75578 The World Bank in Russia Russian Economic Report1 Recovery and Beyond № 29 Spring 2013 WORLD BANK http://www.worldbank.org/eca/rer http://www.worldbank.org/russia 1 The report was prepared by a World Bank team consisting of Sergei Ulatov (Senior Economist), Stepan Titov (Senior Economist), Mikhail Matytsin (Consultant), and Olga Emelyanova (Research Analyst), under the direction of Kaspar Richter (Lead Economist and Country Sector Coordinator for economic policy in Russia). Gregory Kisunko (Senior Public Sector Specialist) and Stephen Knack (Lead Economist) authored the focus note on national and regional trends in regulatory burden and corruption in Russia. John Baffes (Senior Agricultural Economist) provided the box on the global oil market, Alvaro Gonzalez (Lead Economist) the box on the survival of firms, Maya Gusarova (Public Sector Specialist) and Maria Ovchinnikova (Research Analyst) the box on the open budget index, Lawrence Kay (Сonsultant) the assessment on credit, and Theo van Rensburg (Senior Economist) the assessment on the global outlook. We are grateful for advice from and discussions with Michal Rutkowski (Country Director for Russia), Yvonne Tsikata (Director for Poverty Reduction and Economic Management in the Europe and Central Asia Region), Elisabeth Huybens (Acting Sector Manager for Russia, Ukraine, Belarus, and Moldova), Lada Strelkova (Country Program Coordinator for Russia), and Carolina Sanchez (Lead Economist and Regional Poverty Coordinator). Table of Contents Executive Summary .................................................................................................. 2 I. Recent Economic Developments ............................................................................. 4 Growth — slowing down .......................................................................................... 4 Trade and Capital Flows—lower current account surplus, lower capital outflows.................. 8 Jobs – lower unemployment and poverty .................................................................. 11 Money, Exchange Rate and Credit —policy rates stable as inflation remains high and consumer lending continues ................................................................................................ 16 Government Budget — from loosening to moderate consolidation ................................... 18 II. Economic Outlook ............................................................................................. 21 Prospects — recovery postponed ............................................................................. 21 Policies – recovery and beyond ............................................................................... 24 III. Trends in Regulatory Burden and Corruption ........................................................ 28 A. National Trends ............................................................................................. 28 B. Regional Comparisons...................................................................................... 31 C. Conclusions ................................................................................................... 34 Annex. Russian Federation: Main Economic Indicators, 2007-2013 .................................... 36 2 Executive Summary At first glance, Russia’s economy looks strong. While the global economy was losing momentum and the euro area stuck in recession in 2012, growth in Russia was solid thanks to firm consumption. Indeed, the economic expansion in Russia was faster than in Brazil, South Korea and Turkey, something that was unthinkable only two years ago. The achievements are not limited to growth. In 2012, the current account was strong thanks to a large surplus in the trade balance. Capital outflows declined, allowing the Central Bank of Russia to add again to its stock of reserves. The budget was balanced, and the government started to replenish its reserve funds that were depleted during the crisis. While average public debt in advanced economies exceeds 110 percent of GDP, Russia’s public debt is no more than 10 percent of GDP. Unemployment dropped to record lows and wages grew at a solid pace. Annual inflation reached its lowest level in two decades. Strong labor markets and price stability reduced poverty: the number of poor people in Russia declined to 16.4 million in the third quarter of 2012, which was almost two million less than a year ago. However, a closer look reveals weaknesses. High oil prices accounted for a fair share of the recent achievements. The oil price nudged up further from record highs in 2011. High oil prices translated into strong export receipts, buoyant fiscal revenues, and rapid increases in public wages and transfers. Both the non-oil current account deficit and non-oil fiscal deficit remained close to record highs, underlying the economy’s reliance on oil. In addition, economic growth dropped to half the level of the decade up to the 2008 crisis. Industrial output declined in early 2013 for the first time since 2009. Fixed investment remains dependent on public funds, and foreign direct investment is subdued. Inflation increased in the second half of 2012 and is set to remain stubbornly high in early 2013, weighing on consumption. Russia is also stagnating in global economic rankings. Measuring the size of the economy in current dollars, Russia improved globally from the 18th to the 8th position between 2000 and 2008, and remained in this position in 2012. By 2014, growth in Russia is set to be lower again than in Brazil, South Korea and Turkey. Improving growth prospect will be difficult with further increases in oil prices unlikely, capacity utilization approaching pre-crisis peaks, unemployment at a record low, an aging and shrinking workforce and declining oil production in the absence of large investments and new discoveries. In order to revive and modernize the economy and reduce its dependence on natural resources, policymakers face two challenges. First, Russia has to manage macroeconomic policies so as to ensure economic stability in the face of domestic and external vulnerabilities. This implies three policy priorities: sticking with prudent spending plans and saving oil revenues that come in over and above budget; focusing monetary policy on low inflation to keep inflationary expectations in check; and strengthening banking supervision and taking additional measures to mitigate emerging risks in consumer lending. Second, Russia has to step up structural reforms so as to lift the growth potential. Today’s moderate growth reflects Russia’s moderate potential growth rate, as indicated by low unemployment and high capacity utilization, along with a weak external environment . Reviving growth requires, among others, reducing the state’s footprint on the economy and improving the investment climate; confronting the challenges of the aging and shrinking of the population; and strengthening governance through more transparency, better regulations and more effective control of corruption. Table 1: Russia’s Economic Outlook 2012 2013 proj. 2014 proj. Growth (%) 3.4 3.3 3.6 Consolidated budget balance (% of GDP) 0.4 -1.0 0.0 Current account balance (% of GDP) 4.1 2.6 1.3 Capital account balance (% of GDP) -2.1 -1.7 -1.1 Oil price assumption (WB Average, US$ per barrels) 105 102 102 Source: World Bank staff projections. 