- Economic growth has slowed further. GDP growth decelerated from 1.3 per cent in 2013 to 0.8 per cent in the first half of 2014 against the backdrop of subdued investment activity and slowing consumption.
- Western sanctions have dented business confidence and increased the cost of financing. Capital outflows accelerated in the first half of 2014 and the rouble weakened to historic lows. Lending interest rates increased by 100-300 basis points as the central bank tried to support the exchange rate and contain inflation by hiking the policy rate.
- Diversion of private pension contributions, along with weaker business confidence, kept stock market valuations low. The contemplated transfer of private pension funds into the pay-as-you-go system may support short-term fiscal balances but will have a negative effect on capital market development.
Key priorities for 2015
- A fast resolution of the geopolitical crisis is needed to boost business confidence and regain access to international financing. While Western sanctions have largely resulted in weaker investments, Russian counter-sanctions have raised inflation and are containing consumption. These factors have lowered the country’s short-term growth and long-term growth potential. In contrast to earlier years, recovery is expected to be slower due to low investment and the need to find new growth drivers other than oil and gas.
- Tackling inflationary pressures by tightening monetary policy is key to breaking inflationary inertia. In addition to actions taken by the central bank, utility price regulation and improvements in competition policy could also play an important role in lowering inflationary expectations. Sustained disinflation would strengthen the central bank’s policy credibility and would help reduce high nominal and real interest rates.
- Further efforts at the federal and regional level are necessary to improve the business climate. Productivity in the tradeable and services sectors has still not reached the technological frontier. Adopting modern technologies and improving corporate governance are essential to close these gaps, but require a business environment that is attractive to foreign investors, and small and medium-sized enterprises (SMEs) with innovative technologies.
ECONOMIC GROWTH HAS SLOWED FURTHER
WESTERN SANCTIONS HAVE DENTED BUSINESS CONFIDENCE AND INCREASED THE COST OF FINANCING
DIVERSION OF PRIVATE PENSION CONTRIBUTIONS, ALONG WITH WEAKER BUSINESS CONFIDENCE, KEPT STOCK MARKET VALUATIONS LOW
Note: FI – Financial institution; ICT – Information and communication technology; Water – Water and wastewater; IAOFS – Insurance and other financial services; PE – Private equity.
Main macroeconomic indicators %
|Current account balance/GDP||4.4||5.1||3.7||1.7||2.9|
|Credit to private sector/GDP||41.8||42.9||50.2||53.5||n.a.|
Economic growth has been decelerating due to the geopolitical crisis and structural factors. Growth slowed from 3-4 per cent between 2010 and 2012 to 1.3 per cent in 2013, and further to 0.8 per cent in the first half of 2014, year-on-year. This deceleration reflects a combination of the weaker global environment, a lower average oil price, worsening investor and consumer confidence, as well as supply-side constraints. Growing net exports (mainly due to lower imports) and a larger-than-expected agricultural output in the first half of 2014 could only partially offset these negative factors.
Inflation remained at elevated levels, reaching 8 per cent in September 2014. The weakening rouble and the Russian import ban on Western food products have raised consumer prices by 1-2 percentage points. The gap between real wages and productivity growth over the past few years may have contributed to persistently high inflation. However, supply-side constraints could also be playing a role. Slowing wage growth could contain demand-side pressures but capacity constraints may still remain.
The central bank has tightened policies with the dual purpose of tackling inflationary pressures and stemming capital outflows. Since 2011 the central bank has been gradually moving towards an inflation-targeting regime, by increasing exchange rate flexibility. This process was reversed temporarily in 2014, with more interventions taking place under particularly heightened political uncertainty, but overall the central bank is maintaining its course. Political pressures against tight monetary policy, however, are increasingly manifested in recent calls for both fiscal loosening in the context of feeble growth, as well as closer coordination between the monetary and fiscal authorities.
Net private capital outflows increased due to weaker investor confidence. Outflows increased from US$ 34 billion in the first nine months of 2013 to US$ 88 billion in the first nine months of 2014 (around 4.4 per cent of GDP), reflecting weak business confidence, current account surplus and the lack of capital controls. Capital outflows slowed in the third quarter as banks divested foreign assets. Western financial sanctions and anti-offshore measures taken or proposed by the Russian government may also force Russian corporates to repatriate offshore buffers in order to finance their domestic operations. The current account surplus has increased from around 1.7 per cent of GDP in 2013 to 2.6 per cent in the first nine months of 2014, as oil and gas-related export receipts remained high, while imports slowed due to weakening investment and consumption, as well as the depreciating rouble.
Although international reserves decreased in 2014, they are still at very comfortable levels. The decline from US$ 510 billion at the beginning of the year to US$ 465 billion in September 2014 is due to heavy central bank interventions in March and April and the elevated capital outflows noted earlier. Persistent capital outflows and the need to repay Russian companies’ (including banks) foreign debt (around US$ 100 billion in 2015), with limited or no availability of foreign refinancing due to sanctions, could put significant stress on reserves. The central bank’s efforts to make the exchange rate regime more flexible by broadening the intervention band and easing formal requirements to intervene may have helped to mitigate these pressures.
