Russia economic. Report november 2007 презентация

Main Messages
Robust growth supported by high energy prices, large capital inflows, rising domestic demand and prudent macroeconomic management
Short-term challenges:
Control inflation
Limit rapid real exchange rate appreciation
Manage large capital flows
Maintain prudent fiscal policy
Medium-term challenges:
Sustain productivity growth
Close the infrastructure gap
Boost private investment
Promote economic diversification

I. Recent Economic Developments

Rapid Output Growth Driven by Booming Domestic Demand
Economic growth remains robust. Having grown by 7.9 percent in 1H-2007, Russia is likely to post full-year GDP growth of over 7 percent
Output growth was driven by rising domestic demand, in particular, buoyant household consumption (9.8 percent growth in 1H-2007) and business investment (21 percent growth in 1H-2007)
Negative contribution of net exports to GDP growth is explained by rapid import growth and weak export performance, affected by the real appreciation of the ruble

Non-Tradable Sectors Continued to Boom
Sectors servicing domestic demand continued to boom in 9M-2007: construction (23.5 percent) and retail trade (15 percent)
Manufacturing also grew at healthy 10 percent in 9M-2007, driven by the steady performance of a few sectors (machines and equipment, electro- technical, and transportation equipment)

Manufacturing Growth: Strong But Tapering Off
While still strong, manufacturing growth is decelerating. The impressive growth posted in early 2007 was driven by temporary factors (warm winter, low output level in Q1-2006 and unusually high investment demand in machine-building sectors)
Quarterly growth in Russia Manufacturing
(relative to the same period of the previous year)

The downward trend in manufacturing might be associated with the erosion in competitiveness in non-fuel, non-metal tradable sectors
Parts of manufacturing that service domestic demand with limited competition from imports may continue to thrive in Russia’s booming domestic market
But the real appreciation of the ruble, without commensurate increases in productivity, drives up unit labor costs, hindering competitiveness in tradable sectors (outside resources and metals)
Unit Labor Costs in Manufacturing
Russia

Russia continues to experience an investment boom
Capital investment growth, % to previous year
The aggregate fixed capital investment grew by 21.2 percent in 9-M of 2007
(from 11.8 percent growth in the same period in 2006)
While capital investments decelerated in September 2007 they still posted
double-digit growth rates (16.1 percent, relative to the same month in 2006)

Despite Investment Boom, Domestic and Foreign Investments Went to A Few Sectors
Total Fixed Capital Investment by Sector
Foreign Direct Investment by Sector
Resource sectors and Non-Tradable Sectors (retail and construction) remain the favorite direction for domestic and foreign investments.
In Manufacturing, most investments went to the food and metal sectors

Inflation is Rising,
Driven by Food Prices and Monetary Factors
*Data for 9 months. Source: CBR
Inflation increased since April 2007 to reach 9.3 percent over 10M-2007 (compared to 7.5 percent in the same period of 2006)
Most likely, end-of-year inflation will reach 11 percent (Dec/Dec)

Food prices increased, but prices of non-tradable goods and services also increased…
Changes in prices of the main components of the CPI

Keeping inflation in check is becoming increasingly difficult with large capital inflows
Accumulation of Foreign Reserves and the Stabilization Fund
Unlike oil revenues, capital inflows are not absorbed by the Stabilization Fund, driving rapid money expansion and exerting upward pressures on the ruble.
Given the limited monetary instruments for sterilization, one policy response would be gradually allowing more rapid nominal appreciation of the ruble.
The pace of nominal appreciation this year was slower than in 2006. The rubble appreciated by 6 percent against the USD in nominal terms in 10M-2007 (compared to 7 percent in 2006).

BoP continued recording surpluses: weaker C/A
was more than offset by stronger Capital Account
Balance of Payments (USD billions)
The surge in capital inflows pushed the BoP surplus to record highs, becoming an important source of foreign reserve accumulation (gross foreign reserves: 447bn)
Large capital inflows reflected acceleration in foreign borrowing by state corporations and the banking sector. Net capital inflows to the private sector amounted to 56.8 bn in 9M-2007 (compared to 26.3 bn in the same period last year)
Russia has weathered well the global financial turmoil. By October 2007 Russia received a net inflow of capital of about 10 bn