3 I. Recent Economic Developments Growth — slowing down Russia’s economy grew 3.4 percent in 2012, down from 4.3 percent in 2011. The economy slowed in the second half of the year due to weak net exports, negative base effects, and destocking at the end of the year. More than four years after the global financial crisis hit, the world economy remains sluggish . Industrial production lost momentum throughout last year, exports expanded only at a moderate pace, and imports even declined for three month during autumn 2012 (Figure 1). High-income countries continued to struggle as they restructured their economies and took steps to restore fiscal sustainability. While developing countries showed greater resilience, their growth also weakened steadily during 2012.2 Figure 1: (a) World import and export volumes (percent, yoy growth, sa, US$) and world industrial production volumes (percent, yoy growth, sa); and (b) GDP growth (percent, yoy) 20 12 15 8 10 5 4 0 0 -5 -4 -10 -15 -8 -20 -12 -25 3Q 06 3Q 07 3Q 08 3Q 09 3Q 10 3Q 11 3Q 12 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Russia OECD HI Imports Exports Industrial product. EU Emerging Other Emerging Source: OECD, World Bank, World Bank staff calculations. Against the backdrop of a difficult external environment, growth in Russia moderated in 2012. Growth peaked in the third quarter of 2011, and reached 4.3 percent in 2011. It declined throughout 2012, in part due to negative base effects in the second half of 2012, and eased to 3.4 percent in 2012. Nevertheless, growth in Russia was stronger than in Brazil, South Korean and Turkey. These countries were growing significantly faster than Russia only two years ago. However, preliminary estimates suggest that year-on-year growth fell to around 2 percent in the fourth quarter of 2012, which is the lowest rate in three years. Growth declined mainly due to weaker performance of investment. Inventories were flat as the restocking cycle after the crisis came to an end, and fixed investment expanded only moderately as business remained cautious about future prospects. In part due to high investment spending in late 2011 — some of it related to the preparations of the 2014 Sochi Winter Olympics, the contribution of investment to growth declined throughout the year. In contrast, consumption growth remained almost as strong as in 2011 throughout the year thanks to low unemployment, wage increases and credit expansion, and government spending (Figure 2). As a result, consumption became the main growth driver instead of investment. Finally, weak investment dampened import growth. This translated into a lower negative contribution of net exports to growth in spite of weak external demand due to the recession in the European Union. 2 OECD HI includes 25 high-income OECD countries outside of Central Europe. EU Emerging represents the six central European countries that are member both of the EU and the OECD: Czech Republic, Estonia, Hungary, Poland, Slovak Republic, and Slovenia. Other Emerging covers seven countries: Brazil, China, India, Indonesia, Mexico, South Africa and Turkey. 4 Figure 2: (a) Annual growth composition (percent); and (b) Quarterly growth composition (year-on-year, percent) 15 10 8 10 6 5 4 0 2 0 -5 -2 -10 -4 -15 -6 2006 2007 2008 2009 2010 2011 2012 1Q 11 2Q 11 3Q 11 4Q 11 1Q 12 2Q 12 3Q 12 Consumption Fixed investment Consumption Fixed investment Inventories Net exports Inventories Net exports Growth Source: Rosstat, World Bank staff calculations Non-tradable sectors contributed the bulk of growth in 2012. Growth in the non-tradable sector increased to 5.2 percent in 2012 from 4.3 percent in 2011, while growth in the tradable sectors fell to 1.5 percent from 5.9 percent (Figure 3). As a result, the non-tradable sector accounted for more than 85 percent of GDP growth in 2012. The weaker performance of the tradable sectors reflects sluggish global demand and the poor agricultural harvest but also low competitiveness in parts of the industry, as growth declined for all three subsectors (Figure 4). The performance on the non-tradable sectors was uneven. The pick-up in the growth of the non-tradable sector was driven by financial services and wholesale and retail trade, although their momentum weakened in the second half of 2012. By contrast, growth in transportation and communication services as well as construction declined noticeably. Figure 3: (a) Sectoral growth (percent, yoy); (b) GDP growth composition (percent, yoy) 6 5 4 4 3 2 2 1 0 0 -1 2011 2012 2011 2012 Tradable Nontradable GDP Tradable Nontradable Public sector GDP growth Source: Rosstat, World Bank staff calculations. 5 Figure 4: (a) Tradable sector growth (percent, yoy); and (b) Non-tradable sector growth (percent, yoy) 20 16 15 12 10 8 5 4 0 0 2011 2012 -5 Electricity, gas, and water 2011 2012 Construction Transport and communication Agriculture and forestry Mineral extraction Real estate Wholesale and retail trade Manufacturing Financial services Source: Rosstat, World Bank staff calculations. Monthly indicators confirm that economy activity lost steam in the second half of 2012. Towards the end of 2012, five-sector output grew at around 1 percent, compared to more than 5 percent early in the year (Figure 5a). Similarly, agriculture, construction, fixed investment, industrial production and retail trade were all weaker at the end of 2012 than at the beginning of 2012 (Figure 5b and Box 1). Industrial production declined year-on-year in January 2013, the first time since 2009. Only the purchasing manager index for manufacturing remained fairly stable throughout the year. Figure 5: (a) Purchasing Manager Index for manufacturing (level, yoy, sa, 3mma) and Five-Sector Output Growth (percent, yoy, 3mma); and (b) Growth of selected indicators (percent, yoy, 3mma) 60 15 20 55 10 15 50 5 10 45 0 5 40 -5 35 -10 0 30 -15 -5 Agriculture Industrial Retail trade Construction Fixed production investment Purchasing Managers Index (LHS) Jan-12 Jul-12 Jan-13 Five-sector output (RHS) Source: Rosstat, World Bank staff calculations. 6 Box 1: The slowdown in Russia’s economy mirrors developments in other regions The moderation in growth in industrial production is in line with other regions, even though growth remained positive in Russia (Figure 6). Growth of retail sales in Russia exceeded the growth in other regions for most of the time over the last two years, but it declined recently close to levels observed in other emerging economies. OECD’s composite indicator for Russia dropped below the long -term average of 100 in the second half of 2012, even below the levels in other regions, although the business confidence indicator picked up somewhat in recent months (Figure 7). Figure 6: (a) Industrial Production (growth, percent, sa); (b) Retail sales (growth, percent, sa) 20 20 Retail Sales Volumes, Y-o-Y Growth, sa 10 10 0 -10 0 -20 -30 -10 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Months Months Russia OECD HI Russia OECD HI EU Emerging Other Emerging EU Emerging Other Emerging Figure 7: (a) Composite Leading Indicator (level); (b) Business Confidence Indicator (level) Business Confid. Index, LT Level=100, OECD 105 104 102 100 100 98 95 96 90 94 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Months Months Russia OECD HI Russia OECD HI EU Emerging Other Emerging EU Emerging Other Emerging Source: OECD, World Bank staff calculations. 7 Trade and Capital Flows—lower current account surplus, lower capital outflows In spite of a declining current account surplus, the Central Bank of Russia increased foreign reserves thanks to lower capital outflows and the shift to flexible exchange rate policies. However, the non-oil current account deficit remains high. The current account surplus declined. The current account surplus decreased to US$81.3 billion in 2012 from US$98.8 billion in 2011 (Figure 8 and Table 2). The surplus in goods trade decreased moderately in spite of high oil prices due to weak export demand (Figure 9 and Figure 10), and deficits increased in the service and income accounts.3 The non-oil deficit of the current account remained high at US$266 billion, or 13.2 percent of GDP, only slightly below the level of 13.5 percent of GDP in 2011. Figure 8: Current account balance Figure 9: Trade balance and oil prices -10 40 140 60 -20 35 120 50 -30 30 100 40 -40 25 -50 20 80 30 -60 15 60 20 -70 10 -80 5 40 10 2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012 CAB, no oil and gas, bln USD (LHS) Crude oil, Brent, $/b (left axis) CAB, bln USD (RHS) Trade balance, bln USD (right axis) Sources: CBR; and World Bank staff estimates. Sources: CBR; and World Bank staff estimates. Figure 10: Export and imports in current USD Figure 11: Current account balance (percent of GDP) (growth yoy, 3mma nominal US$) Source: CBR, World Bank staff calculations. 50 15 40 10 30 5 20 0 10 -5 0 -10 2007 2008 2009 2010 2011 1Q 12 2Q 12 3Q 12 4Q 12 -10 Jun-10 Nov-10 Apr-11 Sep-11 Feb-12 Jul-12 Transfers Investment income Exports Imports Labor income Services Goods Current account balance Source: Rosstat, World Bank staff calculations. Source: Rosstat, World Bank staff calculations. 