Fiscal balances, although still strong, have been weakening. Due to increased social spending, the consolidated budget (including regional and local budgets) ran a deficit of 1.3 per cent of GDP in 2013, compared with the 0.4 per cent surplus seen in 2012, and the debt of the Russian regions increased by 29 per cent in 2013. The consolidated budget surplus reached 2.1 per cent of GDP in January to August 2014 – up from 1.3 per cent of GDP in January to August 2013 – mainly owing to the weak rouble boosting oil-related revenues. Budgetary revenues have also been reliant on proceeds from state-owned corporations (around 1 per cent of GDP), while the general economic slow-down has led the government to use outlays from the National Welfare Fund (NWF) to recapitalise some state-owned banks and contemplate further support for corporate and state infrastructure projects. Subordinated loans issued to state-owned banks during the 2009 crisis have now been converted into preferred shares belonging to the government. Preliminary discussions are also under way with the NWF to provide funding in the amount of RUB 800 billion for railway, road and nanotechnology projects. Payments into the second pillar of the pension system have been suspended for two years, and the potential nationalisation of pension assets (which amount to 2.8 per cent of GDP) is being discussed.
GDP is expected to stagnate in 2014 and to record a mild contraction in 2015. With oil prices declining, geopolitical uncertainty denting business confidence and consumers paying down debts incurred during the recent lending boom, GDP growth is expected to be around zero per cent in 2014 and slightly negative (-0.2 per cent) in 2015. The balance of risks is heavily tilted to the downside in the medium term, should the geopolitical crisis persist.
Major structural reform developments
A treaty establishing the Eurasian Economic Union (EEU) was signed in May 2014 with Belarus and Kazakhstan. The agreement, which comes into force in 2015, marks the next step in economic integration after the creation of the Eurasian Customs Union (ECU) in 2009. Armenia also joined the ECU and the EEU on 10 October 2014, while the accession process for the Kyrgyz Republic is expected to be finalised by the end of 2014. The agreement envisages the free movement of goods, services, capital and people between its member countries, as well as closer coordination of certain macroeconomic and structural policies. At present, internal trade seems to be limited and it will be important to ensure that the EEU remains open to trade and investment from other countries.
Russia’s ranking in international competitiveness ratings improved further. The World Bank Doing Business 2015 report places Russia at 62nd out of 189 countries for ease of doing business (up two positions from last year). In addition, the country jumped from 64th to 53rd place in the World Economic Forum’s Global Competitiveness Report 2014-2015, with progress in almost all areas. Further progress may come from initiatives to improve the regional investment environment, spearheaded by the Agency for Strategic Initiatives (ASI) and supported by earlier EBRD efforts and funding. The ASI recently presented pilot ratings for 21 regions using statistical data, and business and expert surveys, which may create peer pressure to improve the business climate. Ongoing work on municipal investment standards will set best practices and benchmarks.
Access to the Russian corporate debt market has further improved. Foreign investors can access the Russian corporate debt market through international clearing systems, Euroclear and Clearstream. This comes after a similar change in the government debt market in 2013.
Consolidation of the banking sector has advanced. Since it became the country’s single financial market regulator in September 2013, the Central Bank of Russia has closed down some 80 banks that were deemed to have weak financial performance and corporate governance. Although a high concentration of large state-owned banks still remains (the two largest hold 45 per cent of the system’s total assets), these latest measures should help clean up the banking system, which still has a significant number of small and non-transparent institutions.
The government plans to strengthen regulatory incentives to reduce offshore participation in Russian companies. In July 2013 the government adopted a law, which aims to limit cash transactions and the use of “one-day” companies, set up for specific transactions over a short period of time. A draft law on “de-offshorisation”, destined to take effect from 2015, would apply taxation according to the residency of the beneficial owner, rather than the state of establishment, thus reducing tax benefits. The law would also restrict access to financial support and participation in state procurements for companies with an offshore background. Some large companies have already declared their intention to change their offshore ownership structure to Russian entities.
Against the backdrop of Western sanctions, resulting from the crisis in Ukraine, Russian authorities have introduced a one-year import ban on selected EU food products effective from August 2014. Other measures include a ban on imports of Ukrainian food products, including dairy and confectionery. In addition, a number of temporary measures have been adopted over the past year, which affect agricultural and manufacturing imports. As a result, Russia’s transition score on trade and foreign exchange liberalisation has been downgraded.
Progress with privatisation has been slow. Over the past few years Russia has lagged behind considerably on its privatisation schedule, which envisaged annual property sales of around 0.5 per cent of GDP. In recent years mainly small enterprises have been privatised, making up a fraction of the initial revenue plans. Shares in large companies have not been sold since the Alrosa public offering in October 2013, even though several of them (including Rosneft and VTB) have been on the official privatisation lists for years.
Private pension contributions have been diverted to the pay-as-you-go scheme. Employee contributions to private pension funds have been diverted to the pay-as-you-go system temporarily in 2014 until private pension funds are converted into joint-stock companies to be inspected by the central bank. In August 2014 the government extended the conversion timeline until the end of 2015. Meanwhile, the government is considering nationalising the accumulated funds. Other measures introduced in 2014 will gradually increase the minimum years of service and target a notional defined-contribution scheme from 2015.