline scenario anticipates a further contraction of 1.9 percent in 2016 before growth is expected to resume at a modest rate of 1.1 percent in 2017. Commodity prices will continue to dominate Russia’s medium-term outlook, and in addition to the baseline projections both a lower-bound and an upper-bound oil-price scenario are presented. Poverty projections are bleak; under all scenarios poverty rates are expected to rise, and indicators of shared prosperity are expected to worsen. As the Russian economy gradually adapts to an adverse external environment marked by lower oil prices and ongoing economic sanctions, the focus of its economic adjustment challenges is now shifting to fiscal and financial sector restructuring. The government’s attempts to consolidate its fiscal balances to reflect the drop in oil revenue have thus far remained largely tentative and ad hoc. A return to a credible medium-term fiscal framework is paramount and would boost consumer and business confidence by reducing fiscal uncertainty. A massive recapitalization program and other supportive measures shored up the country’s banking system, but risks to the financial sector will require continued vigilance through 2017. Russia’s medium-term economic outlook is modest, as the economy’s underlying growth potential is low, but new long-term opportunities are emerging. Over the longer term, the government’s key challenge will be to enhance economy-wide competitiveness and promote sustainable diversification beyond the natural resource sector. Russia Economic Report | Edition No. 35 25 II. Economic Outlook 2.1 Growth Outlook – A Shift in Adjustment Challenges Russia’s medium-term growth will remain heavily dependent on oil prices. The World Bank projections reflect three oil-price scenarios: the baseline, an upper-bound scenario and a lower-bound scenario. An alternative baseline scenario combines the baseline oil-price forecast with the projection assumption that economic sanctions would be lifted as early as 2017, while all other scenarios assume that economic sanctions would remain in place until 2018. D uring 2016, the Russian economy is expected to continue its difficult adjustment to a context of low global commodity prices and edition presents a new set of oil-price scenarios that reflect the worsening outlook for global oil exporters. The macroeconomic projections ongoing economic sanctions. Russia’s economy include: (i) a baseline scenario; (ii) an upper- contracted by 3.7 percent in 2015, and economic bound scenario, in which oil prices exceed activity is expected to fall further in 2016, though baseline assumptions; and (iii) a lower-bound at a slower pace. The World Bank’s baseline scenario, in which oil prices fall short of current growth outlook anticipates a contraction of 1.9 forecasts. Each of these scenarios assumes for percent in 2016 (Figure 38), which would cause projection purposes that economic sanctions real GDP to remain below its 2012 level (Figure will remain in place until 2018, while in an 39). GDP growth is projected to return to a alternative baseline economic sanctions would positive rate of around 1.1 percent in 2017. Oil be lifted in 2017. prices are projected to remain at an average of US$37 per barrel in 2016, far below the US$53 Due to a continually adverse external per barrel forecast used in the previous edition of environment, Russia’s journey to recovery the Russia Economic Report (September 2015), will be long and difficult. Investment growth before recovering to around US$50 per barrel is projected to remain weak due to several in subsequent years.22 As the current baseline factors. First, a tepid global recovery in demand forecast for 2016 has now fallen below even for Russian exports, combined with persistently the lower-bound projection of US$40 per barrel low commodity prices, will limit investment included in the last Russia Economic Report, this opportunities in the export sector (Box 11). Figure 38: Real GDP growth projection, year-on-year, percent Figure 39: Real GDP projection, 2012=100 4 103 102 102.0 3 101.3 101.2 2.0 2.0 2 101 1.7 99.2 100 100.0 1 1.7 100.0 99.2 0.5 99 98.3 0 98.2 98.2 -0.7 98 97.5 -1 97 96.4 97.4 -2 96.3 96 -3 -2.5 95 95.8 -4 94 -5 93 2012 2013 2014 2015 2016 2017 2018 2012 2013 2014 2015 2016 2017 2018 Lower-bound scenario Baseline scenario Lower-bound scenario Baseline scenario Upper-bound scenario Early sanctions lift scenario Upper-bound scenario Early sanctions lift scenario Source: Rosstat and World Bank staff estimates. Source: World Bank staff estimates. The current 2016 budget of December 2015 assumes an oil price of US$50 per barrel. 22 26 Russia Economic Report | Edition No. 35 II. Economic Outlook Meanwhile, the ongoing erosion of household The persistent slump in global oil prices and income will continue to undercut domestic the extension of economic sanctions and demand, offering little incentive for firms to counter sanctions is likely to profoundly invest in expanding capacity to produce for alter the internal structure of the Russian the domestic market. Second, the economic economy and transform its relationships with sanctions regime will continue to restrict access its trading partners. As oil prices fell in 2014- to capital and limit the inflow of FDI, exacerbating 2015, the devaluation of the ruble facilitated the negative impact of soft demand conditions. the adjustment of Russia’s external balances. Third, a low-level price equilibrium in the global And as geopolitical tensions and economic oil market and diminished oil revenues will sanctions became the norm, capital outflows sharply restrict the fiscal space for increased fell to near their 2012-2013 levels. Russian firms public investment or other countercyclical and households are gradually adapting, and the policies. As a result, investment is expected to weaker ruble could facilitate the expansion of recover slowly, and the overall investment growth certain non-resource tradable industries (Box 13). rate is not expected to turn positive until 2017. In recent years Russia has tightened its economic The negative impact on consumption growth integration with China and the members of the resulting from the sharp income adjustment in Eurasian Customs Union, while sanctions and 2015 is not expected to be offset by significant countersanctions have weakened trade ties fiscal stimulus. Consequently, consumption with other countries. Overall, Russia’s nonfuel growth is expected to remain negative in 2016 exports are increasing as a share of total exports, before resuming a modest growth rate of 1 to 2 but they continue to consist largely of nonfuel percent per year. commodities. Outdated production capacity and Box 11 The global economic outlook Global growth is projected to accelerate modestly in the coming years, but at a slower pace than previously anticipated (Table 9). A slowdown in large emerging markets is depressing growth prospects in the developing world and exacerbating an uneven recovery among advanced economies. Nevertheless, global growth is projected to reach 2.9 percent in 2016 and 3.1 percent in 2017-18, while the aggregate growth rate for high-income countries is expected to rise from an estimated 1.6 percent in 2015 to a projected average of 2.1 percent over 2016–2018. However, the anticipated improvement in global economic activity in 2016 and beyond is predicated on an orderly slowdown and rebalancing in China, a steady acceleration among high-income countries, a recovery in global commodity prices, the continuation of accommodative monetary policies in advanced economies and the maintenance of fundamental stability in key financial markets. All of these assumptions are subject to substantial downside risks. The protracted slowdown in emerging and developing economies has prompted a negative reassessment of their underlying growth potential. Faltering demand in emerging markets is contributing to an especially grim outlook for major commodity exporters, which are expected to make a significantly lower contribution to global growth than in the past. While developing countries and emerging markets are both expected to recover somewhat in 2016, further contractions are predicted for Brazil and Russia, with negative implications for their trading partners. The aggregate growth rate among developing countries is expected to remain steady at 4.8 percent in 2016 before accelerating to 5.3 percent in 2017. Table 9: Global GDP growth, percent 2009 2010 2011 2012 2013 2014 2015e 2016f 2017f 2018f World -1.8 4.3 3.1 2.4 2.4 2.6 2.4 2.9 3.1 3.1 High income -3.5 3 1.9 1.4 1.2 1.7 1.6 2.1 2.1 2.1 Developing countries 3 7.8 6.3 4.9 5.3 4.9 4.2 4.8 5.3 5.3 Euro area -4.5 2 1.7 -0.7 -0.2 0.9 1.5 1.7 1.7 1.6 Russia -7.8 4.5 4.3 3.5 1.3 0.7 -3.7 -1.9 1.1 1.8 Source: World Bank Global Economic Prospects. Russia Economic Report | Edition No. 35 27 II. Economic Outlook other structural rigidities and the high cost of growth model, the depreciation of the ruble has intermediate imports diminish the benefits of created an opportunity for Russia to enhance the the relative price adjustment. In addition, the competitiveness of its non-resource economy. dearth of new credit underscores the persistent However, a price advantage alone will not enable challenges facing the Russian financial sector. Russian exporters to overcome the unique Meanwhile, the government’s fiscal adjustment historical trends and structural constraints to its diminished revenue position has thus far that continue to define its export profile. The been partial and provisional. special focus chapter included in this edition of the Russia Economic Report explores historic In 2016, the focus of Russia’s economic challenges to Russia’s export competitiveness adjustment will shift to fiscal consolidation and the difficulty of effecting rapid changes in and financial sector restructuring. The its export profile. Expanding and diversifying government will face difficulty in achieving its Russia’s exports will require substantial progress 2016 deficit target of 3.0 percent of GDP despite on the structural reform agenda and far-reaching additional spending cuts announced in January. improvements in the business and investment Meanwhile, financing budget overruns will climate. Russia needs large scale investments in further deplete the already shrinking Reserve its non-resource industries to expand its range Fund. This situation will require bold choices of sophisticated manufacturing and service during the 2017 budget-planning process, as the exports and create a more diversified economy. authorities strive to determine the structure and Accomplishing this could boost Russia’s long- policy priorities of the country’s new medium- term growth beyond the moderate expansion of term fiscal framework. The banking sector 1-2 percent projected over 2017-2018. benefitted from a massive recapitalization effort in 2015, but the expiration of the central bank’s Commodity prices continue to dominate regulatory forbearance scheme on January 1, Russia’s medium-term outlook, particularly oil 2016 has made the health of the financial sector prices. A combination of abundant supply and difficult to precisely gauge. Nevertheless, it is weakening demand is driving down oil-price clear that the sector will remain highly vulnerable forecasts (Box 12). Inventories in OECD countries through 2017, requiring the authorities’ constant remain high, and global output remains robust vigilance and readiness to implement further as OPEC production is not expected to decrease stabilization measures. Challenges related to the significantly from its three-year high in 2016. further fiscal and financial sector adjustment are Meanwhile, slowing growth in China, the world’s discussed in the risk section of this chapter. second largest oil consumer, is undermining global demand. The World Bank has revised its While Russia’s medium-term potential is projections since the previous edition of the low, it now has a valuable chance to set the Russia Economic Report, including an especially foundation for more robust and sustainable sharp downward revision for 2016. Under the long-term growth. Russia’s contribution to current baseline scenario, oil prices are expected global growth is projected to be smaller in the to drop to an average of US$37.0 per barrel in medium-term given its weakened prospects due 2016 before recovering to US$48.0 in 2017 and to low commodity prices. While falling oil prices US$51.4 in 2018. have exposed serious weaknesses in its current 28 Russia Economic Report | Edition No. 35 II. Economic Outlook Box 12 Global oil-price forecast The World Bank’s oil price forecast for 2016 is at US$37 per barrel. This represents a 27 percent year-on-year decline in the global price of crude oil. A gradual recovery is expected through 2017, as high-cost oil producers are driven from the market, reducing aggregate supply, while a continuing recovery in global growth strengthens demand. Non-OPEC production is expected to decline by 0.6 million barrels per day in 2016, while US production is projected to decline by 0.7 million. US shale oil production could drop off sharply as existing wells are depleted and low prices delay investment in new wells. While efficiency gains and technical innovation have increased the shale-oil sector’s resilience to falling prices, further cost reductions are unlikely. Non-OPEC production outside the US is expected to fall by 0.1 million barrels per day, as small declines in most regions will be only partially offset by increases in Canada and Brazil. A further appreciation of the US dollar, the currency in which most commodities are traded, could contribute to persistently low prices. OPEC is expected to maintain its current policy of defending its market share, while increasing Iranian output will further slow the recovery of global prices. OPEC will maintain excess production capacity in 2016, and OECD inventories are expected to remain at record highs (Figure 40). Growth in demand is expected to slow to 1.3 percent (1.2 million barrels per day) in 2016, and global consumption is projected to average 95.7 million barrels per day, as the demand boost generated by low oil prices tapers off. OECD oil demand is expected to remain flat, with a modest gain in North America broadly offsetting declines elsewhere. Non-OECD oil demand is projected to rise by 2.4 percent, but slowing consumption growth in Asia, which still accounts for the bulk of non-OECD demand growth worldwide, will dampen the recovery (Figure 41). As oil prices continue to fall, all major nominal commodity-price indices are expected to decline in 2016. Energy prices are projected to drop by 25 percent, metal prices by 10 percent and agricultural commodity prices by 1.4 percent. Large- scale investments made during the decade-long price boom and, in the case of industrial commodities, slowing demand in emerging market economies, will continue to put downward pressure on nonoil commodities over the medium term. 2016 price forecasts for 37 of the 46 commodities monitored by the World Bank have been revised downward. Figure 40: Excess global oil production capacity and Figure 41: The recent and projected growth of global inventories oil demand mb/d million bbl mb/d, growth year over year 11 3,100 4 10 3,000 9 2 8 2,900 7 OPEC spare capacity (left axis) 0 6 2,800 5 2,700 -2 4 3 2,600 2 -4 Q1-07 Q1-08 Q1-09 Q1-10 Q1-11 Q1-12 Q1-13 Q1-14 Q1-15 Q1-16 Q1-17 OECD crude oil inventories (right axis) 1 2,500 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 OECD China Other Non-OECD Source: International Energy Agency. Source: World Bank and International Energy Agency. Because the global oil market continues to upper-bound scenario projects that oil prices exhibit significant volatility, the projections will begin to recover in 2016. However, even include both a lower- and an upper-bound under this scenario oil prices are still expected to scenario. Although these alternatives are not average just US$50 per barrel in 2016, US$53 in equally probable, as current oil-price forecasts 2017 and US$55 in 2018. are especially susceptible to downside risks, both alternatives are presented in order to Persistent geopolitical tensions continue to provide a balanced growth spectrum. The lower- impact Russia’s medium-term growth prospects. bound scenario envisions an even steeper slide The economic sanctions regime imposed against in average oil prices to US$30 per barrel in 2016, Russia in 2014 and Russian countersanctions followed by a slower recovery to US$40 per barrel have both been extended