3 However, revisions in the methodology make comparisons of current account composition between 2011 and 2012 potentially misleading. 8 Table 2: Balance of Payments, 2007–2012, US$ billions, adjusted for foreign exchange swaps between the CBR and commercial banks 2007 2008 2009 2010 2011 2012* Iq 2012* IIq 2012* IIIq 2012* IVq 2012* Current account balance 77.8 103.5 48.6 71.1 98.8 81.3 39.0 18.2 6.7 17.3 Trade balance 130.9 179.7 111.6 152.0 198.2 195.4 58.7 49.7 38.4 48.6 Capital and financial account 84.5 -131.2 -43.5 -26.0 -76.2 -49.7 -29.5 -5.0 -4.8 -10.4 Errors and omissions -13.3 -11.3 -1.7 -8.3 -10.0 -10.4 -5.0 -1.8 1.8 -5.4 Change in reserves (- = increase) -148.9 38.9 -3.4 -36.8 -12.6 -21.2 -4.6 -11.3 -3.7 -1.6 M emo: average oil price (Brent, US$/barrel) 72.5 96.9 61.5 79.7 111.1 111.9 118.7 108.7 109.9 110.5 Source: CBR. * Preliminary estimates. The capital account strengthened in 2012 as net capital outflows decreased. According to preliminary estimates, the capital account deficit amounted to US$40.9 billion or 2 percent of GDP in 2012, compared to US$76.2 billion or 4 percent of GDP in 2011. This improvement reflected mainly lower net capital outflows of the private sector. They totaled US$56.8 billion in 2012, compared to US$80.5 billion in 2011. Capital outflows declined noticeably after the first quarter of 2012. Several factors are likely to have underpinned this trend. These include the end of political cycle in March 2012 and a return of capital flows to emerging markets in the second half of 2012. In addition, the reduction of capital outflows coincided with the reduction in the current account surplus. During the last three quarters of 2012, the surplus on the current account declined about US$26 billion, while the capital account - adjusted for the currency swaps between the commercial banks and the CBR - improved US$38 billion. These co-movements are natural in the context of CBR’s move towards greater exchange rate flexibility. Table 3: Net Capital Flows, 2007–2012 (US$ billions), adjusted for foreign exchange swaps 2007 2008 2009 2010 2011 2012* Iq 2012* IIq 2012* IIIq 2012* IVq 2012* Total net capital inflows to the private 81.7 -133.7 -56.1 -34.4 -80.5 -56.8 -33.3 -6.4 -7.6 -9.4 Net capital inflows to the banking sector 45.8 -56.9 -30.4 15.9 -24.2 23.6 -9.7 11.6 7.6 14.2 Net capital inflows to the non-banking 35.9 -76.8 -25.8 -50.3 -56.4 -80.4 -23.5 -18.0 -15.2 -23.6 Source: CBR. *Preliminary estimates. Figure 12: Current account financing (percent of GDP) 5 0 -5 -10 -15 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3 Change in reserves Net other flows and errors Net portfolio Net FDI Current account financing Source: CBR, World Bank staff calculations. The reduction in net capital outflows allowed the Central Bank of Russia to increase foreign reserves in spite of the lower current account surplus. According to preliminary estimates, the CBR added about US$39 billion to its reserves, which amounted to US$538 billion at end-December 2012 (27 percent of GDP). Adjusting for CBR currency swap operations for liquidity provision to banks and exchange rate adjustments, the increase in foreign reserves was US$21 billion. In line with the improvement in the capital account and accommodative monetary policy in the US and the euro area, the ruble appreciated about 5.7 percent against the US dollar and 3.5 percent against the euro during 2012. 9 External liabilities increased in spite of volatile global market conditions. According to the preliminary CBR debt statistics, Russia’s outstanding external debt rose to US$6 24 billion at end-2012 from US$545 at end-2011 (Table 4). As a result, external debt increased from 29.1 percent of GDP to 31.1 percent of GDP over this period. However, it remains some 7 percentage points of GDP below the 2009 level. Both bank and non-financial corporations also scaled-up international borrowings in 2012. During the first nine months of 2012, the bulk of the increase was due to the public sector (Table 5). Table 4: External debt of the corporate sector, US$ billions 1-Jan-10 1-Jul-10 1-Jan-11 1-Jul-11 1-Oct-11 1-Jan-12 1-Apr-12 1-Jul-12 1-Oct-12 1-Jan-13 Total debt 467.2 457.4 488.9 538.9 527.8 540.6 559.7 570.7 594.7 624.0 Corporate 421.3 410.1 442.4 491.0 482.6 494.3 511.3 517.7 539.0 564.5 Banks 127.2 122.1 144.2 159.0 157.3 162.8 169.2 175.4 189.8 208.4 Short-term 27.3 30.3 39.2 45.0 43.4 49.3 49.8 53.0 56.0 Non-financial corporations 294.1 287.9 298.2 332.0 325.3 331.6 342.1 342.3 349.2 356.1 Short-term 19.2 20.3 17.3 24.2 20.1 19.6 18.4 24.2 17.3 Source: CBR, World Bank staff calculations. Table 5: External debt of the private sector, US$ billions 1-Jan-10 1-Jul-10 1-Jan-11 1-Jul-11 1-Oct-11 1-Jan-12 1-Apr-12 1-Jul-12 1-Oct-12 State and quasi-state debt 181.3 181.9 199.8 213.5 212.1 220.4 231.6 244.5 258.2 Private Banks 77.0 71.4 80.8 89.1 86.8 89.6 90.6 89.9 98.2 Long-term 56.1 50.9 53.8 56.9 55.8 54.5 54.9 54.9 57.4 Short-term 20.9 20.6 27.0 32.2 31.0 35.1 35.7 35.0 40.8 Private Non-fin. Corporations 208.9 204.1 208.3 236.3 228.9 235.1 237.6 236.3 238.2 Long-term 190.4 184.8 191.7 214.1 210.1 216.7 220.6 213.6 221.5 Short-term 18.5 19.3 16.7 22.2 18.8 18.4 17.0 22.7 16.7 Source: CBR, World Bank staff calculations. 10 Jobs – lower unemployment and poverty The labor market remains tight. The unemployment rate declined across the country, and vacancy and replacement rates increased. However, high inflation and the slowdown in economic activity translated recently into fewer hours worked and weaker growth in wages and incomes. Unemployment in Russia continued to decline in spite of the recent economic slowdown. The winter tends to be a bad time for labor markets. And, indeed, employment and activity rates, which measure the ratio of the employed or economically active population to the working-age population, declined compared to the summer (Figure 13). However, once we allow for seasonal factors, the labor market remains tight: the unemployment rate declined from 6.0 percent early in 2012 to 5.4 percent in January, a record low for the last two decades (Figure 14). In fact, the tightness of the labor market means that even without seasonal adjustment, the unemployment rate barely increased from August to December. While the unemployment rate increased in January 2013, it was mainly due to seasonal factors and it remained noticeably below the level in January 2012. Figure 13: Employment and activity rates, % Figure 14: Unemployment rates, % 70 10 2.5 69.2 69 68 9 2.0 67.9 67 66 8 1.5 65.0 65 64 7 1.0 64.3 63 62 6 0.5 61 5 0.0 60 2009 2010 2011 2012 2013 2010 2011 2012 Total, SA Total Registered (RHS) Employment Activity Source: Rosstat and World Bank staff estimates. Source: Rosstat and World Bank staff estimates. The reduction in unemployment is visible across groups. Urban and female unemployment rates stabilized at record low levels. While rural and male unemployment increased somewhat at the end of the year due to seasonal factors, the rise was less than in previous years (Figure 16). Figure 15: Unemployment rates by gender and locality, Figure 16: Average number of hours worked per % week, SA 14 40 13 12 39 11 10 38 9 8 37 7 6 36 5 4 35 2010 2011 2012 2006 2007 2008 2009 2010 2011 2012 Male Female Urban Rural total men women Source: Rosstat and World Bank staff estimates. Source: Rosstat and World Bank staff estimates. 