Policy Uncertainty Clouds Medium-Term Prospects

Russia Economic Report September 2014 | Edition No. 32

Russia Economic Report No. 32

1. Recent Economic Developments

2. Outlook and Risks

3. Paths to Diversified Development in Russia

• Seasonally adjusted growth for the first two quarters was near zero. • Structural impediments slowed economic expansion even before the impact of

increased policy uncertainty amid increased geopolitical tensions. • The economy needed to internalize several rounds of sanctions,

countersanctions and measures to stabilize the economy: this meant operating in an environment of higher risk, which depressed domestic demand.

Russia’s economy is stagnating and

uncertainty is impacting investor and consumer

decisions

There are substantial risks to Russia’s

medium-term outlook

• Macroeconomic stability prevails and Russia remains in possession of large buffers to uphold stability in the near future.

• It is now policy uncertainty about the economic course the country will take that is casting the longest shadow on Russia’s medium-term prospects.

• Our baseline projection is one of near stagnation with growth of 0.5 percent in 2014, 0.3 percent in 2015, and 0.4 percent and 2016.

Economic recovery will need a predictable

policy environment and a new model of

diversified development

• The stabilization effort should go hand in hand with renewed focus on improving the economy’s microeconomic fundamentals.

• A more balanced portfolio of national assets will help overcome structural constraints to growth.

• Stabilization, transparent rules, better quality of public investment, and competition should be the reform priorities for the next decade.

1

2

3

Prospects for future poverty reduction and shared prosperity are

limited

• Restrained investment makes it less likely that well-paying jobs will be created, which could counterbalance the slowdown in income growth.

• Unless addressed, high inflation will hurt consumption growth, dimming the likelihood for further poverty reduction.

4

Main messages

Russia’s Quarterly Growth GDP growth, y-o-y and q-o-q sa, percent

1.0

1.0

1.4

1.3

0.8 0.70.4 0.0

0.4

0.3 0.3 0.4 0.10.2-1

0

1

2

3

4

5

6

GDP growth, y-o-y GDP growth, q-o-q, sa

Russia’s Growth Outlook GDP growth, percent, y-o-y

-2

-1

0

1

2

3

2012 2013 2014 2015 2016

Pessimistic scenario Optimistic scenario

Low risk scenario (March 2014) High risk scenario (March 2014)

Baseline scenario

Russia’s current asset base: abundant natural resources, good human capital, improving infrastructure, but weak institutions

Russia’s asset portfolio is heavy on natural resources: distribution of wealth by assets, 2005, in percent.

43

24

33

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

AUS AZE CAN KAZ MYS NLD NOR RUS SAU TKM UKR ARE USA UZB VEN

Natural capital Produced capital Intangibles

→ Development Challenges Poverty and Shared Prosperity

0.410

0.412

0.414

0.416

0.418

0.420

0.422

0.424

10

11

12

13

14

15

16

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Poverty rate, % Baseline scenarioOptimistic scenario Pessimistic scenarioGini (rhs)

Recent Economic Developments: An Economy on the Threshold of Recession

→ Weak Domestic Demand Growth composition, percent, y-o-y

-23

-15

-7

1

9

17Q

1 08

Q2

08Q

3 08

Q4

08Q

1 09

Q2

09Q

3 09

Q4

09Q

1 10

Q2

10Q

3 10

Q4

10Q

1 11

Q2

11Q

3 11

Q4

11Q

1 12

Q2

12Q

3 12

Q4

12Q

1 13

Q2

13Q

3 13

Q4

13Q

1 14

Q2

14

Consumption GFCF Change in stockExport Import DiscrepancyGDP growth

Note: Q2 2014: World Bank estimate

→ Increasing Borrowing Cost Depress Investment

4

4.5

5

5.5

6

6.5

7

7.5

8

8.5

16

.09

.20

14

22

.07

.20

14

27

.05

.20

14

01

.04

.20

14

04

.02

.20

14

19

.11

.20

13

24

.09

.20

13

30

.07

.20

13

04

.06

.20

13

09

.04

.20

13

12

.02

.20

13

04

.12

.20

12

09

.10

.20

12

14

.08

.20

12

19

.06

.20

12

24

.04

.20

12

28

.02

.20

12

20

.12

.20

11

25

.10

.20

11

30

.08

.20

11

05

.07

.20

11

10

.05

.20

11

15

.03

.20

11

11

.01

.20

11

Central Banks Key Policy Rate (percent) and Russia’s CDS spreads (bps) for 5 year bonds