this year, dampening in 2017 and US$45 in 2018. The more optimistic economic confidence and cutting off Russian Russia Economic Report | Edition No. 35 29 II. Economic Outlook firms and banks from global financial markets. revision of oil-price forecasts. A further decline However, for projection purposes it is assumed in oil prices is expected to negatively impact that geopolitical tensions will gradually the Russian economy through higher-than- subside in 2016 and that economic sanctions expected inflation, which continues to erode the would be lifted in 2018. An alternative baseline purchasing power of consumers while keeping scenario will illustrate for projection purposes credit costs elevated. This would compound the impact of an earlier lifting of economic the negative carryover effect from the deep sanctions in 2017. contraction in 2015, which greatly depressed consumer demand, and could further delay All forecast scenarios assume accommodative the recovery of business confidence and monetary policy and continued fiscal investment activity. As a result, aggregate consolidation, but no major structural reforms. domestic demand is not projected to rebound The central bank is expected to focus primarily until 2017. Meanwhile, net exports are on adhering to its inflation-targeting regime, expected to make a smaller contribution to but to relax monetary conditions as inflationary growth in 2016 than in 2015 due to the slowing pressures ease. At the time of this report’s pace of import contraction coupled with more publication, government fiscal policies were modest export growth. still under discussion and neither the revised 2016 budget nor the 2017 budget proposal had The baseline scenario includes the following yet been approved. Even in the upper-bound monetary and fiscal policy assumptions. The scenario, low oil prices are expected to exert CBR is expected to maintain its adherence to considerable pressure on the fiscal accounts, the free-floating exchange rate and to keep necessitating a continued drawdown of the monetary policy aligned with its medium-term Reserve Fund and other fiscal buffers. In late inflation target of 4 percent. The ruble’s renewed 2015, President Vladimir Putin announced that depreciation in early 2016 following another the government would attempt to eliminate the drop in oil prices is likely to keep inflation fiscal deficit by 2019. Achieving this target would elevated. The ongoing effects of nonmonetary require an increasingly sharp fiscal consolidation factors are expected to slow the deceleration of and would effectively foreclose the possibility the headline inflation rate, which is projected of significant stimulus spending, either to boost to average 7.6 percent in 2016 before slowing investment or shore up consumption. All of to an average of 4.8 percent in 2017 and the scenarios assume that fiscal consolidation reaching the CBR inflation target by the end will continue through 2017, yet each projects of 2017. A resumption of the CBR’s monetary a significant fiscal deficit. Finally, no major easing cycle is unlikely until the second half structural reforms that might improve Russia’s of 2016. Fiscal consolidation is expected to medium-term growth potential are expected continue in 2016 and 2017, including the limited before the 2018 presidential election. indexation of public wages and transfers. While lower oil revenues are projected to widen the The Baseline Scenario consolidated budget deficit to 4.6 percent in 2016, an anticipated recovery in oil prices is The World Bank baseline scenario projects that expected to narrow the deficit to 2.3 percent Russia’s real GDP will contract by 1.9 percent in in 2017 and 2.2 percent in 2018. Financing the 2016, before recovering to a modest 1.1 percent deficit is expected to fully deplete the Reserve growth rate in 2017 (Table 10). This growth Fund by end-2016, compelling the authorities to projection has been lowered by 1.3 percentage either increase borrowing or generate revenues points since the September edition of the Russia from privatization. Economic Report, largely due to the downward 30 Russia Economic Report | Edition No. 35 II. Economic Outlook Table 10: Economic indicators, baseline scenario 2013 2014 2015 2016 2017 2018 Oil price (US$ per barrel, WB average) 104.0 97.6 51.9 37.0 48.0 51.4 GDP growth, percent 1.3 0.7 -3.7 -1.9 1.1 1.8 Consumption growth, percent 3.1 1.4 -7.9 -2.5 0.1 1.5 Gross capital formation growth, percent -7.3 -6.1 -18.3 -6.4 6.4 8.0 General government balance, percent of GDP -1.2 -1.1 -3.5 -4.6 -2.3 -2.2 Current account (US$ billions) 34.8 58.3 69.5 41.3 36.3 18.4 Current account, percent of GDP 1.6 2.8 5.2 3.5 2.4 1.0 Capital and financial account (US$ billions) -56.9 -173.8 -72.9 -41.2 -36.4 -18.4 Capital and financial account, percent of GDP -2.5 -8.5 -5.5 -3.5 -2.4 -1.0 CPI inflation (average) 6.8 7.8 15.5 7.6 4.8 4.0 Source: Rosstat, Ministry of Finance, CBR and World Bank staff estimates. Investment dynamics are projected to drive expected to amplify the negative carryover effect growth trends over the next few years. In 2016 of the 2015 recession on household income. At weak investor confidence and low consumer the same time, the planned fiscal consolidation demand are expected to cause aggregate will limit the government’s capacity to bolster investment to contract further, while economic consumption through real increases in public sanctions continue to negatively affect foreign transfers or public sector wages, even as investment. As a result, the baseline scenario inflationary pressures ease. Consequently, real projects a 6.4 percent contraction in gross capital household income is expected to continue falling formation in 2016, largely driven by a decline in 2016, while credit growth to households will in fixed investment. A moderate rebound in remain low due to the delay in monetary easing investment demand is projected to drive the and high levels of indebtedness. These factors economy’s recovery in 2017-2018, supported by will cause private consumption to contract by higher oil prices (which will boost investment by 3.0 percent in 2016, leading to a 2.5 percent oil and gas companies), decreasing credit costs contraction in aggregate consumption. In and the accelerated implementation of large 2017, more modest inflation, improved credit off-budget infrastructure projects. The financial conditions and an appreciating ruble are sector is likely to play a limited role in facilitating expected to boost household purchasing power. credit growth due to its continued need for However, due in part to the limited indexation of restructuring. A slowly improving external public transfers and slow growth in real wages, environment will further bolster investment in private consumption is expected to recover only export-oriented industries, and gross capital marginally in 2017 before stabilizing at a new formation is projected to increase by 6.4 percent medium-term growth rate of around 2.0 percent in 2017. Investment growth is projected to in 2018. accelerate to 8.0 percent in 2018 due to stronger consumer demand, improving credit conditions Oil prices will continue to dominate Russia’s and the anticipated end of economic sanctions. external-account and exchange-rate dynamics. An anticipated drop in oil prices in 2016 will Consumption is projected to decline in 2016 for reduce export revenue. Meanwhile, imports the second consecutive year, and no significant will continue to fall, though more modestly consumption growth is expected in 2017. The than in 2015 due to the slower deprecation of recent terms-of-trade shock resulting from the the REER and the decelerating contraction of sharp decline in oil prices in December-January is real household incomes. As a result, the trade Russia Economic Report | Edition No. 35 31 II. Economic Outlook surplus is projected to narrow, reducing the For projection purposes, an alternative baseline current-account surplus to 3.5 percent of GDP. In scenario was formulated to reflect the upside 2017-2018 a sustained improvement in domestic potential of an earlier end to the economic demand, combined with an appreciating ruble, sanctions regime. Positive changes in the is projected to turn import growth positive once geopolitical environment could increase the again, reducing the current-account surplus to probability that economic sanctions against 2.4 percent of GDP in 2017 and 1.0 percent in Russia will be lifted. The alternative baseline 2018. Pressure on the capital account is expected scenario illustrates for projection purposes to ease over 2016-2017, despite the economic the impact of such an early lifting of economic sanctions regime, as the deleveraging by the sanctions in 2017 (Box 13). This alternative private sector in 2015 significantly improved scenario uses the same oil-price forecasts as the the country’s debt-service profile. However, baseline, as well as similar fiscal- and monetary- capital inflows—including FDI—are expected to policy assumptions. While the presumed end remain insignificant through 2017 and are not of the economic sanctions regime may have a anticipated to increase until the assumed lifting positive effect on economic confidence in 2016, of economic sanctions in 2018. Thus, the capital no significant impact on key macroeconomic and financial accounts are expected to largely variables is expected to materialize until the mirror changes in the current account, while oil following year. As a result, the 2016 projections prices will remain the key factor in exchange-rate are the same as in the standard baseline. While dynamics. The baseline scenario projects the this scenario projects a faster recovery in 2017, capital-account deficit to decrease from US$72.9 its impact would be limited and short-lived, and billion in 2015 to US$41.2 billion in 2016 and Russia’s medium-term growth potential would US$18.4 billion in 2018. remain relatively modest in the absence of other structural policy changes. Box 13 Potential impact of the removal of economic sanctions on Russia’s medium-term outlook The removal of economic sanctions is projected to boost investment, though this will have a relatively modest impact during the forecast horizon due to Russia’s limited growth potential. Diminished geopolitical risks and expanded access to international financing would lower Russia’s capital costs and increase inbound FDI. In the context of Russia’s current export profile, rising investment would have the most immediate impact on the production of oil, gas and other export oriented commodities. Greater capital access among Russian banks would reduce the cost of domestic credit, supporting a faster recovery in firm and household lending. In case of a removal of economic sanctions in 2017, increased investment would push the rate of gross capital formation to 10.4 percent in 2017, compared to 6.4 percent in the baseline scenario. Rising consumer confidence would boost the overall consumption growth rate to 0.7 percent in 2017, above the rate of 0.1 percent projected in the baseline. Stronger aggregate demand would accelerate the overall recovery, increasing the real GDP growth rate to 2.0 percent, up from 1.1 percent in the baseline (Figure 42). However, this would not translate into higher growth in 2018 due to structural constraints on Russia’s growth potential. Figure 42: GDP growth composition with and without economic sanctions in 2017, percent A. Baseline Scenario B. Alternative Baseline 3 3 2 1.8 2.0 1.2 2 1.7 1.5 1.1 0.0 1.4 1 0.1 1 1.1 1.1 0.9 1.1 0.8 0 0.1 0.5 -0.5 0 -1.8 -0.5 -1.8 -1 -1 - -1.2 -1.2 -2 -2 -1.9 -1.9 -3 -3 -4 2016 2017 2018 -4 2016 2017 2018 Consumption Investment Net exports GDP growth Consumption Investment Net exports GDP growth Source: World Bank staff estimates. 32 Russia Economic Report | Edition No. 35 II. Economic Outlook The Lower-Bound Scenario In the lower-bound scenario, fiscal risks would intensify. Lower oil prices would directly The lower-bound scenario projects that oil impact tax revenue, while weakening economic prices will fall well below the baseline forecast activity would reduce nonoil revenues, and the and that GDP will contract by 2.5 percent in anticipated depreciation of the ruble would 2016, before recovering modestly in 2017. This not be sufficient to offset these effects. As a scenario assumes that a further oil-price shock result, the general government deficit would in the second part of 2016 would push oil prices exceed the current target of 3.0 percent of GDP to an annual average of just US$30 per barrel. in 2016, widening to 5.6 percent. Assuming Prices would then recover gradually to US$40 that expenditure policies remain the same as per barrel in 2017 and US$45 per barrel in in the baseline, the government would need 2018 (Table 11). This implies that overall global to increase its borrowing, as the Reserve Fund demand would be weaker than in the baseline, would be insufficient to cover the projected which would have negative repercussions for deficit. Heightened budgetary risks would most of Russia’s export commodities. In this intensify pressure for fiscal restructuring, as the scenario, lower oil prices would cause the deficit would reach 3.6 percent of GDP in 2017 ruble to continue depreciating, which would and 2.7 percent in 2018. both increase the relative cost of imports and intensify the pass-through effect on consumer Even in the lower-bound scenario, the current prices, boosting the average inflation rate by 0.9 account is projected to remain in surplus. Lower percentage points over the baseline projection. oil prices would cause a sharper contraction in The CBR would likely postpone the resumption both exports and imports. The 2016 current- of monetary easing until 2017. Meanwhile, account surplus would narrow to 4.6 percent higher inflation would further erode real wages of GDP, slightly smaller than the 2015 surplus, and incomes, depressing consumer demand but notably higher than the baseline projection. and keeping consumption growth negative until Rebounding oil prices and improving growth 2018. These factors, combined with a tighter prospects in 2017 and 2018 would further reduce fiscal stance in response to lower oil revenues, the current-account surplus, especially following would slow the recovery of investment demand. the assumed lifting of economic sanctions in Table 11: Economic indicators, lower-bound scenario 2013 2014 2015 2016 2017 2018 Oil price (US$ per barrel, WB average) 104.0 97.6 51.9 30.0 40.0 45.0 GDP growth, percent 1.3 0.7 -3.7 -2.5 0.5 2.0 Consumption growth, percent 3.1 1.4 -7.9 -3.6 -1.0 1.0 Gross capital formation growth, percent -7.3 -6.1 -18.3 -9.7 3.4 7.9 General government balance, percent of GDP -1.2 -1.1 -3.5 -5.6 -3.6 -2.7 Current account (US$ billions) 34.8 58.3 69.5 50.4 45.7 28.8 Current account, percent of GDP 1.6 2.8 5.2 4.6 3.2 1.7 Capital and financial account (US$ billions) -56.9 -173.8 -72.9 -50.5 -45.6 -28.8 Capital and financial account, percent of GDP -2.5 -8.5 -5.5 -4.6 -3.2 -1.7 CPI inflation (average) 6.8 7.8 15.5 8.5 6.0 5.0 Source: Rosstat, Ministry of Finance, CBR and World Bank staff estimates. Russia Economic Report | Edition No. 35 33 II. Economic Outlook 2018. The prospective decline in oil prices is not However, the negative carryover effect of the expected to directly affect the capital account, deep recession in 2015 would persist through and it is assumed that the CBR will refrain 2016, and consumption growth would not turn from intervening despite rising depreciation positive until the following year. From 2017 pressures. The flexible exchange rate would onward, growth is expected to be largely driven enable the capital account to improve as the by rising investment demand supported by a current account deteriorates. recovery in household consumption, and overall consumption growth is expected to rebound to a The Upper-Bound Scenario new medium-term average of around 2 percent per year. The upper-bound scenario assumes more favorable external conditions, which would Higher oil prices would lessen the fiscal result in a shallower 0.7 percent drop in GDP deterioration in 2016 and lead to significant in 2016, followed by a robust recovery in deficit reduction in 2017-2018. The general 2017-2018 (Table 12). As in the lower-bound government budget deficit would rise from scenario, these projections are primarily driven 3.5 percent of GDP in 2015 to 3.9 percent in by oil prices, while fiscal- and monetary-policy 2016. During 2017-2018, high oil prices and an assumptions are similar to the baseline. Under accelerating recovery would boost both oil and the upper-bound scenario, oil prices would fall nonoil revenues. The government is expected to US$50 per barrel in 2016 before rising to to only slightly relax its fiscal consolidation US$53 per barrel in 2017 and US$55 per barrel efforts under this scenario, and real government in 2018. Higher, more stable oil prices would consumption is projected to remain constant put downward pressure on inflation. As a result, as the authorities strive to meet their stated the average inflation rate would fall faster than target of balancing the budget by 2019. It in the baseline scenario, dropping from 7.0 is assumed that the government will resist percent in 2016 to 4.5 percent in 2017 and 4.0 pressures to use its additional revenue to ease percent in 2018 and remaining below the CBR’s the fiscal consolidation before the upcoming medium-term target from 2017 on. Real wage presidential election. However, the authorities and income dynamics would begin to improve would be expected to resume work on certain by 2017, and lower inflation rates would allow high-priority infrastructure projects that were the central bank to accelerate its monetary previously suspended, and thus real spending easing strategy in support of credit growth. would be somewhat higher than in the baseline. Table 12: Economic indicators, upper-bound oil scenario 2013 2014 2015 2016 2017 2018 Oil price (US$ per barrel, WB average) 104.0 97.6 51.9 50.0 53.0 55.0 GDP growth, percent 1.3 0.7 -3.7 -0.7 1.7 2.0 Consumption growth, percent 3.1 1.4 -7.9 -1.2 0.8 1.7 Gross capital formation growth, percent -7.3 -6.1 -18.3 -2.1 8.6 10.1 General government balance, percent of GDP -1.2 -1.1 -3.5 -3.9 -0.9 -0.9 Current account (US$ billions) 34.8 58.3 69.5 49.8 35.4 18.4 Current account, percent of GDP 1.6 2.8 5.2 3.5 2.1 1.0 Capital and financial account (US$ billions) -56.9 -173.8 -72.9 -50.0 -35.3 -18.5 Capital and financial account, percent of GDP -2.5 -8.5 -5.5 -3.5 -2.1 -1.0 CPI inflation (average) 6.8 7.8 15.5 7.0 4.5 4.0 Source: Rosstat, Ministry of Finance, CBR and World Bank staff estimates. 