11 Unemployment fell across the country. Unemployment rates declined in all federal okrugs whether we look at 2012 as a whole or just at the fourth quarter. The drop was largest in the center and the North Caucas (Table 6). Out of the 83 regions, only three regions experienced increases in unemployment rates in 2012. In line with past trends, unemployment rates were lowest in Moscow (0.6 percent in the fourth quarter of 2012), St. Petersburg (1.1 percent), Samara (2.3 percent), Yaroslavl (2.4 percent) and Moscow oblasts (2.9 percent). They were highest in Dagestan republic (12.2 percent), Tyva republic (15.0 percent), Kalmyk republic (15.9 percent), Chechnya republic (28.8 percent) and Ingush republic (47.1 percent) (Figure 17). Figure 17: Unemployment rate by regions in 4Q 2012, percent 1 Yaroslavl 7 Tula 13 Chuvashia 21 Volgograd 27 North Ossetia 2 Kaluga 8 Nizhniy Novgorod 14, 16 Tatarstan 22 Kalmykia 28 Chechnya 3 Vladimir 9 Ryazan 15 Penza 23 Adygea 29 Ingushethia 4 Ivanovo 10 Mari El 17 Ulyanovsk 24 Stavropol 5 Perm 11 Udmurtia 18 Saratov 25 Karachaevo-Cherkessia 6 Moscow-city 12 Mordovia 19, 20 Samara 26 Kabardino-Balkaria Table 6: Regional unemployment rates, percent 4Q 2011 2011 4Q 2012 2012 Russian Federation 6.3 6.6 5.3 5.7 Central Federal Okrug 4.0 4.2 2.9 3.3 North-Western Federal Okrug 4.8 5.3 4.0 4.3 Southern Federal Okrug 6.6 7.0 6.1 6.3 North-Caucasus Federal Okrug 14.9 15.0 13.6 13.8 Volga Federal Okrug 6.0 6.6 4.6 5.4 Ural Federal Okrug 6.8 6.9 6.2 6.2 Siberia Federal Okrug 7.7 8.2 7.4 7.3 Far East Federal Okrug 7.4 7.4 6.4 6.9 Source: Rosstat and World Bank staff estimates. Vacancy rates continued to rise. With fewer people looking for work, businesses have trouble filling job vacancies. The share of vacant jobs in total jobs increased continuously from 1.6 percent in early 2011 to close to 2.2 percent in late 2012 (Figure 18). With unemployment declining at the same time, the labor market moved towards the top left corner of the Beveridge curve (Figure 19). Vacancy rates are especially high in finance, transport and communication and energy (Figure 20). 12 Replacement ratios also increased. Over the last three years, businesses stepped up hiring for each job dismissal across all sectors. However, due to seasonality, replacement rates remained on average below unity in December 2012. But companies hired more than one worker for each dismissed worker in trade and finance (Figure 21). Figure 18: Unemployment and vacancy rates, % SA Figure 19: Beveridge curve, % SA rates 10 2.2 2.2 Vacancy rate, % 4Q 12 2.1 3Q 12 9 2.0 2.0 2Q 12 8 1.8 1.9 1Q 12 1Q 09 4Q 11 7 1.6 1.8 3Q 11 2Q 11 1.7 1Q 11 4Q 09 3Q 09 6 1.4 4Q 10 2Q 09 1.6 2Q 10 1Q 10 5 1.2 3Q 10 1.5 2009 2010 2011 2012 5.0 6.0 7.0 8.0 9.0 Unemployment Vacancy (RHS) Unemployment rate, % Source: Rosstat and World Bank staff estimates. Source: Rosstat and World Bank staff estimates. Figure 20: Vacancy rate in Dec 2012, by sample of Figure 21: Replacement rate (hiring/dismissing) by sectors, percent sample of sectors Total Total Extraction Extraction Manufacturing Manufacturing Energy and gas Energy and gas Construction Construction Trade Trade Transport/comm. Trasport/comm. Finance Finance 0 1 2 3 4 0 1 Dec-12 Dec-09 Source: Rosstat and World Bank staff estimates. Source: Rosstat and World Bank staff estimates. While unemployment, vacancy and replacement rates signal a tight labor market, the average number of working hours nudged down. At 37.9 weekly hours worked in the third quarter of 2012, the level was moderately lower than a year ago (Figure 16). This might be in response to weaker economic momentum In addition, the number of working hours remained over half an hour below the peaks prior to the crisis. Wage growth also moderated especially in market sectors. After growing at two-digit rates in first half of 2012, real wage growth dropped to almost zero in December before picking up in January (Figure 22). As a result, the contribution of wages to household income declined from 5 percentage point in the first quarter of 2012 to 1.5 percentage points in the last quarter of 2012 (Figure 23). The decline in wage growth reflects three factors: the base of high wage increases at the end of 2011, the rise in inflation since spring 2012, and the slowdown in the economy in the second half of 2012. In particular, wage growth declined more for tradable than for non-tradable sectors, in line with the relative economic performance of these sectors (Figure 24). Towards the end of 2012, non-market sectors contributed the bulk of the wage increases (Figure 25). 13 Figure 22: Real income growth, % y-o-y Figure 23: Contribution to income growth (all population), % y-o-y 14 12 12 10 10 8 8 6 6 4 4 2 2 0 0 -2 -2 -4 -4 -6 -6 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 Mar Mar Jul Oct Jul Oct Apr May Jun Apr May Jun Sep Nov Sep Aug Nov Dec Dec Jan Jan Aug Jan Feb Feb 2009 2010 2011 2012 2011 2012 others property business Wages Pensions Disp income transfers wages total Source: Rosstat and World Bank staff estimates. Source: Rosstat and World Bank staff estimates. The gap in the growth of wages and the growth of productivity declined. The difference narrowed from close to 8 percentage points in the second quarter of 2012 to 2.5 percentage points in the third quarter of 2012 (Figure 26)ю This reflects two factors. First, as we have just seen, the growth in real wages moderated. Second, productivity growth picked up, as employment remained fairly constant while output increased (Figure 27). The gap narrowed in all three sectors but closed fastest in the tradable sector. Figure 24: Real wage growth, % y-o-y Figure 25: Contribution to real wage growth, % y-o-y 25 15 20 10 15 10 5 5 0 0 -5 -5 Mar Mar Apr May Jul Sep Oct Jun Apr May Jul Jun Sep Oct Jan Nov Dec Jan Nov Aug Aug Feb Feb -10 2009 2010 2011 2012 Nov 2011 2012 non-Market non-Tradables Tradables non-Tradables non-Market Tradables Total Source: Rosstat and World Bank staff estimates. Source: Rosstat and World Bank staff estimates. 14 Figure 26: Recovery from crisis (%), 2Q 08=0, SA Figure 27: Difference in growth rates of real wages and output per worker in 2012, y-o-y growth, percent 4 2 Non-Market 0 -2 Tradables -4 Overall -6 -8 Non-Tradables -10 -12 -2 2 6 10 14 18 22 2008 2009 2010 2011 2012 Q1 Q2 Q3 GDP Employment Source: Rosstat and World Bank staff estimates. Source: Rosstat and World Bank staff estimates. The number of poor people in Russia reached a record low. In the first nine months of 2012, some 17.2 million of people were below the poverty line – 3 million less than a year ago and the lowest number in the last two decades. For the first three quarters of 2012, the share of poor people declined to 12.1 percent, compared to 14.3 percent a year ago (Figure 28 and Figure 29). The decline in poverty reflected low unemployment, growth of wages and public transfers, as well as low food inflation in the first half of 2012. Figure 28: Number of poor people and poverty rate, SA Figure 29: Number of poor people and poverty rate, NSA 25 24 22 20 20 18 16 15 14 12 10 10 8 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 1 2 3 4 1 2 3 4 1 2 3 2007 2008 2009 2010 2011 2012 2010 2011 2012 mln. people % of population mln. people % of population Source: Rosstat and World Bank staff estimates. Source: Rosstat and World Bank staff estimates. 15 Money, Exchange Rate and Credit —policy rates stable as inflation remains high and consumer lending continues Even though core inflation stabilized, headline inflation remained noticeably above the target range. Hence, even though the economy lost steam and credit growth eased somewhat, the CBR kept the main policy rates unchanged since December 2012. Inflation continues to be high. Headline year-on-year inflation reached 7.1 percent in January 2013, compared to 4.2 percent in January 2012 (Figure 30a). The increase in inflation in Russia is striking in international perspective (Figure 30b) and related to three factors. First, it reflects the increase in food inflation triggered by the drought in Russia and among international grain producers, as well as higher excise taxes on alcohol. For example, year- on-year food inflation increased from 1.2 percent in April 2012 to 8.6 percent in January 2013. Second, the rise in administrative prices in July and September 2012 and January 2013 pushed up services inflation. As a result, year- on-year services inflation increased from 3.8 percent in June 2012 to 7.8 percent in January 2013. Finally, there was some uptick in core inflation, which excludes food and gasoline. It increased from 5.1 percent in May 2012 to 5.8 percent in October 2012, and then stabilized around 5.7 percent in recent months. Figure 30: (a) CPI inflation by component (percent, yoy); and (b) CPI inflation (percent, yoy) 16 16 14 12 12 10 8 8 6 4 4 2 0 0 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 2007 2008 2009 2010 2011 2012 2013 Food Non-Food Services CPI Russia OECD HI EU Emerging Other Emerging Source: Rosstat, OECD, and World Bank staff calculations. In spite of weaker economic momentum, the CBR kept its main interest