140

160

180

200

220

240

260

280

300

→ Depreciation and Inflation Dampen Consumption

0.0225

0.023

0.0235

0.024

0.0245

0.025

0.0255

0.026

0.0265

0

2

4

6

8

10

12

2011 2012 2013 2014

Food Non-Food Services CPI

Exchange rate dynamics (Euro-Dollar basket) and Russia’s CPI inflation by components

→ Consumption Held Back by Stagnating Real Wages

Real wage growth, percent, y-o-y

-10

-5

0

5

10

15

2009 2010 2011 2012 2013 2014

non-Market non-Tradables

Tradables Total

→ … and by Households’ Debt Obligations Non-performing Loans as a share of total credit, y-o-y, percent

5

6

7

8

9

10

2010 2011 2012 2013 2014

Nonperforming Loans:Total Loans

Loan Loss Provisions:Total Loans

Nonperforming HH Loans: Total HH Loans

→ Output Growth by Sectors

Non-tradable and tradable sector growth, y-o-y

-6

-1

4

9

14

2013 Q1 2014 Q2 2014

Electricity, gas, and water Construction

Retail trade Transport

Financial services Real estate

-1

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

4

2013 Q1 2014 Q2 2014

Agriculture Mineral extraction Manufacturing

→ Limited Import Substitution Potential

Capacity utilization rate in manufacturing in percent and unit labor cost (2005=100)

40

45

50

55

60

65

70

Electronic and Optical Equip Food

Transport Vehicles Machinery & Equip

Textile & Clothing Manufacturing

100

120

140

160

180

200

220

240

260

280

300

World Bank Outlook for Russia: Stagnation in the Face of Policy Uncertainty

Russia’s Growth Outlook GDP growth, percent, y-o-y

-2

-1

0

1

2

3

2012 2013 2014 2015 2016

Pessimistic scenario Optimistic scenario

Low risk scenario (March 2014) High risk scenario (March 2014)

Baseline scenario

Benchmarking Russia’s Growth Global GDP growth, percent, y-o-y

-12

-8

-4

0

4

8

12

Russia OECD HIEU Emerging Other Emerging

Subdued Global Growth Outlook

Global real GDP growth, percent, y-o-y

2009 2010 2011 2012 2013 2014f 2015f 2016f

World -1.9 4.3 3.1 2.5 2.4 2.6 3.2 3.4

High Income -3.6 3.0 1.8 1.5 1.2 1.8 2.4 2.5

Developing Countries 3.0 7.8 6.3 4.8 4.8 4.5 5.0 5.3

Euro Area -4.4 1.9 1.6 -0.6 -0.4 0.9 1.4 1.8

Russia -7.8 4.5 4.3 3.4 1.3 0.5 0.3 0.4

→ Development Challenges Poverty and Shared prosperity

0.410

0.412

0.414

0.416

0.418

0.420

0.422

0.424

10

11

12

13

14

15

16

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Poverty rate, % Baseline scenarioOptimistic scenario Pessimistic scenarioGini (rhs)

Policy Risks

The stalling of structural reforms represents a down-side risk to Russia’s

medium- and long-term outlook.

Structural constraints in the economy could diminish the effectiveness of

the Central Bank’s disinflation policy.

In the current environment of elevated inflation risk, it will be particularly

important to adhere to fiscal prudency.

Special Focus Note Paths to Diversified Development in Russia

Russia reached its potential output

Russia’s potential growth (in percent) may be slowing.

0

1

2

3

4

5

6

7

2009 2010 2011 2012 2013

RussiaBRICS Average (excluding Russia)EU11 Average (excluding Croatia, Latvia and Luthuania)Resource Rich* Average

How to reverse the slowdown in potential output? In the boom years growth became gradually less driven by productivity increases.

Total factor productivity growth growth slowed as productivity gains from first generation reforms wore off

-15

-10

-5

0

5

10

151

99

3

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

Pe

rce

nt

Total Factor Productivity

Capital

Labor

GDP Growth

The National Asset Approach Assets can be classified into three categories: natural resources, built capital, and national institutions.

Natural resources - minerals, arable land, and forests - are largely endowed, but technological progress and better management can radically alter their economic value.

Built capital - physical and human capital, in the form of adequate infrastructure and a healthy and skilled labor force.

National institutions - the regulations and mechanisms that a country has put in place to manage resource rents, deliver public services - such as roads, security, health care, and education - and regulate private enterprise.