34 Russia Economic Report | Edition No. 35 II. Economic Outlook Nevertheless, in the upper-bound scenario the capital goods would cause imports to recover fiscal deficit is projected to diminish rapidly, earlier and faster. The decline in external debt narrowing to 0.9 percent of GDP in 2017 and 0.9 payments caused by the massive deleveraging in percent in 2018. 2015 would ease pressure on the capital account. Deleveraging is expected to continue in 2016, In the upper-bound scenario, the positive though on a smaller scale. The debt-rollover impact of higher oil prices on the current capacity of major oil and gas exporters is expected account would be offset by accelerating import to improve in 2017, and the assumed lifting of growth. The current-account surplus would be economic sanctions in 2018 would expand the somewhat smaller than in the baseline scenario, private sector’s access to international capital shrinking from 5.0 percent of GDP in 2015 to markets. As a result, the capital-account deficit 3.5 percent in 2016, 2.1 percent in 2017 and 1.0 would narrow from US$72.9 billion in 2015 to percent in 2018. A stronger ruble, more rapid US$18.5 billion in 2018 as the current-account income growth and rising demand for imported surplus shrinks. 2.2 Poverty and Shared Prosperity Outlook – Fortunes Reverse The continuing recession is projected to partially reverse Russia’s recent progress in alleviating poverty and promoting shared prosperity. Poverty levels are expected to rise in 2016 under all three scenarios, even if oil prices swiftly recover. Dim prospects for income growth are likely to continue to negatively impact shared prosperity and poverty trends. T he recession is reversing Russia’s substantial achievements over the past decade in reducing poverty and promoting shared Weak income dynamics are expected to continue to adversely impact poverty projections. Under the baseline scenario the headcount poverty rate prosperity. Russia’s poverty rate is expected is expected to increase from 13.4 percent, or 19.2 to rise further in 2016 as the economy million people, in 2015 to 14.2 percent, or 20.3 continues to contract, unemployment rises, million people, in 2016. The number of people and inflation reduces the real purchasing power living below the national poverty line already of households. Meanwhile, the demands of rose by 3.1 million between 2014 and 2015. The the fiscal consolidation will sharply limit the projected increase in 2016 would return poverty government’s latitude for countercyclical policies rates to their 2007 levels, undoing nearly a and antipoverty spending. A rising share of the decade’s worth of gains. It would represent the world’s poor live in countries with slowing growth largest increase in the poverty rate since the rates. There are also growing concerns that 1998-1999 crisis, far exceeding the increase poverty will become increasingly concentrated observed during the global financial crisis in in natural-resource-based economies. For 2008 (Figure 43). The weakening of the labor commodity exporters, such as Russia, the gains market is expected to boost unemployment and in poverty reduction made over the past decade put further downward pressure on real wages, are gradually reversing. Poor households in these thereby contributing to the increase in poverty. countries have been hit by higher import prices Due to the demands of the fiscal consolidation and sharp currency declines, the disappearance the government is unlikely to reinforce income of jobs in construction and other non-tradable growth through higher transfers or pensions, sectors, and cutbacks in relief programs because further diminishing the prospects for income of fiscal pressures (Box 14). growth among Russian households. Russia Economic Report | Edition No. 35 35 II. Economic Outlook Box 14 The impact of fiscal policy on poverty reduction and shared prosperity since 2008 Russia’s progress in reducing poverty and promoting shared prosperity stalled in 2014. As the economy entered its current recession, poverty rates increased due to a decline in real wages and a rapid increase in inflation, which reduced the real value of social transfers. Income growth among households in the bottom 40 percent of the income distribution fell below the national average, and the middle class stopped expanding for the first time since 2000.23 Households in the bottom 40 percent of the income distribution depend heavily on public transfers, which account for an average of 60 percent of their total income. As inflation continues to reduce the real value of these transfers, while a shrinking fiscal envelope prevents the government from fully compensating for this effect, the erosion of household purchasing power is reversing past progress in poverty reduction and shared prosperity. In the years following the global financial crisis, pensions and public wages played a significant role in increasing the incomes of poorer households in Russia. On average, households in the bottom 40 percent experienced faster income growth than those in the top 60 percent. However, different factors drove income growth among poorer and richer households. Between 2008 and 2014 private sector wages accounted for 44 percent of real income growth among households in the bottom 40 percent, while public sector wages accounted for 36 percent and pensions accounted for 13 percent. The cumulative growth of public wages for the bottom 40 percent reached 39 percent in 2008-2014. Meanwhile, middle-class and high-income households benefited from the massive growth of pensions. During 2008-2009 pension indexation reached 10-20 percent in real terms, and a valorization increase in 2010 increased real pension payments by 35 percent while also expanding their coverage. Rising real pension payments were responsible for almost all of the income growth among households in the top 60 percent between 2008 and 2014. Private sector wages and other income had a far more modest effect, and was even negative among households in the richest deciles. Public sector wage growth had a mixed impact on the middle class and a slightly positive effect on households in the top three deciles. In 2016, poverty is projected to increase further the government launched a large-scale fiscal in all scenarios. The projected increase in the stimulus program that reinforced household poverty rate under all three scenarios is due in consumption and prevented an increase in part to the deeply negative carryover effect of the poverty. However, the recent collapse of oil sharp contraction in real income in 2015 combined revenues has largely exhausted the government’s with the continued deterioration of employment capacity for countercyclical spending, and the indicators. Elevated inflation, together with the projected fiscal consolidation will greatly limit continued zero indexation of public wages, and its ability to shield vulnerable households from below inflation indexed pensions will keep real the impact of the recession. Under the baseline wages and income growth negative in 2016. scenario the poverty rate is projected to increase Labor markets are expected to be impacted by to 14.2 percent in 2016, or 20.3 million people. lower demand and the unemployment rate is The poverty rate is projected to rise to 14.7 projected to increase from 5.6 percent in 2015 percent (21 million people) in the lower-bound to 6.0 percent in 2016, further increasing wage scenario and to 13.6 percent (19.5 million people) pressures. During the 2008 global financial crisis in the upper-bound scenario. Figure 43: Poverty rate projections, percent 16 0.424 15.2 15.2 15 14.8 0.422 14.7 14.2 14.2 0.420 14 13.3 13.4 13.5 13.4 13.6 0.418 13 13.4 13 12.7 12.6 0.416 12.5 12 0.414 11 11.2 0.412 10.7 10.8 10 0.410 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Poverty rate, % Baseline scenario Lower bound scenario Upper-bound scenario Early sanctions lift scenario Gini (rhs) Source: Rosstat and World Bank. With the exception of a brief pause during the global financial crisis in 2009. 23 36 Russia Economic Report | Edition No. 35 II. Economic Outlook Better growth prospects in 2017 could translate likely to benefit from rising wages due to their into a stabilization of poverty rates. However, disproportionate reliance on public transfers. even the improvement in economic conditions Under the upper-bound scenario the poverty projected in the baseline scenario would be rate is expected to remain at 13.4 percent in unlikely to stop the erosion of household 2017, similar to its 2015 level, but lower than the incomes in 2017, as nominal increases in public peak of 13.6 percent observed in 2016. In 2018, sector wages and transfers are unlikely to pressures related to the presidential election keep pace with inflation. As a result, under the are expected to result in the full indexation of baseline scenario the poverty rate would remain pensions, public wages and social transfers. At elevated in 2017 at close to its 2016 rate of the same time labor markets are expected to 14.2 percent. Under the lower-bound scenario recover somewhat. Thus, poverty dynamics are the poverty rate would rise further, from 14.7 expected to improve significantly in 2018. The percent in 2016 to a peak of 15.2 percent in poverty rate is projected to fall to 13.5 percent 2017. Only the upper-bound scenario would under the baseline scenario, 12.6 percent under allow for a modest increase in real wages in 2017, the upper-bound scenario, and 14.8 percent though lower-income households would be less under the lower-bound scenario. 2.3 Risks and Policy Challenges – Prevailing Headwinds Risks to Russia’s outlook are tilted to the downside as it faces strong headwinds from an uncertain recovery in global demand, especially for oil and other commodities. At the same time, the policy space for Russia’s second phase of adjustment to increase medium-term fiscal and financial sector stability has shrank in light of depleting buffers. Russia’s longer-term growth potential will depend on the strength of its structural reforms. G lobal economic growth and commodity- price projections are subject to substantial downside risk. Emerging markets and developing place are supportive of short-term growth, they can also undermine the profitability of financial institutions. In the first few months of 2016 low economies continue to face serious challenges interest rates have already caused a sharp slide due to slumping commodity prices and in bank equity prices. The slowdown in emerging diminished capital inflows. The broad weakness markets, combined with rising international in commodity prices is expected to persist in financial volatility, could delay the projected 2016, maintaining pressure on commodity recovery in global growth (Box 15). exporters such as Russia. The sharp drop in oil prices in January underscored the continued Weak growth and sharply lower commodity instability of both supply and demand in the prices have narrowed the room for Russian policy global oil market. This includes the possibility makers to respond, should risks materialize. of a more rapid resumption of oil exports from The depletion of Russia’s fiscal reserves has Iran, greater resilience in US oil production and increased its vulnerability to further shocks. slower growth in oil consumption as the impact Similar to the experience of other commodity of lower prices on demand fades. Protracted exporters, the recent collapse of global oil prices low oil prices in 2016 could further slow global has sharply limited the Russian government’s inflation, keeping policy interest rates low across capacity for countercyclical measures to advanced economies. While low policy interest support macroeconomic stability in a prolonged rates that several central banks have put in downturn. Nevertheless, fiscal policies can still Russia Economic Report | Edition No. 35 37 II. Economic Outlook Box 15 Risks to the global outlook Global growth is expected to accelerate slightly in 2016, but downside risks are substantial. This includes a disorderly slowdown in major emerging market economies, financial market turmoil arising from sudden shifts in borrowing costs amid deteriorating fundamentals, lingering vulnerabilities in some countries, and heightened geopolitical tensions. Though it remains relatively unlikely, a disorderly slowdown in the largest emerging markets would have important global spillovers through its negative impact on commodity prices and growth in the developing world. Compounding these risk is the possibility of a protracted decline in potential growth throughout emerging and developing economies. Empirical estimates indicate that a sustained 1 percentage point decline in the aggregate growth rate for Brazil, Russia, India, China and South Africa (the BRICS) would cut growth in other emerging and developing economies by around 0.8 percentage points and reduce global growth by 0.4 percentage points.24 While China’s fiscal buffers may be sufficient to manage the risks associated with its own slowdown, this may not be the case for countries such as Russia, in which low commodity prices have greatly diminished revenues and depleted fiscal reserves. Declining global inflation and persistently low policy interest rates in advanced economies are increasing international financial risks. Headline inflation is expected to be close to zero in a number of advanced economies, due largely to the decline of global oil prices. Key central banks have adopted a more accommodative monetary policy stance. Following a modest increase in interest rates in December 2015 the US Federal Reserve indicated in February 2016 that it was closely monitoring external risks and the impact of global turbulence on US growth, and a sudden readjustment of expectations regarding the future trajectory of US interest rates could increase financial stress in developing economies. As low oil prices continue to reduce inflationary expectations, policy rates are projected to remain at their current levels well into 2017. Several central banks in advanced economies have introduced negative policy rates, including the European Central Bank. Though these policies are intended to support growth, the combination of negative rates, large excess reserves, and low long-term yields could undermine the profitability of banks by narrowing net interest margins and reducing revenues from traditional maturity-transformation activities. Amid growing concerns about credit risks, these factors contributed to a significant sell-off in bank shares in early 2016. play an important role in mitigating risks and confidence has not yet been restored. Consumer supporting growth, and a combination of cyclical confidence deteriorated in the last quarter of and structural policies could prove mutually 2015 and is likely to have weakened further in reinforcing. Near-term policy actions should the first quarter of 2016. Business confidence focus on building resilience to withstand global slightly improved in the first quarter of 2016, yet financial market turbulence and reinforcing remained low overall (Figure 44). Weak investor financial sector stability. The authorities confidence is not due solely to the continued should design policies to support a smooth softness of domestic demand. However, policy fiscal adjustment that equitably distributes the uncertainty became the single most important burden across the economy and promotes long- constraint reported by businesses (Figure 45). This term productivity growth. These cyclical policies refers to uncertainty about medium-term fiscal should be complemented by structural reforms policy choices and priorities in economic policy intended to bolster investor confidence in the which should address structural inefficiencies in short term and enhance growth prospects in the the allocation of factors of production and rethink long term. the footprint of the state in the economy. It also includes the unpredictability in the application Policy uncertainty has become the most of laws and regulations, which prevent the important obstacle to investment and development of a level economic playing field. consumption decisions. Recent trends in These policy uncertainties now stifle private business and consumer sentiments show that investment and limit Russia’s growth potential.25 World Bank Global Economic Prospects, January 2016. 