rates unchanged since September 2012. The minimum auction repo rate stayed at 5.5 percent, the fixed repo rate at 6.5 percent and the refinancing rate at 8.25 percent (Figure 31a). This policy reflects three considerations. First, the CBR estimates that the output gap in Russia is about zero, and any monetary stimulus would translate into higher inflation rather than faster sustainable growth. Second, the rise of inflation since summer 2012 implies that price increases exceeded CBR’s initial end-year target of 5 to 6 percent. In view of tight labor markets, swift consumer lending and inflation exceeding money market rates, the CBR intends to anchor inflation expectations to ensure that inflation returns within the target range as soon as possible. The lagged impact of the slowdown in money supply during 2012 will help to bring down inflation (Figure 31b). Finally, the policy sends a signal to market participants that the CBR remains committed to transitioning to inflation targeting. In line with this policy, the exchange rate became more flexible. The CBR reduced the amount of interventions at the foreign exchange markets from US$34 billion in 2010 to US$13 billion in 2011 and to US$7 billion in 2012. In the second half of 2012, the CBR largely refrained from interventions. The CBR’s refinancing operations maintained adequate liquidity in the banking system. In spite of rising bank deposits, banks continue to have a structural liquidity shortage as the demand for credit continues to be solid. This translated into increases in the money market rates in autumn 2012. However, the interbank interest rates declined at the end of the year towards the middle of the CBR repo band as the CBR stepped up refinancing operations in the last quarter of 2012. 16 Figure 31: (a) Interest rates (percent); and (b) Money supply growth (percent, yoy) 60 50 7 40 30 20 10 0 2 -10 Jan-11 Jul-11 Jan-12 Jul-12 Dec-12 -20 Mosprime, 1 day REPO 1 day 2007 2008 2009 2010 2011 2012 Q4 Overnight deposit rate Policy rate Change in M2 Change in M0 Min REPO rate REPO rate, fixed Source: CBR, World Bank staff calculations. The pace of credit expansion slowed somewhat in spite of robust consumer lending. Credit growth to households declined only moderately from 43 percent in June 2012 to 39 percent in December 2012 (Figure 32a). In turn, the stock of mortgage debt to households reached nearly RUB2 trillion in January 2013, up from just under RUB1.5 trillion in January 2012. Nevertheless, there are several mitigating factors with regard to emerging risks of consumer lending. First, bank lending rates remain high mainly due to a large spread between bank lending rates and money market rates. For example, average mortgage lending rates were around 12 percent for much of 2012. Second, year-on-year growth in credit to non-financial corporations slowed from above 24 percent in December 2011 to 13 percent in December 2012. As a result, overall credit growth declined from a peak of 27 percent in June 2012 to 19 percent in December 2012. Third, while the stock of private credit increased from 45 percent of GDP at end-2011 to 48 percent of GDP at end-2012, the level remains moderate for emerging economies. Finally, the level of non-performing loans declined towards 6 percent at the end of 2012 (Figure 32b); the capital adequacy ratio of banks, while it declined from 14.7 percent in December 2011 to 13.6 percent in December 2012, stayed above the required 10 percent in line with Russian accounting standards; and bank profits in 2012 remained high. However, maintaining credit quality might become more difficult in future as economic and wage growth are moderating. Figure 32: Credit growth (percent, yoy); and (b) Nonperforming loans and loan loss provisions (percent of total loans) 60 10 50 8 40 30 6 20 4 10 0 2 -10 0 -20 2007 2008 2009 2010 2011 2012 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Nonperforming Loans:Total Loans Nonfinancial Organisations Households Loan Loss Provisions:Total Loans Source: CBR, World Bank staff calculations. 17 Government Budget — from loosening to moderate consolidation Fiscal policy was expansionary in 2012, although the rise in expenditures fell short of the planned increase and the federal budget remained close to balance. Based on the newly adopted fiscal rule and medium-term budget, the government envisions moderate fiscal consolidation up to 2015, leaving the non-oil fiscal deficit elevated and fiscal buffers below pre-crisis levels. The government loosened fiscal policy in 2012. In 2011, the federal budget turned from deficit to surplus and the non-oil federal budget deficit was cut by a large margin. In 2012, fiscal policy loosened. First, federal expenditures increased 0.6 percent of GDP, although they stayed below the levels foreseen in the original budget law (Figure 34a and Table 7). Second, federal revenues decreased 0.3 percent of GDP. Oil revenues declined 0.1 percent of GDP, and non-oil revenues fell 0.2 percent of GDP. Third, as a result, the fiscal balance moved from surplus in 2011 to a marginal deficit in 2012. And higher spending and lower non-oil revenues increased the non-oil fiscal deficit from 9.6 percent of GDP to 10.4 percent of GDP (Figure 34b). Fourth, revenues of the consolidated subnational governments declined more than expenditures, so their budget deficit increased from 0.1 percent of GDP in 2011 to 0.4 percent of GDP in 2012 (Figure 34a). Table 7: Federal Budget 2011-2012, % of GDP 2012 Budget 2012 June 2012 Dec. 2012 Prelim. 2011 Actual Law Amendment Amendment Estimate Revenues 20.9 20.1 20.9 21.1 20.6 Oil Revenues 10.4 9.5 10.5 10.5 10.3 Expenditures 20.1 21.6 21 21.2 20.7 Balance 0.8 -1.5 -0.1 -0.1 -0.1 Non-Oil Balance -9.6 -11 -10.6 -10.5 -10.4 Ural oil price, USD/barrel 109.3 110.0 115.0 115.0 110.7 Source: Ministry of Finance, Economic Expert Group, World Bank staff calculations. Figure 33: (a) Revenue and expenditures of federal budget, % of GDP; and (b) Balance of the federal budget, overall and non-oil, % of GDP 21.0 2 20.5 0 20.0 -2 19.5 -4 19.0 -6 18.5 -8 18.0 17.5 -10 17.0 -12 Expenditures Revenues Balance Non-Oil Balance 2011 2012 2011 2012 Source: Ministry of Finance, Haver Analytics, World Bank staff calculations. Federal debt remained stable. Debt of the federal government declined marginally as the federal budget remained roughly balanced and the government drew on case reserves to limit public borrowing (Figure 34b). As in 2011, over three quarters of public debt was domestic. Low public debt helps Russia to improve the market’s risk assessment (Box 2). 18 Figure 34: (a) Revenue and expenditures of consolidated budget of subnational governments in 2011-2012, % of GDP; and (b) Federal government debt 2011-2012, % of GDP 14.0 10 13.5 9 8 13.0 7 12.5 6 12.0 5 11.5 4 3 11.0 2 10.5 1 10.0 0 Expenditure Revenues 2011 2012 2011 2012 Domestic External Source: Ministry of Finance, Haver Analytics, World Bank staff calculations. The government foresees moderate fiscal consolidation until 2015. The 2013 budget and 2013 to 2015 medium- term budget are based on the newly adopted fiscal rule. The rule proposes a ceiling on federal expenditures equal to the sum of oil revenues at the base oil price, the nonoil revenues, and a net borrowing limit of 1 percent of GDP. In spite of this rule, both consolidated and federal budget fiscal balances are projected to deteriorate in 2013. They then improve gradually in 2014 and 2015, so that the federal budget would return to surplus in 2015 (Table 8). The non-oil fiscal deficit is projected to decline from 10.4 percent of GDP in 2012 to 8.4 percent of GDP in 2015, compared to the suspended pre-crisis target of 4.7 percent of GDP. On the revenue side, increases in excise duties, natural resource taxes and payroll taxes compensate losses from the reduction of import and export duties due to WTO accession. On the expenditure side in 2013, defence and national security increase 10 percent or more, education rises less than 2 percent, and national economy declines. The main upside risk to the budget is the relatively prudent oil price assumption for 2013. The main downside risks are that fiscal consolidation is back- loaded and lower rouble oil revenues due to exchange rate