Three ways to integrate and grow: export product share, by factor intensity

Russia’s current asset base: abundant natural resources, good human capital, improving infrastructure, but weak institutions

Russia’s asset portfolio is heavy on natural resources: distribution of wealth by assets, 2005, in percent.

43

24

33

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

AUS AZE CAN KAZ MYS NLD NOR RUS SAU TKM UKR ARE USA UZB VEN

Natural capital Produced capital Intangibles

→ Abundant natural resources Russia is one of the richest countries in the world in subsoil wealth: Subsoil

natural resource wealth per capita, 2005, in constant 2005 US$.

118,111

99,706

86,620

32,468

24,238

24,090

20,328

20,268

12,644

10,102

9,563

9,194

7,061

5,365

3,940

3,478

1,970

982

United Arab Emirates (3)

Norway (4)

Saudi Arabia (6)

Turkmenistan (12)

Russian Federation (13)

Venezuela, RB (14)

Australia (15)

Kazakhstan (16)

Canada (19)

Malaysia (22)

Chile (23)

Azerbaijan (24)

Netherlands (26)

Uzbekistan (28)

Nigeria (30)

United States (33)

Ukraine (44)

Botswana (55)

→ Improving infrastructure

0

5

10

15

20

25

30

35

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

Russia

BRICS Average (excluding Russia)

EU11 Average

Resource Rich* Average3

3

4

4

5

5

6Russia

BRICS Average (excluding Russia)

Investment rates have improved but remain lower than comparators: Gross capital formation, percent of GDP –

Quality of infrastructure has been improving: Global Competitiveness Index: Quality of infrastructure, score 1 (low) to 7 (high)

→ Good Human Capital

NORAUS USA

NLDCAN

CHI UAE

RUS

SAU

MYSKAZVEN

UKR AZE

TKMUZB

BWA

NIG

y = 7E-06x + 0.6294R² = 0.7405

0.40

0.50

0.60

0.70

0.80

0.90

1.00

0 10,000 20,000 30,000 40,000 50,000

HD

I V

alu

e,

20

12

GDP per capita, PPP (constant 2005 international $), 2012

2.0

2.5

3.0

3.5

4.0

4.5

Russia

BRICS Average (excluding Russia)

EU11 Average

Resource Rich* Average

The quality of human capital is higher than predicted by income by capita.

But there is a mismatch between education achievements and employer perception of the quality of education: Global Competitiveness Index: Quality of education, score 1

(low) to 7 (high)

But Weak Institutions … for Managing Volatility, Providing Public Services and Regulating Enterprises

The quality of institutions lags in several dimensions: World Governance Indicators, 1996-2012 average

Average of

Governance

Indicators

Government

Effectiveness

Control of

Corruption

Political

Stability

and

Absence of

Violence

Regulatory

QualityRule of Law

Voice and

Accountability

Netherlands 1.71 1.89 2.15 1.11 1.79 1.75 1.58

Norway 1.71 1.92 2.12 1.29 1.39 1.91 1.6

Canada 1.62 1.87 2.04 1.01 1.59 1.73 1.5

Australia 1.59 1.75 1.98 0.98 1.63 1.75 1.45

United States 1.32 1.64 1.51 0.44 1.54 1.55 1.22

Chile 1.15 1.21 1.43 0.56 1.48 1.25 0.98

Botswana 0.7 0.54 0.89 0.97 0.61 0.61 0.58

United Arab Emirates 0.49 0.85 0.84 0.86 0.66 0.54 -0.81

Malaysia 0.36 1.06 0.27 0.2 0.53 0.5 -0.39

Saudi Arabia -0.36 -0.2 -0.23 -0.29 0.03 0.16 -1.62

Ukraine -0.58 -0.68 -0.92 -0.21 -0.53 -0.85 -0.27

Kazakhstan -0.63 -0.6 -0.98 0.16 -0.4 -0.89 -1.06

Russian Federation -0.73 -0.47 -0.93 -1.05 -0.33 -0.89 -0.7

Azerbaijan -0.88 -0.8 -1.08 -0.79 -0.59 -0.88 -1.13

Venezuela, RB -1.02 -0.98 -1.01 -1.12 -1.07 -1.33 -0.62

Nigeria -1.14 -1.02 -1.11 -1.73 -0.89 -1.24 -0.84

Turkmenistan -1.32 -1.47 -1.25 0.15 -1.99 -1.42 -1.94

Uzbekistan -1.34 -1 -1.07 -1.16 -1.66 -1.27 -1.91

Weak Institutions … for regulating enterprises

The regulatory environment is highly restrictive of competition: Product market regulation, OECD Product Market Regulation Index

1.52

-0.5

0.5

1.5

2.5

3.5

4.5

Product Market Regulation (PMR) State Control Barriers to Enterpreneurship Barriers to Trade and Investment

Russia 2008 OECD Average 2008 OECD Average 2013

Rebalancing Russia’s Asset Portfolio: Transparent Rules, Better Public Investment and Competition

More transparent rules for investors would enhance the contribution of

natural resources to Russia’s growth.