24 The output gap turned negative in 2015 from a positive 2-3 percent in 2014, and it is expected to widen further in the next two years to about 6 25 percent, which could justify further countercyclical policies. However, given the existing structural constraints, projected growth is unlikely to exceed its estimated long-run potential. As a result, aggressive countercyclical policies may boost inflation rather than supporting domestic demand. 38 Russia Economic Report | Edition No. 35 II. Economic Outlook Figure 45: Key constraints to manufacturing, rosstat Figure 44: Business confidence surveys in manufacturing business survey, percent 1 4 0 3 Weak domestic demand -1 2 -2 High tax level 1 -3 0 -4 -1 High policy uncertainty -5 -2 -6 -3 High interest rates -7 -8 -4 -9 -5 Lack of financial resources Oct-12 Oct-13 Oct-14 Oct-15 Apr-12 Apr-13 Apr-14 Apr-15 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jul-12 Jul-13 Jul-14 Jul-15 0 10 20 30 40 50 60 Rosstat Business Confidence (LHS) PMI (RHS) Jan-Mar, 2016 Jan-Mar, 2015 Source: Rosstat and HSBC. Source: Rosstat. Financial Sector Stability The rising share of NPLs is increasing pressure on bank capital.27 Russian banks have been Financial sector stability will be essential to the obliged to increase their loan-loss provisioning, recovery of private investment, yet financial which is eroding profits, depleting capital assets, stability in the near term will be tested by and undermining their ability to attract new a number of factors. First, both private and investment. Further loan-loss provisioning is public banks are likely to experience increased likely in the near term as a consequence of weak capitalization pressures due to the rising share of economic conditions for households and firms, NPLs on bank balance sheets and the expiration of which cumulatively present the authorities with temporary regulatory forbearance measures by a near ‘perfect storm’ as they continue to adapt the central bank. Russian banks exhibited weak measures to sustain financial stability. Russian financial indicators in 2015, and the recession has banks appear to be adequately capitalized slowed new business growth.26 Second, banks overall; at end-2015 almost all banks met the are becoming increasingly reliant on central 10 percent capital-adequacy requirement, and banks and government funding support, due to average capital ratios were generally sound restrictions on access to international capital and thanks to a massive state recapitalization effort the shallowness of domestic capital markets. and CBR forbearance policies.28 However, the Finally, despite significant improvements in end of forbearance at the beginning of 2016 is recent years, weaknesses in financial sector expected to increase pressure on bank capital, oversight and the uneven enforcement of and the capital-adequacy ratios of affected banks banking regulations persist. are likely to decline. 26 The growth of corporate loans is expected to remain in the low single digits, driven by the refinancing needs of large companies and the obligation of recapitalized banks to increase their exposure by 1 percent per month in certain strategic sectors, such as small-business loans mortgage lending. Loans to households are not expected to grow, as banks are less willing to offer consumer credit and auto loans. 27 The aggregate share of NPLs may be underreported, as more than half of the banking system’s total assets are held by public banks. The CBR’s specific methodology for determining NPLs may also result in underreporting. 28 The CBR introduced forbearance in 2015 to ease pressure on banks’ prudential ratios. In particular, it allowed banks to convert foreign-currency assets into rubles at more favorable exchange rates beginning in 2014. Russia Economic Report | Edition No. 35 39 II. Economic Outlook Many of Russia’s largest state-owned or state- declining market value of assets on bank balance controlled banks continue to provide support sheets. The CBR has responded by intensifying to the economy despite the increase in NPLs. bank supervision, and it continues to close weaker The CBR’s efforts notwithstanding, high interest financial institutions. More than 100 banks were rates continue to exert upward pressure on closed during the past year, and the consolidation funding costs, while credit levels are in decline of the banking sector is expected to continue and defaults are increasing. This threatens as the CBR tightens regulatory compliance. In to create a vicious cycle in which tight credit the near-term, the resolution of troubled banks constraints further discourage investment. To should be encouraged, including the merger and/ maintain the viability of the sector, banks need or takeover of smaller banks, possibly by raising to resolve their stock of NPLs, which would lead the minimum capital requirements. Bank closures to stronger balance sheets and encourage more have depleted the reserves of the Deposit sustainable lending. Insurance Agency (DIA), and the CBR has already provided liquidity to sustain DIA operations. Banks have become increasingly dependent on Achieving and maintaining a sustainable level central bank funding as the Russian banking of reserves would allow further banking sector system has remained cutoff from international consolidation while still protecting depositors. The capital markets since 2014. As of end-2015 the DIA would require a premia top-up from industry, CBR had provided bank funding equivalent to a raise in its deposit-insurance premia assessment 6.5 percent of total banking sector liabilities. amount and extended coverage to legal entities. Foreign-exchange exposure poses a serious risk for certain banks, especially corporate Fiscal Adjustment borrowers with foreign-currency-denominated loans in non-tradable sectors such as real estate Fiscal policy uncertainty represents a significant and construction. Foreign-exchange exposure risk to Russia’s growth prospects. Russia has is often the single greatest risk to banks whose a disproportionately large public sector. As a clients have little or no foreign-currency earnings significant share of the workforce is employed and have been hard hit by currency depreciation by the public administration or by state-owned and the economic downturn. Given that foreign- enterprises and banks, many households are currency-denominated assets represent about directly dependent on public employment and 30 percent of corporate-banking assets, this risk wages. Russia also has a relatively generous is being closely monitored by the CBR as it strives social welfare system, and transfers and to reduce banks’ foreign-exchange exposure in pensions constitute a substantial share of terms of both assets and liabilities. household income in the form of social transfers and pensions. Given the state’s prominent role Government and central bank policies in the economy, many private firms rely on implemented as part of the 2015 anti-crisis public contracts. The state’s major role in the plan have provided important short-term relief economy increases risks for households and to banks, but these measures are straining the firms when fiscal constraints tighten or when capacity of financial sector authorities. The CBR uncertainty regarding fiscal priorities or the fiscal has provided immediate liquidity, in some cases planning horizon is high. As a result, the manner accepting the underlying portfolio as collateral in which fiscal policy is carried out contributes despite the significant risks involved. CBR liquidity profoundly to economic sentiments and it has support and the collateral requirements for central strong implications for employment, income and bank loans could expose the central bank to the economic growth. A new CBR regulation, which is currently pending approval, would introduce higher risk weights on foreign-currency-denominated loans and securities 29 as of April 1st, 2016: http://www.cbr.ru/analytics/?PrtId=project&ch=732#CheckedItem 40 Russia Economic Report | Edition No. 35 II. Economic Outlook As the collapse of global oil prices put increasing investment and consumption decisions. Such a pressure on public revenues, Russia launched plan should provide for continued spending on a fiscal consolidation effort to address rising strategic public investments while shielding poor fiscal imbalances. Russia’s large fiscal reserves and vulnerable households from the brunt of the facilitated the first phase of the adjustment by fiscal adjustment. Ensuring that the burden of buffering the impact of terms-of-trade shocks. the adjustment is equitably distributed and that However, as low oil prices persisted, these the fiscal consolidation is consistent with long- reserves were progressively depleted. Moreover, term productivity growth will likely require a the volatility of oil revenues made medium- comprehensive review of expenditure priorities term fiscal planning difficult, and policymakers focusing on key sectors, such as national defense, shortened the budget horizon to one year in economic subsidies, and social programs 2015. Despite a new round of spending cuts and pensions. Improvements in expenditure announced in January, Russia is unlikely to meet efficiency could help the government maximize it 2016 deficit target of 3 percent of GDP, and the value of its existing resources, but such the country’s Reserve Fund is expected to be gains may not be sufficient to compensate for exhausted by the end of the year. The president’s increasing structural imbalances. This would recently announced target of a balanced budget require a review of tax policies, which would by 2019 effectively constitutes a new fiscal rule, serve as the basis for developing a strategy to yet the government lacks a mechanism for increase nonoil revenues and sustainably lower implementing it. the nonoil deficit. Going forward, two key fiscal policy challenges Sizable fiscal deficits are projected over remain. The first will be to embark on a strategic the medium-term, and maintaining fiscal expenditure restructuring process going stability will require a new medium-term well beyond general budget cuts, while also budget financing strategy as well as a strengthening the nonoil revenue base to adjust renewed discussion on borrowing limits. to a protracted downturn in oil and gas revenues. The government’s current plan includes only Budget cuts can be effective as an emergency temporary financing measures, such as using response to shocks, but more sophisticated the remainder of the Reserve Fund or privatizing reforms extending to both sides of the budget will public assets. The government is considering be necessary to adjust to a protracted downturn an ambitious privatization effort, which could in oil and gas revenues. The second challenge begin as early as the second half of 2016 (section will be to manage expenditure uncertainty in the 1.4). The privatization process would need to absence of medium-term budgeting, which was guarantee transparency and that investors are suspended in August 2015. A return to a credible sourced competitively to ensure that public medium-term fiscal framework is paramount and assets are not undersold. While the Reserve Fund would boost consumer and business confidence is used to finance recurrent expenditures, the by reducing fiscal uncertainty. National Welfare Fund is used for infrastructure investment financing. Investment decisions Formulating medium-term policies that should follow a transparent vetting process support a smooth fiscal adjustment is among based on financial viability assessments to the government’s most pressing challenges. A ensure that scarce capital resources generate clear, well-sequenced plan for eliminating the adequate long-run returns. Strengthening public deficit over the next several years would allow investment management would help to ensure firms and households to make more efficient that projects generate value for money. Russia Economic Report | Edition No. 35 41 II. Economic Outlook Structural Reforms to Accelerate Long-Term to diversify its export profile, the authorities Growth will need to enact structural reforms designed to facilitate the reallocation of labor and capital The shift in relative prices caused by the between sectors and firms and to create a ruble’s depreciation could enable a broad- level playing field for private investors. Private based improvement in Russia’s international investment remains constrained by regulatory competitiveness. The depreciation has presented uncertainty and variations in how the rule of Russia with an opportunity to transform its law is applied. The government should shift its export profile by diversifying away from primary focus to providing highly effective regulatory commodities. However, relative prices are not institutions that promote robust competition the only dimension of competitiveness, and and curtail opportunities for corruption. Russian firms will face considerable challenges in improving the quality of exports, increasing their The government’s new anti-crisis plan does technological content and ensuring compliance not focus exclusively on emergency measures, with international standards. Achieving these but also includes a number of medium-term objectives will require substantial investment, economic development initiatives. This includes especially FDI, which is associated with the reforms designed to improve the investment strongest technological spillovers. The price climate, reduce the frequency of business audits, advantage generated by the depreciation might diminish regulatory uncertainty, and strengthen not be sufficient to attract investors, particularly judicial processes and law-enforcement in the context of the economic sanctions systems (Box 16). The swift and comprehensive regime, unless it is accompanied by sustained implementation of these measures would improvements in the investment climate and provide a clear signal to international capital deep structural reforms. markets that the Russian government is committed to improving the investment climate. Structural reform measures could boost investor Without rapid and sustained investment in new confidence in the short term and enhance industries, Russia may miss the opportunity Russia’s growth prospects over the long afforded by its current price advantage, and term. Investors face a range of economy-wide promoting sufficient productivity growth to constraints, including administrative barriers to accelerate the country’s long-term economic doing business, corruption, high transportation trajectory would prove far more challenging. and logistics costs, and unequal access to