appreciation. Table 8: Medium-Term Government Budget 2013-2015, % of GDP Preliminary Estimate Preliminary Draft Approved Law 2012 2013 2014 2015 2013 2014 2015 Consolidated Budget Revenues 37.0 36.6 36.2 36.2 37.1 36.7 36.4 Expenditures 36.6 37.9 36.6 35.9 37.7 36.8 35.9 Surplus (+)/Deficit (-) 0.4 -1.3 -0.4 0.3 -0.6 -0.1 0.5 Federal Budget Revenues 20.6 18.8 18.6 18.7 19.3 19 18.8 Expenditures 20.7 20.3 19.2 18.8 20.1 19.2 18.8 Surplus (+)/Deficit (-) -0.1 -1.5 -0.6 -0.1 -0.8 -0.2 0.0 Non-oil Surplus (+)/Deficit (-) -10.4 -10.1 -8.9 -8.6 -9.7 -8.7 -8.4 Urals oil price, US$/barrel 110.4 97.0 101.0 104.0 97.0 101.0 104.0 Source: Ministry of Finance, Budget Laws for the Federal Budget and EBFs for 2013-2015, World Bank staff calculations. Russia’s fiscal buffers will stay below pre-crisis levels. In early 2013, the government replenished the reserve fund, which provides resource to protect the economy in the event of a crisis, lifting it to around 4.5 percent of GDP (Figure 35). Nevertheless, the reserves remain less than half of the pre-crisis level. In addition, according to the medium-term budget projections, the reserve fund will remain below the new target level of 7 percent of GDP 19 by 2015. Furthermore, the government is planning to draw on the national welfare fund to cover some of the pension fund deficit, so both funds are projected to stay below 10 percent of GDP by end-2015. Figure 35: Reserve and National Welfare Funds in 2008- 2015, % of GDP 18 16 14 12 10 8 6 4 2 0 Reserve National Wealth Source: Ministry of Finance, World Bank staff calculations. Box 2: Market sentiment stable since September 2012 Thanks to a strong oil price, large current account surplus and low public debt, along with an improvement in global market sentiment in recent months, market risk perception of Russia improved (Figure 36). The 5-year credit default swap spreads and spreads of sovereign bonds declined since early 2012. The spreads for Russia remain somewhat higher than for Brazil. Figure 36: (a) 5-year CDS spreads (basis points); and (b) Sovereign debt spreads (basis points) 600 750 550 650 500 450 550 400 450 350 350 300 250 250 200 150 150 100 50 Russia Brazil Hungary Mexico Poland Turkey South Russia Turkey Brazil Poland Hungary Czech Africa Republic Jun-10 Jan-12 Mar-12 Sep-12 Feb-13 Dec-11 Mar-12 Sep-12 Feb-13 Source: Bloomberg, World Bank staff calculations. 20 II. Economic Outlook Prospects — recovery postponed The weak external environment, high inflation, flat oil prices and sluggish domestic demand are set to postpone a pickup in growth towards the second half of 2013. Nevertheless, modest growth and lower inflation are projected to reduce poverty further. The world economy is set for a slow recovery. After growing 2.3 percent in 2012, global GDP is projected to stay weak in 2013 and strengthen to 3.1 in 2014 (Table 9 and Figure 37a). For high-income countries, fiscal consolidation, high unemployment and weak consumer and business confidence are likely to delay a pick-up of growth to 2014. The euro area is likely to remain stuck in recession in 2013 as deleveraging continues to weigh on domestic demand. In developing countries, better financial conditions and improved confidence are projected to lift growth in developing countries in 2013, and further in 2014 with support of the recovery in high-income countries. Table 9: GDP growth projections (percent) 2007 2008 2009 2010 2011 2012 2013 2014 World 4.0 1.4 -2.2 3.9 2.8 2.3 2.4 3.1 High-income countries 2.7 0.1 -3.5 2.8 1.6 1.3 1.3 2.0 Developing countries 3.8 1.9 7.3 6.2 5.1 4.9 5.5 5.7 Russia 7.4 3.9 -7.8 4.3 4.3 3.4 3.3 3.6 Source: World Bank staff projections Growth in Russia will recover only in 2014. Compared to the forecast from autumn 2012, we lowered growth estimates from 3.6 percent to 3.3 percent for 2013 (Table 10). The projection reflects six main factors. First, we revised downwards the projections of average World Bank oil prices for 2013 from US$105.8/bbl to US$102/bbl, although this adjustment is somewhat mitigated by a higher spread between the Urals and WTI oil prices (Box 3). Second, the external environment is worse than anticipated. Our 2013 growth projection declined 0.2 percentage points for high-income countries and 0.4 percentage points for developing countries. According to the February 2013 forecast of the European Commission, the euro area, which Russia’s most important economic partner, is expected to return to growth only in 2014 rather than this year as in their autumn 2012 forecast. Third, economic activity in Russia weakened more than expected in the last months of 2012. This will lower growth in 2013 due to a larger carryover effect. Fourth, as in 2012, we expect consumption to be the main driver of growth. However, inflation is likely to decline at a slower pace than expected which in turn will dampen consumption growth compared to 2012. Fifth, in view of weak investment in 2012 in spite of large-scale projects such as the 2014 Sochi Winter Olympics, we now expect a recovery in investment only in mid-2013 in line with global trends. Finally, growth in Russia is set to pick up in 2014 thanks to stronger growth in other high-income countries, as well as a rebound in investment. However, the up-tick in growth is likely to be moderate as the pace of the expansion will be held back by modest potential growth. 21 Figure 37: (a) GDP growth projections (percent); and (b) Poverty projections for Russia 8 25 21.5 18.7 18.8 18.2 17.9 18.1 4 20 16.9 16.5 15.9 15 0 15.2 13.3 13.4 13 12.6 12.8 10 11.7 11.6 11.2 -4 5 -8 2007 2008 2009 2010 2011 2012 2013 2014 0 World High-income countries 2006 2007 2008 2009 2010 2011 2012 2013 2014 Developing countries Russia Million People Poverty rate Source: World Bank staff projections, Rosstat In spite of the weak economic momentum, inflation is likely to decline only later in the year. Seasonal factors and tight labor markets are set to keep inflation above CBR’s target range of 5 to 6 percent in the coming months. Later in the year, the slowdown in monetary growth, along with the moderation in credit growth and the closed output gap, will support a reduction in inflation. Table 10: Main economic indicators for the projection 2012 2013 proj. 2014 proj. Growth (%) 3.4 3.3 3.6 Consolidated budget balance (% of GDP) 0.4 -1.0 0.0 Current account balance (US$ billions) 81.3 56.8 30.5 Current account balance (% of GDP) 4.1 2.6 1.3 Capital account balance (US$ billions) -50.0* -36.0 -25.0 Capital account balance (% of GDP) -2.1 -1.7 -1.1 Oil price assumption (WB Average, US$ per barrels) 105 102 102 Source: World Bank staff projections. *Adjusted for currency swaps The current account surplus and capital account deficit are set to decline. We project a decline in the current account surplus as solid consumption and a stable ruble will bolster imports while the weak external environment and somewhat lower oil prices will dampen exports (Table 10). At the same time, the capital account deficit is projected to decline. This reflects improved borrowing capacity of banks and nonfinancial corporations, lower debt repayments and a lower current account surplus. The consolidated budget is likely to turn into deficit in 2013, and be close to balance in 2014 as a result of modest fiscal consolidation efforts. However, the non-oil deficit is estimated to remain close to 9 percent of GDP in 2014. The risks to our projections are broadly balanced. The main upside risk is that the recent improvements in global business sentiment could translate into a faster rebound of the global and domestic economies. In addition, businesses could step up investment in response to capacity constraints and consumer could reduce savings in order to step up spending. The main downside risk remains a persistent drop in the oil price. This could be triggered by either a renewed slowdown in the global economy or a decline in oil supply disturbances in the Middle East. Poverty is likely to decline further. The share of the population with incomes below the national poverty line is estimated to drop from 11.7 percent for the full year of 2012 to percent 11.2 percent in 2014 (Figure 37b). Low unemployment, wage growth and the reduction in inflation are set to reduce the number of poor people from 16.9 million in 2012 to 15.9 million in 2014. 