Better prioritization of expenditures and focus on results will strengthen

the quality of public service provision.

Increased private participation could improve the quantity and quality of

the delivery of public services.

Effective competition policy will increase the productivity of the

business sector. 32

Thank you!

For more information about the World Bank and its activities in the Russian Federation, please visit:

http://www.worldbank.org/en/country/russia

If you would like to be access our Russia Economic Reports, please visit:

www.worldbank.org/eca/rer

For questions and comments relating to this publication, please contact bhansl@worldbank.org.

EXTRA SLIDES

Baseline Scenario Projections

Main economic indicators

2012 2013 2014 2015 2016

GDP growth (%) 3.4 1.3 0.5 0.3 0.4

Consumption growth, percent 6.8 3.5 2.1 0.5 0.6

Gross capital formation growth, percent 0.6 -6.0 -8.1 0.3 1.0

General government balance (percent of

GDP) 0.4 -1.3 -1.1 -2.1 -1.0

Current account (US$ billions) 71.3 34.1 62.8 57.9 54.3

percent of GDP 3.6 1.6 3.1 2.8 2.5

Capital account (US$ billions) -32.3 -62.2 -113.0 -60.1 -55.6

percent of GDP -1.6 -3.0 -5.6 -2.9 -2.6

Oil price assumption (US$ per barrel) 105.0 104.0 102.9 99.5 100.1

Gross Domestic Product (mp), bln Rub 62218.4 66755.3 71785.3 76320.7 81223.6

CPI inflation 5.1 6.8 8.0 7.0 5.0

Optimistic Scenario Projections

Main economic indicators

2012 2013 2014 2015 2016

GDP growth (%) 3.4 1.3 0.5 0.9 1.3

Consumption growth, percent 6.8 3.5 2.2 0.9 1.5

Gross capital formation growth, percent0.6 -6.0 -8.1 1.5 2.5

General government balance (percent of GDP) 0.4 -1.3 -1.1 -2.3 -1.2

Current account (US$ billions) 71.3 34.1 62.8 42.9 28.6

percent of GDP 3.6 1.6 3.1 2.0 1.3

Capital account (US$ billions) -32.3 -62.2 -113.0 -45.0 -25.5

percent of GDP -1.6 -3.0 -5.6 -2.1 -1.1

Oil price assumption (US$ per barrel) 105.0 104.0 102.9 99.5 100.1

Gross Domestic Product (mp), bln Rub 62218.4 66755.3 71785.3 76777.3 82441.9

CPI inflation 5.1 6.8 8.0 6.0 5.0

Pessimistic Scenario Projections

Main economic indicators

` 2012 2013 2014 2015 2016

GDP growth (%) 3.4 1.3 0.4 -0.9 -0.4

Consumption growth, percent 6.8 3.5 2.0 -0.3 -0.3

Gross capital formation growth, percent0.6 -6.0 -8.5 -4.3 -1.2

General government balance (percent of GDP) 0.4 -1.3 -0.7 -2.8 -1.2

Current account (US$ billions) 71.3 34.1 69.3 82.2 80.8

percent of GDP 3.6 1.6 3.6 4.5 4.3

Capital account (US$ billions) -32.3 -62.2 -128.0 -82.3 -80.0

percent of GDP -1.6 -3.0 -6.6 -4.5 -4.3

Oil price assumption (US$ per barrel) 105.0 104.0 102.9 99.5 100.1

Gross Domestic Product (mp), bln Rub 62218.4 66755.3 71713.9 76753.9 81798.2

CPI inflation 5.1 6.8 8.0 10.0 8.0

Fiscal Impact: Balances under Pressure

-15

-10

-5

0

5

10

0

5

10

15

20

25

2007 2008 2009 2010 2011 2012 2013 2014

Non-oil revenues, percent of GDP Oil revenues, percent of GDP

Non-oil balance, percent of GDP Total balance, percent of GDP

Federal budget revenue and balance, 2007-2014, percent of GDP