These issues are examined in greater detail in factors of production and markets due to the the special focus chapter of this report. lack of competition. Especially if Russia wants 42 Russia Economic Report | Edition No. 35 II. Economic Outlook Box 16 The Government’s 2016 anti-crisis plan On March 1, 2016 the government approved the Plan of Government Action for Stable Socioeconomic Development in 2016. This new anti-crisis plan calls for RUB684.8 billion (US$9.5 billion), or 0.8 percent of GDP, in new spending, focused primarily on supporting selected industries and regional governments. In 2015, the authorities had developed an anti-crisis plan in the amount of RUB2.4 trillion, about 70 percent of which was devoted to financial sector support. The government did not originally intend to have a second 2016 plan and instead expected to work on a more routine basis. However, the sharp decline in oil prices in January 2016 caused the government to reconsider its decision. The plan focuses on short- and medium-term economic development measures. It includes transfers to regional governments (RUB310 billion), support to selected sectors (RUB340.8 billion), enhanced social protection (RUB38.3 billion), and reforms designed to improve the investment climate (Figure 46). Transfers to regional governments will consist of credits from the federal budget in place of more expensive commercial debt. In 2015, the net increase in budget credits totalled RUB161.2 billion. Short-term support to selected sectors will encompass the automobile industry (RUB137.7 billion), the state-owned railway company (RUB39.8 billion) and the construction sector (including RUB25 billion for building new schools and RUB16.5 billion for mortgage subsidies). RUB33.5 billion will go to support small and medium enterprises, and RUB21.1 billion will be devoted to promoting non-resource exports. Social protection spending is primarily designed to shore up employment. Finally, measures to improve the investment climate include reducing business audits, increasing the predictability of legislation, improving the judicial and law enforcement systems, decreasing the costs of doing business, privatizing certain state-owned companies and enhancing the efficiency of others. The bulk of the plan’s financing, RUB468 billion, has already been accounted for in the 2016 budget. Expenditures to support the economy increased by 11.6 percent in nominal terms, though this may be altered during the upcoming budget revisions. The government’s plan guarantees that support to certain industries will be allocated before amendments to the federal budget are introduced (Figure 47). Support to Russian Railways will come from the National Welfare Fund. The allocation of the remaining RUB158 billion in financing will be determined based on budget execution during the first half of 2016. This includes support to the ailing state-owned development bank, VEB, and a possible second round of pension indexation in addition to the one included in the current budget proposal. Potential sources of financing could include the government’s anti-crisis fund (RUB120 billion, mainly consisting of undisbursed resources from the 2015 anti-crisis plan), the president’s special fund (RUB342 billion, consisting of the frozen second-pillar pension contributions), privatization proceeds, or expenditure reallocations. Figure 46: The anti-crisis plan by expenditure area Figure 47: The anti-crisis plan by financing source To be defined 23% Social support Support to regions 6% 45% Other sources 3% Budget 68% NWF Support to 6% industries 49% Budget NWF Other sources To be defined Social support Support to industries Support to regions Source: Ministry of Finance. Source: Ministry of Finance. Russia Economic Report | Edition No. 35 43 PART III EXPORT COMPETITIVENESS AND FOREIGN DIRECT INVESTMENT: The Complex Puzzle of Diversification 30 T he combined effects of economic sanctions and falling oil prices have brought renewed attention to Russia’s longstanding policy discussion on trade diversification and export competitiveness. This focus note explores historic challenges to Russia’s export competitiveness and why it might be difficult to expect quick changes in the country’s export-profile. For decades the growing dominance of the natural resource sector has undermined economy-wide competitiveness, as high commodity prices have skewed the country’s economic and export structure in favor of oil, gas and mining. Russia’s export pattern narrowed on both the extensive and intensive margins, becoming increasingly concentrated in terms of both products and markets as the high rate of return offered by primary commodities discouraged value addition and stifled the development of new export sectors. While the depreciation of the ruble has enhanced the competitiveness of Russia’s non-resource exports, leveraging this opportunity to develop a broader and more sophisticated export mix will require a substantial and sustained increase in private investment. The price advantage generated by the depreciation might not be sufficient to attract investors, especially foreign investors, unless it is accompanied by deep and sustained improvements in the investment climate. Russia’s profound regional disparities underscore the critical role of private investment in the country’s development, and empirical evidence reveals that the ability to attract FDI at the regional level is among the single strongest predictors of per-capita income growth. 30 This section was prepared by Birgit Hansl, Michael Ferrantino and Gabriela Schmidt based on the findings of a background report entitled Export Performance and FDI Performance across Russia’s Regions. The original report was part of a suite of papers prepared for the World Bank’s Trade and FDI Competitiveness across Russia’s Regions in the post-WTO Accession and Eurasian Customs Union Environment research project under the guidance of Birgit Hansl. The team would like to thank peer reviewers Jean-Pierre Chauffour and Borko Handjinski for their comments and suggestions. The team is also grateful for the additional support provided by Karlygash Dairabayeva and Patrick Ibay, as well as Olga Emelyanova, who supplied the data used in the analysis. Russia Economic Report | Edition No. 35 45 III. Export Competitiveness and Foreign Direct Investment 3.1 Introduction E xpanding and diversifying Russian exports could reinforce macroeconomic stability, accelerate economy-wide growth and alleviate relative prices are not the only dimension of competitiveness, and Russian firms face challenges in product quality, innovation capacity regional disparities. Diversifying export and compliance with international standards, as products and destinations can mitigate external well as economy-wide structural constraints. macroeconomic risks. As the recent experiences with oil price volatility and economic sanctions In order for firms to capitalize on their current highlight, broadening the export profile beyond relative price advantage in international the natural-resource sector can lessen Russia’s markets they would need to expand and change vulnerability to commodity-price volatility by their output capacity and invest in both their diluting Russia’s fiscal and economic reliance products and production processes. Efforts on oil and gas. Second, export industries and to boost output, improve quality, introduce export-oriented FDI are believed to generate innovative technologies and/or comply with vital technological spillovers that accelerate international standards will require a large and innovation and facilitate the production of sustained influx of new capital. But attracting more sophisticated goods and services which international investors will require more than a boost economic growth in the long-term. price advantage: in order to become competitive Finally, encouraging investment in regions as an exporter and as a destination for global FDI, with a competitive advantage in sectors other Russia would need to establish a more hospitable than natural resource production and related investment climate.31 Accomplishing this goal industries can boost interregional convergence will require eliminating administrative barriers in wage rates and living standards. to doing business, reducing transportation and logistics costs, lowering corruption and While export competitiveness has always been regulatory uncertainty, and ensuring equitable a prominent element of Russia’s discussions access to productive factors and markets. on trade diversification, the collapse of global oil prices and the imposition of economic Over the past several decades high commodity sanctions have brought renewed attention to prices have skewed Russia’s economic and the importance of expanding production and export structure towards oil, gas and mineral exports beyond the resource sector. Repeated products. Russia has gradually developed a two- oil-price shocks and a grim medium-term outlook tiered export structure, in which the bulk of its for global commodity markets have exposed export revenue is derived from a “one-product- serious weaknesses in Russia’s resource-driven one-market” pattern of oil and gas exports to the growth model. However, the weaker ruble could European Union, while a more stable and diverse also help Russia transform its export profile by range of non-commodity goods is exported diversifying away from primary commodities in almost exclusively to markets in the former Soviet general and from the oil and gas subsectors in Union. Russia has had considerable difficulty particular. The weakened ruble has given Russian introducing and sustaining new non-commodity firms a comparative edge in global markets, exports beyond markets in the Eurasian and exchange-rate projections indicate that Customs Union (ECU) and former Soviet Union, this advantage is likely to endure long enough which are by far its most reliable and enduring to justify medium-term investments. However, export partners. Russia’s exports are also less See also: http://www.brookings.edu/blogs/future-development/posts/2015/11/03-ruble-depreciation-russia-hansl 31 46 Russia Economic Report | Edition No. 35 III. Export Competitiveness and Foreign Direct Investment sophisticated than those of Brazil, India, China relatively high FDI inflows per capita, or both. and South Africa—the other BRICS countries— Higher-income regions also tend to have larger and their average level of sophistication has non-commodity exports per capita, but those declined over time. that have been most successful in attracting FDI have enjoyed the most robust economic growth Russia has historically attracted foreign rates and exhibit the highest average income investment at rates comparable to those of the levels. other BRICS countries, but the establishment of economic sanctions in 2014 drastically In order to improve export performance, curtailed inbound FDI.32 Russian mining accelerate growth and enable poorer regions and quarrying firms (including oil and gas to converge with their wealthier counterparts, companies) are the most likely to have foreign Russia would need to become more attractive investors, followed by financial and insurance to FDI despite the inherent challenges of firms. While the resource sector has traditionally the economic sanctions regime. Even before been the main target of foreign investment, the economic sanctions were imposed, the sectoral distribution of FDI has become more prevalence of round-tripping FDI—i.e. channeling diverse over time. Over 2005–2012 FDI in the domestic capital through offshore tax havens so secondary sector (manufacturing, utilities and that it is treated as foreign investment—indicated construction) grew four times faster than FDI serious deficiencies in Russia’s business climate. in the resource sector, while FDI in the service External shocks exacerbated these weaknesses, sector grew three times faster.33 particularly restricted access to global financial markets. Falling commodity prices have Russia suffers from vast and persistent regional compounded the impact of the sanctions regime disparities in export performance and FDI on oil, gas and mining exports. However, the attractiveness, and empirical analysis reveals current challenges for the resource sector also a strong link between FDI, export performance presents an opportunity to reinvigorate growth and regional growth. Gross regional product in the non-resource economy—provided that (GRP) per capita varies enormously across the authorities can establish an adequately Russia’s regions, the wealthiest of which are supportive investment climate. Moreover, comparable to high-income OECD members, depressed commodity prices are diminishing the while the poorest are comparable to low-income advantages of wealthier, resource-rich regions, developing countries.34 Beyond the historical potentially facilitating long-term interregional economic centers of Moscow and St. Petersburg, convergence in export performance, growth most of Russia’s more developed regions are and ultimately living standards. However, many spread across the north of the country, while of Russia’s poorer regions also suffer from the poorest are concentrated in the south and serious deficiencies in economic connectivity, southwest. The uneven distribution of oil and institutional capacity and the quality of the other natural resources largely explain this local business environment. Addressing these pattern: Russia’s wealthiest regions tend to have disparities should be a key priority of the relatively large commodity exports per capita, government’s FDI strategy. 32 After adjusting for FDI outflows to tax havens (e.g., Cyprus, Bermuda and various Caribbean countries), Russia’s inbound FDI-to-GDP ratio for 2007– 2013 was at 2.4 percent, but since the imposition of economic sanctions in 2014 FDI inflows have been negligible. 33 This was due in part to the reduced value of oil and gas investments following the 2008–09 drop in global oil prices. 34 Russia’s regions are collectively referred to as federal subjects. These include a number of different administrative entities: oblasts, federal republics, krais, autonomous okrugs, federal cities, and one autonomous oblast. Each federal subject has a unique constitutional and historical relationship with the Russian Federation, and many have significant populations of ethnic minorities. The number of federal subjects has varied over time, and the data used here refer to the 83 federal subjects that existed in 2012. Russia Economic Report | Edition No. 35 47 III. Export Competitiveness and Foreign Direct Investment 3.2 Russia’s Export Profile and the Challenge of Diversification Trade Orientation and Growth 2014. Oil and gas exports peaked in 2013 at 71 percent of total exports (Figure 48). Yet even in T he Russian economy is well integrated into global markets, but over time oil and gas exports have dominated the growth of its 2014 and 2015, as global oil prices collapsed, oil and gas continued to account for 66 percent and 62 percent of Russian exports, respectively. global export share. The most basic indicator Crude oil represented more than one-third of oil of trade openness and economic integration is and gas exports. the trade-to-GDP ratio.35 This indicator is slightly lower for Russia than for most BRICS countries, Russia’s dependence on oil and gas exports with the exception of Brazil. Russia’s actual trade is exacerbated by its focus on a single export is below its potential.36 While Russia successfully market, the European Union. In 2014, 46 expanded its export share in global exports to 3 percent of Russia’s total exports went to EU percent during the 2000s, this was due entirely countries, down from 55 percent in 2013, of to increases in oil and gas exports.37 which oil and gas represented by far the largest share. This “one product-one market” export The current slump in global commodity prices is pattern has heightened Russia’s vulnerability not the first time that the overwhelming share to shocks, as either falling global oil prices or of natural resources in Russia’s export basket decelerating EU growth can negatively affect has posed a major threat to macroeconomic Russian exports. Since 2013, Russian exports stability. A steep drop in oil prices in 2009 in have been continuously impacted by one or both the wake of the global financial crisis adversely of these dynamics. impacted Russia in much the same way as in Figure 48: Oil and gas and nonfuel exports, 1997-2015 A. Share of Mineral Fuel Exports in Total Exports B. Export Composition 80 100 90 70 155,600 80 130,219 60 70 50 60 55,240 50 41,844 40 40 115,808 67,403 30 30 20 20 153,888 10 89,577 10 0 2014 2015 0 Exports of Crude Oil (mln. USD) Exports of Oil Products (mln. USD) Exports of Natural Gas (mln. USD) Exports of Liquified Gas (mln. USD) 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Exports of Coal (mln. USD) Exports of Coke (mln. USD) Non-fuel Exports (mln. USD) Source: COMTRADE and Haver Analytics. 