22 Box 3: Global Oil Market Developments and Outlook Despite considerable fluctuations within 2012, oil prices and the year US$ 105/barrel (bbl), essentially where they began. Since the beginning of 2013, oil prices firmed further, up 5 percent by mid-February, largely on better prospects for the global economy, output reduction by OPEC, and less so on lower geopolitical concerns. The World Bank expects most commodity prices to ease marginally during 2013; oil price (World Bank average) is expected to average US$ 102/bbl in 2013, almost 3 percent lower than 2012. Following weak growth in 2011, global oil demand picked up moderately in 2012; it increased by about 1.1 percent or 1.02 million barrels per day (mb/d) to reach almost 90 mb/d. As in previous years, oil consumption in OECD countries continued to fall and is now 7.7 percent lower than its 2005 peak. Japan is the only OECD country for which oil demand increased in 2012 (by 0.3 mb/d); most of this increase was to fill the loss of nuclear power generation capacity as a result of the Tohoku earthquake. Currently, only 2 out of the 50 nuclear facilities in Japan are operational and it will take some time before nuclear capacity is restored due to the stricter rules of operation and safety considerations. Thus, oil demand by Japan is expected to remain strong. Consumption by non-OECD countries remains strong. Most emerging economies increased consumption in 2012 and are expected to do so in 2013. For example, oil consumption in China is expected to increase by 4 percent in 2013 with similar increases to take place elsewhere, including former Soviet Union (FSU) countries and India (4 and 3 percent respectively) and Brazil (2.3 percent). Globally, oil demand is expected to grow by 0.9 percent in 2013 to reach almost 90.7 mb/d—almost half will be accounted by non-OECD economies. On the supply side, non-OPEC producers added more than 1 mb/d to global supplies, mainly reflecting earlier large-scale investments, especially in North America. Oil production among OPEC members has risen considerably, especially following disruptions of oil supplies by Libya, with Saudi Arabia accounting for most of the growth. Currentl y, Libya’s oil output is about 80 percent of pre-war levels (1.4 mb/d). Iraq’s output has reached pre-war levels (a little over 3 mb/d). Iran’s oil exports are 0.3 mb/d below pre-sanctions levels and may tumble even further. OPEC’s spare production capacit y stands at about 4 mb/d, two-thirds of which is in Saudi Arabia. Thus, it is mostly up to Saudi Arabia to fill any gap, in case of a major oil supply disruption. Although the price of Brent crude (the international marker) topped US$113/bbl in September, West Texas Intermediate (the U.S. mid-continent price) has remained almost US$20/bbl less due to the build-up of regional stocks. A decline in the Brent- WTI spread in late 2011 and early 2012, which reflected reduced euro zone demand for Brent, turned out to be temporary; by August 2012, the spread again exceeded 20 percent, where it currently stands. Oil from Urals is trading at small discount to Brent (the discount fluctuating around 1 percent in 2012 and early 2013). Typically, when Urals is in surplus it will trade at a discount while when exports to the Meditanean are tight then it will trade closer to parity with Brent. The discount of Urals against Brent is expected to widen, as light/sweet crude output returns, and incremental OPEC output is of heavier grades. The forecast for the World Bank crude oil average is set at US$ 102/bbl and is expected to remain at that level through 2014. The downside risks to this forecast are limited since the outlook has improved (albeit) marginally. Upside risks, however, exist and reflect mainly disruptions on the supply side. Nevertheless, oil prices are likely to be capped around US$ 120/bbl because of price-induced demand restraint and publically announced intentions to release oil from strategic reserves in France, United Kingdom, and the United States. Thus, any crossing of the US$120/bbl is likely to be of limited duration. Over the longer term, prices are expected to fall (slightly) in real terms due to growing supplies of conventional and (especially) unconventional oil, efficiency gains and some substitution away from oil. The assumptions underpinning these projections reflect upper-end cost of developing additional oil capacity, notably from the oil sands in Canada, currently assessed by the industry at US$ 80/bbl in 2012 constant terms. While it is expected that OPEC will continue to limit production to keep prices relatively high, the organization may be sensitive to letting prices too high, for fear of inducing technological innovations that would alter the long term price of oil. Figure 38: (a) Oil prices and OECD oil inventories; and (b) World oil demand growth (y/y change) $US per bbl mb/d million bbl 4 140 2,800 non-OECD OECD 120 2 2,700 100 0 80 2,600 60 OECD oil inventories (right axis) 2,500 -2 40 Oil price, World Bank average (left axis) 20 2,400 -4 Jan-06 May-07 Sep-08 Jan-10 May-11 Sep-12 1Q03 1Q05 1Q07 1Q09 1Q11 1Q13 Source: International Energy Agency and World Bank 23 Policies – recovery and beyond Economic activity in Russia has lost momentum. In order to revive the economy, policies face two challenges. First, it has to manage macroeconomic policies so as to ensure economic stability. Second, Russia has to step up structural reforms so as to lift the growth potential. Russia's economic performance in 2012 was solid. Aided by a high oil price, growth was steady, the current account balance was strong, the government budget was balanced, and unemployment and poverty receded to record lows. However, economic activity weakened in recent quarters, and is likely to remain sluggish in early 2013. The recent slowdown reflects Russia’s moderate potential growth rate, as indicated by low unemployment, high capacity utilization and a weak external environment. With oil prices projected to remain unchanged at best, capacity utilization approaching pre-crisis peaks, and unemployment at a record low, additional growth momentum will be difficult to come by. In addition, an aging and declining workforce and declining oil production in the absence of large investments and new discoveries dampen long-term growth prospects. In order to revive the economy, Russia’s economic policies have to address two issues. Macroeconomic Stability In early 2012, growth was increasing and inflation declining. Now, growth is decreasing and inflation rising. Bolstering macroeconomic policies in three areas can help to ensure stability in the face of domestic and external vulnerabilities.  First, sticking with prudent spending plans and saving oil revenues that come in over and above budget is the priority for fiscal policy. The newly adopted fiscal rule and the 2013 to 2015 budget should be consistently implemented and complemented with a credible medium-term plan to phase out ineffective public spending, to improve vital public services and protect growth enhancing investment programs. Furthermore, the fiscal rule should not be undermined through excessive use of supplementary budgets. Only then will the government be able to replenish the oil funds adequately and reduce its dependence on high oil prices.  Second, focusing monetary policy on low inflation will help to keep inflationary expectations in check in spite of tight labor markets and strong consumer lending. Bringing inflation down in line with the CBR’s target range for 2013 will also make economic growth more sustainable. Greater exchange rate flexibility helps the transition towards full inflation targeting by end-2014. It also strengthens the CBR's ability to withstand an oil price shock without significant losses of its foreign exchange reserves and to discourage speculative capital inflows. Exchange rate flexibility is also an important shock absorber for the government budget in view of potential commodity price volatility.  