Fiscal surpluses continue, but recently fiscal policy has become more accommodative
The approved 3-year budget entails fiscal relaxation (that might reduce the budget surplus to 0.2 % of GDP by 2008). Recent revisions to the 2007 federal budget entail additional fiscal easing (that would reduce the budget surplus to 2.8 percent by end 2007).
The bulk of the planned increase in public expenditures goes to infrastructure and social spending with a view of boosting growth.
Two cautionary notes:
(i) raising public investments might not be enough to achieve a sustained impact on economic growth. Keeping up private investments and improving the efficiency of investments will be as important;
(ii) the pace of fiscal policy needs to be studied carefully to avoid exacerbating tensions in the macro mix (additional fiscal stimulus might increase pressures for ruble appreciation)
(..)* capitalization of development institutions: Bank for Development, Russian Nanotechnology Corporation,
Investment Fund, Fund for Housing reform support
Federal budget
surplus reached 7.1 percent of GDP (9M-2007 )

Prospects
Growth is likely to remain robust. With energy prices set to remain high, booming domestic demand will continue to translate into strong growth in services and manufacturing
However, growth might slowdown if medium-term challenges are not addressed….
Sustain Productivity Growth (which can also help alleviating pressures from the real appreciation of the exchange rate)
Promote Economic Diversification
Boost Private Investment

II. Productivity Growth
in Russia

Russia has experienced a productivity surge, propelling economic growth
Total factor productivity growth (5.8 percent) drove GDP growth (6.5 percent) over (1999-2005)
Real income per capita (constant $2000,PPP) rose from $5,964 in 1998 to $9,650 in 2005
But capital and labor accumulation played little role in total output growth

What are the drivers of the productivity surge?
Capacity utilization
Sectoral shifts
Firm dynamics

Higher capacity utilization explains part of the productivity surge
Utilization of excess capacity yields ‘easy’ productivity gains in a growth rebound after a deep recession
But higher capacity utilization only explains part of the productivity surge
Even after adjusting for capacity utilization, TFP growth still accounts for 4.15 percent of total GDP growth (of 6.5 percent)

The productivity surge is also explained by major sectoral shifts in the economy
A substantial reallocation of resources toward services
Efficiency gains ‘within sectors’ had more impact on total productivity growth than cross-sector shifts
Labor productivity over 1999-2004 grew by :
4.4 percent in agriculture,
4.7 percent in industry and
6.4 percent in services

Firm dynamics
Decomposing total productivity growth into three components:
‘within’: accounts for productivity growth within existing firms
‘reallocation’: reallocation of labor across existing firms
‘net entry’: entry of new firms and exit of obsolete firms

Productivity growth came mostly from efficiency gains within firms -but reallocation & net entry also mattered
Highest Productivity Growth in ICT sectors

Firm turnover plays a smaller role than in other advanced economies
Private entrants are less productive than state-owned peers (suggesting barriers to entry and exit)
Entrants do not promote productivity of incumbents (suggesting weak market competition)
In advanced market economies 5-20 percent of firms enter and exit the market every year.
In Russia, only about 5 percent of firms were created or destroyed during the last decade

Challenges Ahead
In spite of the productivity surge, Russia’s income per capita remains low (at 28 percent of EU-15 average)
Rapid productivity gains were ‘easy’ to achieve in the first years of the growth rebound
But now with the economy growing close to potential, sustaining productivity gains will be more difficult.
Capital and labor accumulation must play a greater role
Economic diversification including higher export sophistication also needs to be promoted…

Sustaining Productivity Growth Calls For Policy Reforms that Accelerate Reallocation of Resources towards More Efficient Uses
Russia has most to gain from policy catch-up

III.
From Red to Gray:
The Third Transition of
Aging Population in Russia

Shrinking and Rapid Aging Population
% Population Decrease, 2000-2025
17 million
% of over-65 population, 2000-2025
These demographic trends will affect labor supply:
Declining and aging labor force: labor force will decline by 3 percent (about 11 million people). Over 95 percent of the decline will come from the 15-39 age group
Russian population is also aging rapidly: by 2025, one person in every five will be over the age of 65.
(share of population over 65 will be 18 percent in 2025)
Russia’s population will shrink by 12 percent (over 17 million people) by 2025

Aging is not a stop sign for growth:
Message 1) Address labor shortage through reforms to boost productivity Message 2) Address fiscal risks associated with aging (pension, health & long care)
Russia, Growth decomposition, 1998-2005
Share of growth due to higher:
Labor productivity
Employment rates
Working-age population
But growing older does not have to mean growing slower