Odd Per Brekk on economic prospects for Russia's recovery

Odd Per Brekk, a Norwegian national with a long and geographically varied career in the International Monetary Fund (IMF), has since 2009 acted as the Senior Resident Representative of the IMF in Moscow, Russia. In this interview with the NIB Newsletter, he talks about the determinants of long-term economic growth in Russia.

 

What is the current economic outlook for Russia?

In the short run, the Russian economy is recovering, but fairly modestly despite the high oil prices. General uncertainty in the world markets is compounded in Russia by the approaching parliamentary elections in December 2011 and presidential elections in March 2012, and the IMF is projecting 4.3% growth for this year. 

Looking further, the economic growth outlook will clearly depend on the economic policies in place. In the medium term, there are two possible scenarios. In the pessimistic scenario, if Russia continues with its current policies-meaning a fairly modest reduction in its reliance on oil in the budget, continued inflation around of 10% and slow reforms regarding the investment climate-the lack of investments will stall productivity, with the result of growth slowing to 3.5% per annum.

In the optimistic scenario, Russia gets its economic policies successfully in place. This means, first of all, reducing the country’s reliance on the use of oil resources to finance the budget, so as to limit the scope for Dutch disease. It also means crowding in private investment and the adoption of credible measures targeting inflation, which would improve the domestic banking system and mobilise savings and lending in roubles. In such a case of productive investment recovery, the growth rate may be closer to 6% per annum.

Furthermore, as reserve funds are built up, government debt is low and inflation is well-anchored, the economy will be more robust and better equipped for shocks.

What are the biggest risks in the current forecast?

Problems and plans are well understood amongst the political leadership, but which scenario will materialise is, of course, dependent on to what extent the economic policies are implemented.

Russia managed the 2008-2009 crisis well and fairly ample buffers still exist in the economy. The current exposure to Greece and Europe in general is not large, but spillover effects may come through traditional channels of financial markets and oil price risk, acting as reminders of problems. If there is a new shock, the main vulnerability is on the credit side, but Russian banks would still be quite well positioned as they are small. This, however, is more a question of short-term instability. 

In the longer term, inflation is a big risk. Currently, expected inflation adjusts quickly to actual inflation and even when compared to other transition economies, variability of the inflation rate is particularly high in Russia. As the only G20 country with double-digit inflation prior to the crisis, there is a need to focus on reducing its volatility, with a suggested inflation target of 3%-5%.

You mentioned Russia’s dependence on oil as a particular stumbling block for growth. How could the negative effects of commodity dependence be tackled in Russia?

As long as the budget remains heavily oil dependent, the Russian economy will be very vulnerable to swings in the international commodity and financial markets. Any shock in the world economy that leads to a drop in oil prices or creates risk aversion could easily lower growth and create higher instability in Russia. 

Resource-based economies are faced with very unique fiscal policy challenges. Countries with large resource bases tend to have worse than average growth performance and weaker institutions, and in that sense Russia may not be doing so badly. Some countries, such as Norway and Chile, have however shown how resources can be successfully managed. The main lesson they can provide is the need to have strong institutions and a clearly defined, politically supported medium-term anchor for fiscal policy.

The IMF has recommended that Russia focus on its non-oil budget deficit: this will insulate the budget in the short run from swings in the oil markets and impede automatic pro-cyclical policies. Clearly and actively striving for the anchor is even more important in the medium term, as it helps build consensus in internal policy-making while building credibility to the outside. 

To support such a move in Russia, the IMF recommends setting up an independent fiscal agency, like the UK has done recently, with no practical policy-implementation role but one that will assess assumptions in the budget, monitor developments, add transparency and generate discussion regarding the formulation of fiscal policy.

How does the investment climate affect productive investments in the Russian economy?

This is a long-term and important issue. The Russian banking system, as well as its capital markets, is not sufficiently developed and well-equipped to service large parts of potential domestic clients simply because it is too small, so what you typically see is that bigger Russian companies borrow from international banks or international capital markets. This creates drawbacks. For example, large external borrowing by enterprises before the crisis left them very exposed to the depreciation of the rouble after the crisis. 

If one should draw lessons from this, over the longer term macroeconomic and financial stability needs to be complemented by protection of property rights, bankruptcy resolution, credit recovery, and domestic resource mobilisation. Dealing with these more structural policy issues supports a more stable financing of investments.

What possible role does NIB’s lending have on the economic development of Russia?

International financing in Russia can particularly contribute to knowledge transfer. Lending by institutions such as NIB, which in volume terms to Russian markets is small, helps by bringing in best practices and important processes which can positively add to the economic development of Russia in the long-term.