35 Dairabayeva, Ferrantino, Portugal-Perez and Schmidt, 2015. The ratio gives an indication of the dependence of domestic producers to foreign demand and of domestic consumers and producers on foreign supply. 36 Russia’s trade potential is estimated though a regression analysis comparing actual trade to GDP per capita. 37 World Bank 2013: Export Diversification through Competition and Innovation: A Policy Agenda. 48 Russia Economic Report | Edition No. 35 III. Export Competitiveness and Foreign Direct Investment The dominance of oil and gas in its export profile years, notwithstanding a modest and temporary has decreased Russia’s revealed comparative improvement between 2012 and 2013 (Figure 49). advantage (RCA) over time. Russia’s RCA38 is A variety of factors contribute to Russia’s focus primarily in oil and gas, minerals, metals, and on primary commodities, agricultural goods and wood due to the key role of primary commodities simple manufactures. While the large share of in total exports. Moreover, during the 2000s oil and gas exports itself tends to drive down the the number of Russian products with a positive sophistication index, Russia’s domestic economy RCA declined from 139 to around 100. This also lags many of its peers in terms of service means that in the short-to-medium term Russia intensity.39 Accelerating the growth of modern can generate the most revenue by increasing business services could enhance innovation output within its relatively narrow range of and boost economy-wide competitiveness. In traditional exports, while over the longer term addition, Russian product standards often differ export diversification—in terms of both products significantly from international norms, which and markets—could increase its resilience to can make it difficult for Russian exports to fully external shocks and accelerate the transfer of access international markets, especially markets new productive technologies. In recent years for complex and sophisticated goods.40 some nontraditional exports have grown at above-average rates, expanding Russia’s export Figure 49: The sophistication of BRICS exports, 2006-2013 mix. However, most of these are still primary Log EXPY 10.05 commodities and intermediate goods, such 2013 2010 2012 2008 2011 2009 2006 2007 as nonfuel minerals, agricultural products and 2007 2006 2009 2008 2010 2011 2013 foodstuffs, and more sophisticated, higher-value- 2012 10 added goods and services remain conspicuously absent from the export profile. 9.95 2009 2008 2011 2013 2006 2007 2010 2012 2007 2008 2006 Export Sophistication, Value Addition and New 9.9 2010 2009 2011 Export Survival 2012 2013 8 8.5 9 9.5 10 Russian exports tend to be relatively Log GDP per capita unsophisticated compared with those of the Russia China Brazil India other BRICS countries. Indicators of aggregate Source: Real GDP per capita in purchasing power parity (PPP) is compiled from the World Bank’s World Development Indicators, the proxy for export export sophistication have declined in recent sophistication (EXPY) is derived from COMTRADE data. 38 The RCA reflects a given country’s relative advantage in terms of a group of goods or services as evidenced by trade flows. It provides information about the trade potential of new partners and nontraditional products. Countries with similar RCA profiles are unlikely to have high bilateral trade potential. The RCA index of country i for product j is measured by the product’s share in the country’s exports relative to its share in world trade: RCAij = (xij/ Xit) / (xwj/Xwt), where xij and xwj are the values of country i’s exports of product j and global exports of product j, and where Xit and Xwt refer to the country’s exports and total global exports. A value of less than unity implies that the country has a revealed comparative disadvantage in the product, and a value above unity indicates a revealed comparative advantage. 39 Sáez and van der Marel, 2015. 40 Ferrantino, Gillson and Schmidt, 2015. Core ideological differences between Russia’s product standard regime and those of its trading partners outside the former Soviet Union have caused tensions with other WTO members, as Russian product standards also govern non-tariff measures on imports. Russian standards cover product characteristics, production techniques, and packaging and are designed to ensure that different firms produce goods with a high degree of compatibility and interchangeability. By contrast, international standards are more often focused on basic requirements for public safety and health, allowing firms considerable latitude to produce highly differentiated products. Under international standards the private sector ensures product quality throughout the supply chain, while in Russia the state ensures quality though “end-of-pipe” inspections. The specificity and rigidity of Russian standards may stifle innovation by relegating scientific health and safety testing to a subordinate role and creating both compliance problems for firms and monitoring problems for the government. Russia Economic Report | Edition No. 35 49 III. Export Competitiveness and Foreign Direct Investment A statistical technique known as product-space Soviet Union have an especially low survival rate analysis explores the complex relationships as do products outside the country’s dominant between different products, revealing resource and commodity sectors. Indeed, many important information about a country’s new exports to nontraditional partners survived underlying economic structure. A product-space for just a few years. Conversely, exports to the analysis of the Russian economy indicates that ECU and other former Soviet Union countries its comparative advantages tend to be skewed have enjoyed above-average survival rates. Over toward products with limited connectivity to time, this has generated a dual export structure, other sectors and little potential for positive in which a relatively diverse and enduring mix of spillover effects. While Russia’s product-space exports to traditional regional trading partners map illuminates the roughly 100 products in exists alongside a highly concentrated and which the country has an RCA, most of these are vulnerable set of mostly resource-based exports located at the periphery of the product space. bound for partners outside of Russia’s historical This focus on economically isolated products sphere of influence. Export survival depends on makes it more difficult to build comparative many factors. In Russia, exchange-rate volatility advantages in other sectors. Strikingly, most new has significantly increased the likelihood that products in which Russia has developed an RCA exports will be terminated. tend to be commodities and intermediate goods, including raw materials, forestry products, Compared to its peers, Russia’s ability to expand cereal grains, and oil and gas products. While into new markets has been limited, and its trade there are some exceptions, such as chemicals, profile has become increasingly concentrated Russia has largely failed to develop an RCA since 2008. In recent years, Russia has recorded in complex manufactures and sophisticated no growth in exports of new products, either to services, reflecting the slow pace of structural existing markets or to new markets. Russia’s sales transformation over the past decade. of existing products to new markets accounted for only 7 percent of its export gains in 2006– While Russia has periodically launched new 2008 (Figure 50 A), and for 6 percent in 2011– export products and entered nontraditional 2012 (Figure 50 B). These exports are mainly oil markets, it has struggled to sustain non-resource and gas, and growth on the extensive margin is exports to countries outside its geographic negligible when fuel products are excluded. region. Exports to countries outside the former Figure 50: Export growth in BRICS countries, 2006–2008 and 2011–2012 A. 2006-2008 138.92 150 134.08 135.36 128.01 129.52 100 50 21.83 23.88 15.85 6.5 4.92 0 -50 -100 Intensive Margin Extensive Margin Increase of existing Decrease in existing Extinction of Introduction of new Introduction of new Introduction of Product diversification in products in products in exports of products products in new products in existing products in established markets established established in established markets established new markets markets markets markets markets Bra Rus Ind Chn Zaf 50 Russia Economic Report | Edition No. 35 III. Export Competitiveness and Foreign Direct Investment B. 2011-2013 200 145 150 134 134 119 108 100 50 32 2 10 6 12 3 15 0 0 0 0 0 0 0 0 0 0 0 0 0 0 -2 -9 -11 -5 -10 -20 -50 -35 -35 -48 -46 -100 Intensive Margin Extensive Margin Increase of existing Decrease in existing Extinction of Introduction of new Introduction of new Introduction of Product diversification products in products in exports of products products in new products in existing products in in established established established in established markets established new markets markets markets markets markets markets Bra Rus Ind Chn Zaf Source: COMTRADE. Note: The analysis excludes 2009, the year of the trade crisis, in order to focus on periods of trade growth. Export Diversification in an Adverse External advantage might be not be sufficient to generate Environment a commensurate increase in the scope, scale and sophistication of Russian exports. In 2014 a combination of economic sanctions and the collapse of global oil prices brought The drop in commodity prices and the renewed attention to Russia’s longstanding establishment of the economic sanctions policy dialogue on diversification and export regime significantly decreased export values in competitiveness. While none of the economic 2014-2015. Fluctuations in the price of crude oil, sanctions targets Russia’s exports, Russia Russia’s main export, have influenced the prices itself imposed a number of import bans from of Russia’s other commodity exports (Figure Western countries, mostly for food items. Also, 51 A). Economic sanctions, which were phased economic sanctions prohibit the export of some in from March to December of 2014, inhibited technology and dual-use goods to Russia, which cross-border financial transactions, and their could be used for military purposes. Finally, impact on foreign investment may affect future economic sanctions also prohibit the export of oil-production capacity. The value of Russia’s goods, services and technology that could be exports declined by 52 percent between 2012 used for the exploration or production of deep- and 2014, with oil declining twice as fast as water, Arctic offshore and shale-oil projects. other exports. As a result, the share of oil and gas Most importantly, the rapid devaluation of the in total exports shrank from 67.2 percent in 2012 ruble created a relative price advantage for to 61.6 percent in 2015. Meanwhile, non-resource Russian exporters, giving rise to considerable exports also contracted by about 30 percent. The optimism regarding Russia’s potential to expand value of primary merchandise exports (such as into new products and nontraditional export ferrous metals, steel and nickel) also declined over markets. Yet higher import prices might prevent that period, but this drop was less pronounced Russia from importing important intermediate for machinery and equipment, processed timber inputs necessary for high-value exports. In and aluminum (Figure 51 B). However, economic addition, Russia faces structural and historical sanctions have likely had an even stronger impact constraints on its export competitiveness and on investment than on trade. without addressing them the relative price Russia Economic Report | Edition No. 35 51 III. Export Competitiveness and Foreign Direct Investment Figure 51: Trends in key export goods A. Composition of Exports, 2007-2015 B. Primary Merchandise Exports, 2012 and 2015, US$ billions Million USD Billion dollars 60 30 50 25 20 40 15 30 10 20 5 10 0 Machinery and equipment Wheat and meslin Fertilizer Timber, processed Ferrous metals Steel semi- finished products Flat-rolled carbon steel Refined copper Niclel, unwrought Raw aluminum 0 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Other Machinery and equipment Ferrous metals Natural gas Petroleum products Crude oil 2012 2015 Source: Haver Analytics While Russia’s recent diversification strategy toward China and the rest of Asia, and the has focused on expanding exports to the EU economic sanctions regime is likely to accelerate beyond oil and gas, China has become an this trend. Figure 53 shows the evolution of increasingly important export market. In 2014 exports to non-EU destinations between 2007- exports to China accounted for 8 percent of 2008 and 2013-2014. Oil and gas exports to China Russia’s total exports, and exports to the rest of and the rest of Asia more than doubled during Asia represented 13 percent (Figure 52). Exports this period. Other exports to Asia also increased, to ECU partners made up 6 percent, down 2 though at a much slower pace. After oil and percentage points from 2013, whereas exports gas, metals and chemicals are Russia’s most to other CIS countries accounted for 5 percent, important exports. In 2015 metals accounted for down 1 percentage point from 2013. These 29 percent of nonfuel exports, while chemicals declines were offset by an increase in the share accounted for 19 percent (Figure 55). of exports to the rest of the world. Russia has long struggled to diversify both Figure 52: Russian exports by destination, 2014 its export products and destination markets, Non CU-CIS 5% Belarus and the rise of the natural resource sector Rest of Europe, 3% China incl. Turkey 4% 8% has increased the concentration of the export Rest of Asia basket. The Herfindahl-Hirschman Index (HHI) 13% measures the concentration of export shares by product and destination. A score of 0 indicates infinite diversification, while a score of 1 reflects ROW EU28 mineral fuels (37.43%) complete concentration. Russia has one of the 13% highest HHI scores for export products among North America EU28 non-fuel (8.73%) EU28 46% comparable countries, but a relatively low score 2% MENA for export markets. Exports to China and the 3% Kazakhstan EU are the most concentrated, while exports 3% to Kazakhstan are the least (Figure 54). This Source: COMTRADE data. Note: “Fuel exports” refer to Chapter 27 of the Harmonized System. pattern reflects the dual structure of Russian exports to major international markets, which are dominated by oil and gas, and exports to Russian exports, especially oil and gas, have traditional regional trading partners, which are been gradually shifting away from Europe and far more diverse. 52 Russia Economic Report | Edition No. 35 III. Export Competitiveness and Foreign Direct Investment Figure 53: Russian exports to non-EU countries, 2007-08 and 2013-14 US$ billions US$ billions 80 18 16 60 14 12 10 40 8 6 20 4 2 0 0 Belarus China Kazakhstan MENA America America Non CU-CIS North ROW Belarus China Kazakhstan MENA North ROW Non CU-CIS Rest of Asia Rest of Turkey Rest of Asia Rest of Turkey Europe, incl Europe, incl Avg. 2007-2008 Avg. 2013-2014 Avg. 2007-2008 Avg. 2013-2014 Source: COMTRADE. Note: MENA refers to the Middle East and North Africa. Non-ECU CIS is former members of the Commonwealth of Independent States (CIS) excluding Belarus and Kazakhstan, ROW is the rest of world, and EU is the European Union. Belarus’s values for 2007-08 are derived from mirror data. Figure 54: HHI for Russian exports, 2012 metals, Russia’s main nonfuel exports to China 0.350 include wood and chemicals. Importantly, a 0.300 third of nonfuel exports to the Middle-East and North Africa are agricultural and food products, 0.250 which could indicate further export potential. 0.200 Chemicals dominate Russia’s nonfuel exports to 0.150 other regions, such as Latin America and Africa. 