Russia Needs to Bolster Banks, Target Fiscal Stimulus

• Author: International Monetary Fund

Even though Russia's far-sighted policy of saving most oil revenues allowed for a large fiscal stimulus, the IMF in its annual Article IV assessment of the country's economy projects real GDP to turn from 5½ percent growth in 2008 to a contraction of 6½ percent in 2009, followed by only a tepid recovery in 2010 (see Chart 1).

Fixed investment has plummeted, weakening the nexus of high rates of growth in investment, productivity, and real wages that had powered Russia's consumption and output boom before the crisis. Unemployment has skyrocketed to an eight-year high, dampening growth in real wages. Banks have come under increased strain, and private sector credit has contracted.

[ CHART ARE NOT INCLUDED ]

So, the authorities now face two key challenges:

* fortifying the banking system; and

* balancing short- and medium-term fiscal considerations.

These tasks must be viewed against the background of pre-crisis policies.

Credit boom

The crisis has highlighted some of the strengths and weaknesses in Russia's pre-crisis policies.

Russia's prudent policy of taxing and saving much of its oil wealth during the good years has left it in a strong position. Despite some weakening of fiscal policy discipline in recent years, the budget was still balanced at an oil price of just half the world market price when the crisis hit. This allowed the government to undertake a large fiscal stimulus to support domestic demand. Moreover, Russia's sizable reserves, fortified by the oil savings of some 16½ percent of GDP, initially allowed the central bank to cushion the impact of the crisis by easing monetary policy.

That said, the pre-crisis policy of controlled appreciation of the ruble had contributed to excessive foreign currency borrowing, as high oil prices helped inflate investor appetite for Russian assets. The result was an oil price-related surge in capital inflows and an associated credit boom, which led to overheating and left Russian banks and corporates vulnerable to a reversal of inflows.

Tackling the crisis

The government's initial policy response in late 2008 was swift and substantial. It was driven by concerns that weaknesses in the banking and corporate sectors could lead to a full-fledged crisis. Policy interventions focused at first on maintaining stability in the external and financial sectors.

The central bank...