0.100 Despite the overall concentration of Russia’s exports, the EU remains the primary destination 0.050 for nonfuel products, followed by the CIS 0 countries, China and the rest of Asia. EU28 ROW Belarus America China Non CU-CIS North MENA Kazakhstan Rest of Asia While the ruble’s depreciation has created an Source: COMTRADE data. The index is calculated based on the three-digit important price advantage for non-resource standard international trade categories exports, yet well-known obstacles are inhibiting Despite the recent depreciation of the ruble, investment in sectors with high growth Russia has had little success in introducing new potential. Export volumes rose in the wake of non-resource exports, especially in markets the depreciation, especially to countries outside outside the former Soviet Union, though the the former Soviet Union countries. However, experience of different regions has varied the improvement in relative prices did not substantially (Figure 55 and Box 3-1). Metals significantly impact exports for most of Russia’s and chemicals remain Russia’s most important manufacturing sector, and many of the country’s nonfuel exports. Nonfuel exports to ECU and industrial products remain uncompetitive on other former Soviet Union countries tend international markets. to be significantly more sophisticated than those to other destinations, and they include Experienced exporters appear to be benefitting complex manufactures such as machinery and from the weaker ruble, while firms that have transportation equipment. Most nonfuel exports traditionally produced for the domestic market to Europe are metals, and the same is true for have been less able to take advantage of the shift much of Asia and North America. In addition to in relative prices. Adjusting product profiles and Russia Economic Report | Edition No. 35 53 III. Export Competitiveness and Foreign Direct Investment Figure 55: Russian nonfuel exports by product and destination, 2014 A. Composition of Nonfuel Exports B. Nonfuel Exports by Destination Belarus Food & Agriculture nonCU-CIS 6% China Miscellaneous 14% 11% 7% 12% Minerals (excl. mineral fuels) Rest of Europe, 3% incl. Turkey 9% Machinery & Transportation 15% Rest of Asia EU28 11% 30% Chemicals 19% ROW 6% North America Metals 4% 29% Wood MENA Kazakhstan 8% 7% 9% C. Destination of Nonfuel Exports by Type Miscellaneous Machinery & Transportation Belarus China Metals EU28 Kazakhstan Wood MENA North America ROW Chemicals Rest of Asia Rest of Europe nonCU - CIS Minerals (excl. mineral fuels) Food & Agriculture 0 20 40 60 80 100 Source: COMTRADE. MENA refers to the Middle East and North Africa, Non-ECU CIS refers to CIS members excluding Belarus and Kazakhstan, the EU is the European Union, and ROW is the rest of world. achieving compliance with international quality diversification have been taken into account.41 standards will require both time and investment. Other government measures attempt to assist This process already appears to be underway, firms in overcoming challenges related to and investment in certain sectors has increased specific export cycles and exploiting emerging substantially in recent years (see Box 1.3). export opportunities, often by reducing the cost and risks involved in entering new markets. Diversification policies tend to focus on Export-promotion strategies have achieved increasing returns to investment by supporting mixed results, and their success or failure the growth of specific sectors and even individual largely depends on the specifics of each policy. firms. In principle, this type of intervention could The robust involvement of the private sector accelerate productivity growth and enable firms is a common element among more effective to achieve international competitiveness more export-promotion efforts. However, even quickly. In practice, however, there is limited successful export-promotion measures may evidence for the success of targeted industrial prove unsustainable once public sector support policies once all other factors affecting export is withdrawn. World Bank, 2014. 41 54 Russia Economic Report | Edition No. 35 III. Export Competitiveness and Foreign Direct Investment Box 17 Regional differences in export composition and export destinations Russia’s regions vary substantially in both the composition of their nonfuel exports and their major destination markets. The Central Federal Region focuses on machinery and transportation equipment. The Ural Mountains and Siberia primarily export metals. The North Caucasus and the Volga Federal Region have the largest shares of chemical exports, and the Northwest and Far East regions concentrate on wood and agricultural products. Export destinations are largely determined by geography: the Far East region exports primarily to Japan and the rest of Asia, the provinces bordering China export to China, and the southwestern provinces export to the Middle East and North Africa. The major exception is oil-rich Siberia, which joins the western provinces in exporting primarily to Europe (Figure 56). Figure 56: Primary non-ECU destinations for Russia’s regional exports by value Total exports main destination (largest export value) Non-CU CIS EU28 Rest of Europe, incl Turkey VENA China Rest of Asia North of America ROW No data Source: GTIS data. MENA refers to the Middle East and North Africa, Non-ECU CIS includes all members of the Commonwealth of Independent States except for Belarus and Kazakhstan, EU is the European Union, and ROW is the rest of the world. Numbered regions: 1 Yaroslavl, 2 Kaluga, 3 Vladimir, 4 Ivanovo, 5 Perm, 6 Moscow City, 7 Tula, 8 Nizhniy Novgorod, 9 Ryazan, 10 Mari El, 11 Udmurtia, 12 Mordovia, 13 Chuvashia, 14 Tatarstan, 15 Penza, 17 Ulyanovsk, 18 Saratov, 20 Samara, 21 Volgograd, 22 Kalmykia, 23 Adygea, 24 Stavropol, 25 Karachevo-Chercheskia, 26 Kabardino-Balkaria, 27 North Ossetia, 28 Chechnya, 29 Ingushethia Most investment decisions are driven by will require substantial improvements in the enduring improvements in the investment efficiency of factor markets, along with a climate rather than relative price adjustments regulatory environment that fosters competition, or government support to certain sectors. In innovation and quality. Previous analytical work Russia, confidence remains weak among both has demonstrated the particular importance foreign and domestic investors, discouraging of FDI in increasing productivity, fostering long-term investment (Section 2.3). Securing innovation and boosting the export capacity of adequate capital to restructure and expand Russian firms,42 and recent developments in the the non-resource export sector will hinge external environment will have key implications on the success of Russia’s structural reform for the future of FDI in Russia. agenda. Attracting long-term capital investment Lee and Liu, 2005; World Bank, 2013. FDI is strongly associated with productivity growth and technology transfer, as foreign firms tend to have 42 ownership-specific advantages in productive systems and management techniques. Russia Economic Report | Edition No. 35 55 III. Export Competitiveness and Foreign Direct Investment 3.3 Attracting FDI in a Challenging External Environment P rior to 2014 Russia’s inbound FDI levels were comparable to those of the other BRICS countries, though “round-tripping” was Million USD Figure 57: Net FDI inflows to Russia, 2008-2015 45,000 especially common. Between 2007 and 2012 as 40,000 much as one-third of Russia’s inbound FDI was in 35,000 fact Russian capital channeled through offshore 30,000 tax havens. Correcting for round-tripping, 25,000 inbound FDI hit its post-2008 peak during the 20,000 first quarter of 2013, when net inflows reached 15,000 US$69 billion.43 However, net FDI plunged by 10,000 two-thirds during 2014. The most severe declines 5,000 were observed in the third and fourth quarters, 0 Q 1 Q 3 Q 1 Q 3 Q 1 Q 3 Q 1 Q3 Q 1 Q 3 Q 1 Q 3 Q 1 Q 3 Q 1 when aggregate net inbound FDI turned -5,000 2008 2009 2010 2011 2012 2013 2014 2015 negative across all sectors of the economy, Source: CBR. indicating widespread capital flight (Figure 57). A tenuous recovery began during the first half round-tripping due to the weak enforcement of of 2015, though net FDI inflows remained far financial laws and property rights in the domestic lower than in previous years. Round-tripping, market, as well as the tax advantages offered by which was always more prevalent in Russia than offshore financial centers. Since round-tripped in other BRICS countries, has intensified since FDI is not authentically foreign capital, but rather 2014 (Figure 58). domestic capital reentering the country, it is less likely to generate the same gains in technology The increasing prevalence of round-tripping transfer and productivity growth associated with is cause for concern. Russian firms likely favor genuine FDI. Figure 58: Sources of Russian net incoming FDI, 2014 Latvia Japan Hungary Germany 1.48% 1.29% 2.3% 1.52% Rest of world Kazakhstan 1.36% 1.56% United States 3.09% Switzerland Bahamas France Austria 16.44% 3.67% China Netherlands Austria Netherlands United States 5.41% Hungary Cyprus 25.66% Kazakhstan Possible round-tripping Germany China origins Latvia 5.55% 55.55% Japan Rest Of World Cyprus Bahamas France British Virgin Islands 9.09% Bermuda British Virgin Islands 11.11% Switzerland Bermuda 10.80% 2.34% Source: CBR. The large spike in 2013 was due to a historically large single investment in the oil-refinery sector (Table 13) by the British Petroleum Company. It 43 acquired a 20 percent share in Rosneft, using cash arising from BP’s sale of its 50 percent stake in the vertically integrated TNK-British Petroleum consortium to Rosneft. 56 Russia Economic Report | Edition No. 35 III. Export Competitiveness and Foreign Direct Investment The economic sanctions regime established in firms expanded into the domestic pharmaceutical 2014 restricts FDI by targeting both financial subsector. Foreign firms also diversified the range transactions in general and investments in of available construction services. The minority the oil sector in particular. The economic participation of foreign investors in Russia’s sanctions regime has inhibited the international telecommunications subsector accelerated operations of Russia’s largest banks, preventing technology transfer despite an especially large Russian firms from acquiring international debt share of round-tripped FDI. or making cross-border financial transactions. They have also partially blocked the oil sector Net outflows of foreign capital since 2014 from acquiring new technology and equipment, affected all sectors of the Russian economy and some prospective FDI projects have been simultaneously, particularly during the third frozen. Russia’s oil sector is the country’s primary quarter of 2014 (Table 13). A modest rebound destination for inbound FDI, and by targeting the in FDI, focused largely on the oil and gas sectors, oil sector the economic sanctions regime has began in the first half of 2015. Unless FDI inflows had an immediate and deeply negative impact continue to recover, the government is unlikely on FDI inflows.44 to achieve its ambitious medium-to-long-term plans to enhance the export competitiveness of Prior to 2012 FDI rates were increasing fastest in Russian firms. Constrained FDI inflows are not high-tech manufacturing, utilities, construction only slowing Russia’s overall growth, but also and financial intermediation, sectors that are have significant negative implications for regional strongly associated with positive technological development. Russia’s regions have benefitted spillovers.45 Foreign auto manufacturers differently from FDI, and regional development broadened the range of affordable and high- patterns illustrate the important links between quality cars in the domestic market. Rising FDI in foreign investment, export performance and the chemicals sector leveraged Russia’s absolute economic growth. advantage in fossil fuels, and foreign chemical Table 13: Net inbound FDI by sector, 2013-2015 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2013 2013 2013 2013 2014 2014 2014 2014 2015 2015 All sectors/industries 40,140 6,900 13,515 8,664 12,907 11,751 -709 -1,059 1,704 2,640 Primary 3,361 6,083 -1,329 -394 2,036 2,789 -442 344 2,373 2,551 AGRICULTURE, FORESTRY AND FISHING 294 150 32 143 -53 148 39 -164 28 151 MINING AND QUARRYING 3,067 5,933 -1,361 -537 2089 2641 -481 508 2345 2400 including: 0 0 0 0 0 0 Mining and quarrying of fuel and 3,366 3,943 -700 -75 1999 2388 24 1286 2038 1941 energy materials Mining and quarrying except fuel and -300 1,990 -662 -462 89 252 -505 -778 307 459 energy materials Secondary 21,172 -5,722 1,686 4,046 2,201 2,883 -27 -272 1,339 1,721 MANUFACTURING 19,635 -7,494 1,023 3,330 758 1524 -453 -662 1195 1943 including: Food products, beverages, and tobacco -151 215 -507 348 -365 520 -584 462 -45 805 products 44 Participants in the economic sanctions regime include Australia, the European Union, Japan, Norway, Switzerland, Ukraine, and the United States. The particular nature and timing of the economic sanctions has varied by participant. 45 Kuznetzov, 2010. Russia Economic Report | Edition No. 35 57 III. Export Competitiveness and Foreign Direct Investment Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2013 2013 2013 2013 2014 2014 2014 2014 2015 2015 Wood and products of wood and cork 9 6 -21 10 1 62 124 75 21 153 Pulp and paper production; publishing 60 -139 60 71 158 -268 -17 177 11 -1 and printing Refined petroleum products and coke 17,001 767 1,062 1,877 95 549 -2012 -130 -1245 -268 Chemicals and chemical products 272 249 170 456 147 52 346 956 412 542 Rubber and plastic products 95 31 -2 125 108 197 -30 59 193 136 Other non-metallic mineral products 298 144 29 102 194 45 19 -226 273 102 Basic metals and fabricated metal 1,383 -9,238 -725 212 336 645 1524 -1837 1162 -13 products Machinery and equipment 148 162 317 -148 138 -418 51 195 60 101 Computer, electronic and optical 364 220 154 85 1 83 42 65 14 16 products Manufacture of motor vehicles, trailers and semi-trailers and other transport 145 80 474 171 17 5 92 -480 327 365 equipment Other manufacturing 11 11 13 21 -70 53 -8 23 12 6 UTILITIES (electricity, steam, gas and 542 299 485 468 313 636 -48 -1 39 -285 water supply) CONSTRUCTION 995 1,474 178 248 1129 723 475 391 105 62 Services 14,114 6,198 12,788 5,603 8,244 6,054 -134 -1,145 -2,490 -1,717 WHOLESALE AND RETAIL TRADE; REPAIR OF MOTOR VEHICLES AND 7,412 2,811 8,049 2,270 3682 2904 898 -4218 342 -517 MOTORCYCLES TRANSPORT AND COMMUNICATION 1,316 734 -729 -2,265 -187 624 -2,231 -1,310 -1,554 -83 FINANCIAL AND INSURANCE ACTIVITIES 5,232 2,928 2,103 4,192 3832 1445 2117 1668 -345 253 OTHER 154 -275 3,365 1,405 916 1,081 -919 2,717 -933 -1,369 Unallocated 1,411 194 325 -666 370 -19 -119 -28 507 81 Notes: “Other manufacturing” includes textiles and apparel, leather and miscellaneous manufacturing. “Other services” includes real estate and rentals, business activities, education, health and social work. 3.4 Foreign Investment, Export Performance and Regional Development Regional Export Dynamics and FDI Trends of the country’s 12 wealthiest regions are also among the top export performers (Figure 59), E xport performance varies significantly across regions. Oil, gas and other natural resources have a major influence on regional exports. and 7 have rates of per capita FDI that are in the top 15 percent of the distribution.46 Conversely, the North Caucasus include 6 of the 11 poorest Russia’s wealthiest regions tend to have very regions in the Russian Federation. In 2011 the high exports and/or FDI inflows per capita, while export performance of these 6 regions was far moderately wealthy regions often have relatively below the national average, and 4 reported high non-resource exports per capita. Seven receiving no FDI at all. As of 2012, the most recent year for which regional export data are available. 46 58 Russia Economic Report | Edition No. 35 III. Export Competitiveness and Foreign Direct Investment Figure 59: Total exports per capita by region, US$ Million Per Capita Total Export (to all destinations, million USD) 4191.62,32216.60 2552.18,4191.62 1590.20,2552.18 780.27,1590.20 484.37,780.27 259.47,484.37 123.74,259.47 57.49,123.74 0.00,57.49 No data Source: GTIS data. Numbered regions: 1 Yaroslavl, 2 Kaluga, 3 Vladimir, 4 Ivanovo, 5 Perm, 6 Moscow City, 7 Tula, 8 Nizhniy Novgorod, 9 Ryazan, 10 Mari El, 11 Udmurtia, 12 Mordovia, 13 Chuvashia, 15 Penza, 16 Tatarstan, 17 Ulyanovsk, 18 Saratov, 20 Samara, 21 Volgograd, 22 Kalmykia, 23 Adygea, 24 Stavropol, 25 Karachevo-Chercheskia, 26 Kabardino-Balkaria, 27 North Ossetia, 28 Chechnya, 29 Ingushethia. High rates of FDI and natural-resource exports has been round-tripped, suggesting that the relative to GRP are both positively correlated rapid growth of investment in financial services with regional per capita income (Figure 60 A and may be driven more by policy weaknesses than Figure 60 B). Since the global financial crisis the by economic opportunity. export intensity of GRP—the share of exports in regional economic output—has remained flat or Regional competitive advantages affect the declined in all regions except Moscow.47 Export type of FDI each region attracts, and investment intensity has been lower than average in Central may drive the transformation of comparative Russia and very low in the North Caucuses, which advantage over time. The largest share of are also the country’s poorest regions (Figure 61 foreign-owned mining and quarrying firms is in A). The Far East has received the largest share of the Far East, followed by Siberia and the Urals. Oil FDI in the country, and it has the highest FDI-to- and gas dominate exports from the Far East and GDP ratio (Figure 62 B). FDI has increased fastest Ural regions, though not from Siberia. However, in the chemical and pharmaceutical products, FDI may ultimately drive Siberia to specialize machinery, electronics and transport equipment, in oil and gas. Agriculture, forestry, and fishing and financial intermediation subsectors. As noted also are attracting FDI in the relatively wealthy above, mining and quarrying firms are most likely Far East, as well as in Southern Russia and in to have foreign investors, followed by financial the relatively poor North Caucasus. These three and insurance firms. However, an estimated 50 regions also have the highest concentration percent of FDI in the financial services subsector of food and agriculture exports. The Volga As of 2012, the most recent year for which regional export data are available. 47 Russia Economic Report | Edition No. 35 59 III. Export Competitiveness and Foreign Direct Investment region is a major destination for manufacturing growth over the period 2001–2011 illustrates investment, which has enabled it to build an this relationship.48 Along with attracting more export base comprising chemicals, machinery FDI, rapidly growing regions are more likely and transportation equipment. to have better business-climate indicators. Ceteris paribus, poorer regions grow faster FDI as a Predictor of Regional Growth than wealthier regions.49 However, despite the accelerated growth of poor regions, large Regional FDI inflows are among the strongest disparities persist and convergence rates are predictors of per capita income growth. A slow and uneven. cross-sectional model of regional income Figure 60: Intensity of resource exports, FDI and GDP per capita by region, 2012 Per capita income and mineral exports by regions, 2011 Per capita income and FDI flows by regions, 2011 ln mineral exports,/capita, U.S. 000 ln FDI inflows/capita, U.S. million 20 20 - 5.162 y = 3.397x 18 18 R² = 0.436 16 16 14 14 12 12 10 y = 3.287x -6.149 10 R² = 0.154 8 8 6 6 4 4 2 2 0 0 0 1 2 3 4 5 6 7 8 0 1 2 3 4 5 6 7 8 ln per capita income, 2003 roubles ln per capita income,2003 roubles Source: Rosstat. Figure 61: Average export intensity and FDI inflows, percent of nominal GRP percent percent 60 50 45 50 40 35 40 30 30 25 20 20 15 10 10 5 0 0 Central (excl. Moscow Moscow City Northwestern (excl. St. Petersburg) St. Petersburg City Southern Ural Northwestern (excl. St. Petersburg) St. Petersburg City North Caucasian Volga Siberian Far Eastern Central (excl. Moscow Moscow City Southern Ural North Caucasian Volga Siberian Far Eastern 2000-2008 2009-2011 2000-2008 2009-2011 Source: Rosstat. Note: “Location” refers to the firm’s headquarters, not necessarily the site of production. 48 The model is adapted from Mankiw, Romer and Weil (1992). The determinants of income growth in the model are p, in which variables are measured as period averages, either in per capita terms or in shares, and are expressed as follows: yi,t − yi,t−1 = β0 + β1yi,t−1 + β2human_capitali,t−1 + β3exportsi,t−1 + β4FDIi,t−1 + β5business_climatei,t−1 + β6share_minerali,t−1 + β7share_urbani,t−1 + εi,t In this model, y denotes real per capita income in each region i, yi,t−1 represents 2001, the initial year, human capital is measured by the percentage of the population enrolled in secondary school, FDI is measured in U.S. dollars per capita, the business climate is based on 2003 scores from the consulting firm Expert RA, resource exports are expressed as a share of total merchandise exports and the urban population as a share of the total population. For non-income dependent variables, t-1 denotes the period averages. 49 Barro and Sala-i-Martin, 1995. Beta convergence, which has been found for subnational regions in the EU, Japan, and the US, is necessary but not sufficient for sigma convergence. These countries have less regional income inequality than Russia, and regional incomes have become more equal over time. 60 Russia Economic Report | Edition No. 35 III. Export Competitiveness and Foreign Direct Investment Despite the tendency towards convergence Figure 62: Standard deviation of log per capita income by region in income by regions, Russia’s poorest regions 0.7 have not narrowed the gap with their wealthier counterparts.50 Russia’s regions vary greatly 0.6 in terms of their resource endowments, 0.5 governance quality, institutional capacity, and 0.4 ability to attract FDI. The dispersion of levels of income across regions—the standard deviation 0.3 of log per capita income across regions—fell 0.2 from 1996 to 2001, but rose in 2011, indicating 0.1 that regional inequality has actually increased in recent years.51 Regional income inequality 0 1996 2011 1940 1988 1940 1987 1950 1987 1950 1987 1950 1987 is more pronounced in Russia than in most Russia United States Japan Italy France United Kingdom comparable countries (Figure 62). While Russia’s Source: World Bank staff calculations drawing on data from Barro and Sala-i- poorer regions are converging with wealthier Martin (1995). regions that have similar characteristics, the divergent influence of resource endowments, and FDI. Thus, increasing exports and attracting governance quality and FDI inflows currently FDI are central to efforts to enhance living outweighs the factors favoring convergence.52 standards and promote development in these regions. The long-term economic convergence of Sustained improvements in the business Russia’s regions will require a level playing field climate will be critical to promoting Russia’s for attracting FDI. In the current context of low overall growth and alleviating its profound oil prices and economic sanctions, accelerating regional disparities. Russia’s poor regions have progress on the structural reform agenda will be much more tenuous international engagements especially critical. than the rest of Russia in terms of both exports 3.5 Conclusion I n the short-to-medium term Russia could expand exports by focusing on sectors in which it already enjoys a competitive advantage and are overwhelmingly bound for Europe, and the heavy concentration of destination markets intensifies Russia’s external vulnerabilities. Oil working to expand its range of export partners. and gas exports to the EU represent close to These include natural resources and resource- half of Russia’s total goods exports, and this based goods such as oil and gas, petroleum “one product-one market” model comprises products, chemicals, metals and wood products. the foundation of the country’s export income. Oil and gas, including both unrefined and China and the rest of Asia receive a large share processed products, accounted for about 66 of commodity exports, but there is considerable percent of Russia’s exports in 2014 and 62 percent scope to broaden Russia’s range of trading in the first half of 2015. However, these exports partners for resource-related exports. 50 In the economic growth literature convergence can be twofold: sigma-convergence refers to a reduction in the dispersion of levels of income across economies while beta-convergence occurs when poor economies grow faster than rich ones. 51 This calculation is made for 83 federal subjects for which complete data from 1996-2011 are available. Since the federal subjects with partial data are at the extreme ends of the income distribution, actual regional inequality is likely greater than reported here. 52 Guriev and Vakulenko (2012) also found that interregional income inequality in Russia was high during the 1985-2005 period, even by the standards of emerging markets. They also found a lack of convergence in per capita income across Russia’s regions during the 2000s, though other measures (such as wages and unemployment rates) have tended to converge. Guriev and Vakulenko (2015) found evidence that lower-income households in the poorest regions of Russia may face particular difficulty in moving to richer regions. Russia Economic Report | Edition No. 35 61 III. Export Competitiveness and Foreign Direct Investment Russia’s non-resource exports are largely of technology-intensive goods and firm-level confined to trading partners in the former innovation capacity. In order to maximize the Soviet Union, and non-resource exporters have potential spillover effects of export-oriented struggled to maintain an enduring presence investment, Russia must increase its global beyond regional markets. While Russia exports competitiveness in technology-intensive sectors. complex manufacturing goods to a number Attracting sufficient FDI to sustainably diversify of former Soviet Union countries, and these Russia’s export profile will pose an especially export relationships are durable, many of serious challenge in the current external its non-resource goods are not globally context, and meeting this challenge will require competitive. Moreover, those countries a similarly exceptional improvement in the accounted for just 10 percent of Russia’s total investment climate. Enhancing the quality of the exports in 2014. The low survival rates of non- regulatory environment, removing obstacles to resource exports to nontraditional markets are accessing productive factors and harmonizing largely attributable to deficiencies in product product standards with international norms will quality, innovation capacity and compliance be essential to attract increased investment, with international standards. particularly in poorer regions and new economic sectors. While there is considerable scope Investment in the sophisticated productive for further analysis, Russia’s ability to further capabilities necessary to export to advanced integrate into global markets will have critical economies can boost economy-wide growth. implications for both its regional and national This is especially important as there is a development objectives. highly positive association between exports 62 Russia Economic Report | Edition No. 35 REFERENCES ▪ Barro, Robert J., and Xavier Sala-i-Martin (1995), Economic Growth. New York: McGraw-Hill. ▪ EBRD 2008: Transition Report. ▪ Dairabayeva, Karlygash, Ferrantino, Michael J., Portugal-Perez, Alberto and Schmidt Gabriela, (2015): “Export Performance and FDI Performance across Russia’s Regions” background paper for project on Trade and FDI Performance Across Russia’s Regions in the Post-WTO Accession and Eurasian Customs Unit Environment, Washington, DC; The World Bank Group. ▪ Guriev, Sergei, and Elena Vakulenko (2012), “Convergence between Russian Regions,” CEFIR / NES Working Paper No. 180, October. ▪ Guriev, Sergei, and Elena Vakulenko (2015), “Breaking Out of Poverty Traps: Internal Migration and Interregional Convergence in Russia,” processed. ▪ Mankiw, N. Gregory, Paul Romer, and David N. Weil (1992), “A Contribution to the Empirics of Economic Growth.” Quarterly Journal of Economics 107: 407-37. ▪ Ferrantino, Michael J., Ian Gillson and Gabriela Schmidt (2015), “Russia, the WTO, and the ECU: Tariff and Non-Tariff Policy Challenges,” background paper for project on Trade and FDI Performance Across Russia’s Regions in the Post-WTO Accession and Eurasian Customs Unit Environment, Washington, DC; The World Bank Group. ▪ Kuznetsov, Alexey (2010), “Inward FDI in Russia and its Policy Context,” Columbia FDI Profiles, New York: Vale Columbia Center on Sustainable International Investment. ▪ Sáez, Sebastian, and Eric van der Marel (2015), “Russia Case Study: How Services Contribute to Competitiveness,” background paper for project on Trade and FDI Performance Across Russia’s Regions in the Post-WTO Accession and Eurasian Customs Unit Environment, Washington, DC; The World Bank Group. ▪ World Bank 2013: Russian Federation Export Diversification through Competition and Innovation: A Policy Agenda. ▪ World Bank 2014: Diversified Development. Russia Economic Report | Edition No. 35 63 Annex 1: Main Macroeconomic Indicators 64 2015 2016 Output Indicators 2012 2013 2014 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2015 Jan Feb GDP, % change, y-o-y 3.5 1.3 0.7 - - -2.8 - - -4.5 - - -3.7 - - -3.8 -3.7 - - Industrial production, % change, y-o-y 3.4 0.4 1.7 0.9 -1.6 -0.6 -4.5 -5.5 -4.8 -4.7 -4.3 -3.7 -3.6 -3.5 -4.5 -3.4 -2.7 1.0 Manufacturing, % change, y-o-y 5.1 0.5 2.1 -0.1 -2.8 -1.9 -7.2 -8.3 -6.6 -7.1 -6.8 -5.4 -5.9 -5.3 -6.1 -5.4 -5.6 -1.0 Extraction of mineral resources, % change, y-o-y 1.0 1.1 1.4 1.5 0.1 0.4 -0.8 -0.9 -0.9 0.2 0.8 0.8 1.4 -0.1 0.1 0.3 0.4 5.8 Fixed capital investment, % change, y-o-y 6.8 0.8 -1.5 -4.1 -5.6 -4.6 -6.2 -9.9 -9.6 -11.7 -13.4 -13.7 -3.7 -6.5 -8.1 -8.4 - - Fiscal and Monetary Indicators Federal government balance, % GDP 1/ -0.1 -0.5 -0.5 -5.4 -7.4 -4.9 -4.4 -3.7 -2.6 -2.8 -2.1 -1.5 -1.2 -1.3 -18.6 -2.4 -6.9 -8.1 2 Russia Economic Report | Edition No. 35 M2, % change, p-o-p / 17.9 15.4 7.3 -2.1 0.9 -0.3 1.5 0.6 0.6 0.5 1.1 -0.2 -0.3 1.4 7.5 7.2 -2.7 0.8 Inflation (CPI), % change, p-o-p 5.1 6.8 7.8 3.9 2.2 1.2 0.5 0.4 0.2 0.8 0.4 0.6 0.7 0.8 0.8 15.6 1.0 0.6 Producer price index (PPI), % change, p-o-p 6.8 3.4 6.1 1.3 2.1 5.5 2.7 -1.2 0.7 1.5 0.1 -1.1 1.8 -0.7 -2.2 10.7 -1.3 -1.5 Nominal exchange rate, average, Rb/USD 31.1 31.8 38.4 61.7 64.6 60.2 52.9 50.6 54.5 57.1 65.2 66.8 63.1 65.0 69.7 60.6 76.3 77.2 Reserve fund, bln USD e-o-p 62.1 87.4 87.9 85.1 77.1 75.7 76.4 76.3 76.8 72.9 70.7 70.5 65.7 59.4 50.0 46.0 49.7 49.9 National wealth fund, bln USD, e-o-p 88.6 88.6 78.0 74.0 74.9 74.4 76.3 75.9 75.7 74.6 73.8 73.7 73.5 72.2 71.7 71.7 71.2 71.3 Reserves (including gold) billion $, end-o-p 537.6 509.6 385.5 376.2 360.2 356.4 356.0 356.8 361.6 357.6 366.3 371.0 370.0 365.0 368.0 368.4 372.0 380.0 Balance of Payment Indicators Trade balance, billion $ (monthly) 191.7 180.6 189.7 15.4 13.7 15.5 14.3 15.2 13.7 10.3 8.6 9.4 10.0 8.8 11.0 148.5 7.9 - Current account, billion $ 71.3 33.4 58.3 - - 30.0 - - 16.6 - - 8.0 - - 15.0 69.6 - - Export of goods, billion $ 527.4 521.8 497.8 27.7 29.2 32.7 30.6 30.6 30.0 27.2 25.0 26.3 27.2 25.2 28.4 341.5 17.6 - Import of goods, billion $ 335.8 341.3 308.0 12.3 15.5 17.2 16.3 15.4 16.3 16.9 16.4 16.9 17.2 16.4 17.4 193.0 9.7 - Financial Market Indicators Average weighted lending rate for enterprises, % 3/ 9.4 9.4 18.3 19.9 18.1 17.9 17.2 16.0 15.5 14.7 14.2 14.0 13.6 13.8 13.8 15.7 13.4 - CBR policy rate, %, end-o-p 5.5 5.5 17.0 17.0 15.0 14.0 12.5 12.5 11.5 11.5 11.0 11.0 11.0 11.0 11.0 11.0 11.0 11.0 Real average rate for ruble loans, % (deflated by PPI) 3.9 5.5 11.7 12.1 8.1 4.3 1.9 2.3 2.1 1.4 -0.4 1.2 -0.5 -0.1 2.8 2.8 5.7 - Stock market index (RTS, ruble term, eop) 1,527 1,443 791 737.4 896.6 880.4 1029.3 968.8 939.9 858.8 833.6 790.0 846.0 847.0 757.0 757.0 745.0 769.0 Income, Poverty and Labor Market Real disposable income, (1999 = 100%) 286.2 297.7 294.7 201.3 263.6 254.7 286.6 256.4 279.3 284.8 285.2 261.5 279.1 271.0 395.5 282.9 187.3 245.4 Average dollar wage, US $ 859 942 841 448.7 511.3 558.4 664.9 649.0 637.5 574.7 484.0 497.0 518.0 503.0 596.0 553.5 427 427.2 Share of people living below subsistence, % 1/ 10.7 10.8 11.2 - - 15.9 - - 15.1 - - 14.1 - - 13.4 13.4 - - Unemployment (%, ILO definition) 5.1 5.6 5.3 5.5 5.8 5.9 5.8 5.6 5.4 5.3 5.3 5.2 5.5 5.8 5.8 5.8 5.8 5.8 Source: Rosstat, CBR, EEG, IMF, staff estimates. 1 / Cumulative from the year beginning. 2 / Annual change is calculated for average annual M2. 3 / All terms up to 1 year. Russia Economic Report | Edition No. 35 65 The World Bank Russian Federation 36/1 Bolshaya Molchanovka Str., 121069 Moscow, Russia T: +7-495-745-7000 F: +7-495-745-7002 W: www.worldbank.org/eca/rer www.worldbank.org/russia Produced by the Macroeconomics and Fiscal Management Practice of the Europe and Central Asia Region of the World Bank Photo credits: © World Bank