Third, strengthening banking supervision, also for intra-group lending, is important to bolster stability of Russia's financial markets. In addition, the decline in the capital adequacy ratios suggests that the CBR should stand ready to take additional measure to mitigate risks in consumer lending. Structural Reforms Russia’s growth prospects are uncertain. In the decade leading up to the 2009 crisis, Russia grew at around 7 percent per annum, driven mainly by gains in total factor productivity and capacity utilization. During the rebound from the crisis in 2010 and 2011, the economy expanded over 4 percent. Now, growth has slowed to less than 3.5 percent. Reviving growth requires, among others, removing structural barriers in three areas.  First, reducing the state’s footprint on the economy through privatization, continuing the improvements in the investment climate (Box 4), and following through on the commitments taken on as part of the WTO accession and the envisioned OECD accession will help closing Russia’s productivity gap with high-income economies.  Second, confronting the economic challenges of the aging and shrinking of the population will be important to ensure that improvements in life expectancy translate into prosperous aging (Box 5).  Third, improving governance through more transparency (Box 6), better regulations and more effective control of corruption (Section III) will contribute to the institutional basis for shared prosperity. 24 Box 4: Does low survival of new firms prevent economic diversification? Oil and gas provide half of the revenues of the central government’s budget and two thirds of Russia’s exports. But what exactly is holding back firms outside the natural resource sector to prosper? Combining UNIDO firm-level data representing 84 sectors from 134 countries with World Bank data from the enterprise survey databases, initial findings of ongoing World Bank research sheds new light on this issue. First, compared with the rest of the world and Europe and Central Asia, Russia’s enterprise sector is dominated by larger firms whether measured in terms of labor force or sales revenues (Figure 39a). Second, older firms in Russia employ fewer people and earn lower revenues than the comparator groups (Figure 39b). This could indicate that underperforming firms survive longer in Russia than elsewhere, preventing the reallocation of resources to new firms in emerging sectors. Third, the spread of sectoral growth rates in Russia is higher than in other countries (Figure 40a). The volatility in growth rates is especially pronounced in small sectors. Fourth, the greater volatility is reflected in longer and deeper collapses in growth than in comparator groups (Figure 40b). Again, this affects small sectors in particular. This analysis indicates that one of the reasons for a lack of diversification in Russia could be that smaller sectors are less resilient than larger sectors to cope with growth collapses. This might be because new firms face tough business conditions and a rigid non-competitive environment. These findings underscore the importance of economic policies that improve the prospects for new firm entry, raise allocative efficiencies, and strengthen competition on the path to a more diversified economy. Figure 39: (a) Distribution of firm labor force; and (b) Age as predictor of size of the labor force Figure 40: (a) Growth rate spread; and (b) Growth collapses by duration (years) Source: World Bank staff calculations 25 Box 5: Russia’s population is aging and shrinking The next decades will see a dramatic decline in Russia’s working -age population. Compared to many countries in Europe, Russia has a still young population and benefited until recently from a demographic window as large cohorts entered the labor market. However, the population structure will age dramatically in the coming decades. The population is aging for three reasons: younger cohorts are smaller due to the sharp decline in fertility rates in the early 1990s; large cohorts are moving close to the top of the age pyramid; and increases in life expectancy are projected to continue. These dynamics imply a shrinking labor force and rising dependency rates. • Shrinking population: According to the United Nations’ Population Division, Russia’ s population is projected to decline by more than 15 million people over the next 40 years—from about 143 million people in 2012 to 126 million in 2050. Combined with population growth in other countries, this implies that Russia will move from being the 9th most populous nation in 2010 to the 14th most populous nation in 2050. • Declining labor force: Between 2009 and 2017, Russia’s working -age population is expected to decrease by about one million people a year, and it is predicted to shrink from 70 percent of total population in 2010 to 56.6 percent by 2050 (Figure 41a). • Rising share of elderly: The share of elderly in the total population and the old-age dependency ratio (the number of people aged 65 or older relative to the number of people aged 15 to 64) in Russia are expected to nearly double from 2010 to 2050, increasing from 12.4 percent to 21.8 percent and from 18 percent to 36 percent respectively (Figure 41b). • Increasing ranks of oldest-old: The number of people aged 80 years or older, who often are frail and unable to care for themselves, is set to double from 4.1 million in 2010 to 8.0 million in 2045. • Large fluctuations in the size of age cohorts: A distinguishing feature of Russia’s demographics in the last half-century is the significant fluctuations in fertility, with the "baby boom" of the post-World War II period and the spike in 1980s interrupted by periods of declining fertility in the mid-1960s and in the 1990s. Figure 41: (a) Working-age population; and (b) Old-age dependency ratio 50 100 Old-Age Dependency Ratio 95 40 90 30 85 20 80 75 10 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 1990 2000 2010 2020 2030 2040 2050 2060 Year Year Western Europe Eastern Europe Russia Western Europe Eastern Europe Russia Source: UN World Population Prospects: The 2010 Revision Source: UN World Population Prospects: The 2010 Revision Russia’s demographic transition poses profound social and economic challenges. With current behaviors and policies, population aging could turn out to be an economic burden in Russia. First, a declining labor force can potentially negatively affect the economy because, other things being equal, fewer workers will lead to lower output and lower economic activity. Second, population aging can lower private savings since elderly people tend to save less than the prime working�age individuals. Lower savings could thus dampen investment and growth prospects. Third, to the extent that the existing workforce is aging and skills become progressively obsolete, labor productivity could plummet. Finally, an aging population is likely to exert additional demands on public resources because the elderly tend to have higher health care and long term care needs, and because the change in the age structure of the population will have a significant impact on pension revenues and expenditures. However, pessimism about Russia’s ability to meet economic challenges in the light of population aging may well be unwarranted. International experiences show that the issue is not aging per se but failure to respond to aging populations. Simple projections are likely to overstate the impact of aging on economic outcomes as people change their behavior, and policy makers change policies. But to turn greater longevity into prosperous aging, Russia will need to employ additional resources and develop new policies to mitigate the aging challenge. Ongoing World Bank research investigates measures to ensure prosperous aging in Russia. They include: • People working more and longer, improving their skills and engaging in lifelong learning, and increasing savings for old age. • Enterprises attracting talent from abroad, drawing on the experience of older workers, and investing in technology; and • Government becoming more efficient and containing the rise in age-related spending. 26 Box 6: Russia makes it to the top ten countries with the most open budget Russia has improved budget transparency over the years and is now telling its public more about government income and spending than countries such as Germany or Spain, a new open budget survey suggests. The Open Budget Survey 2012 released in January 2013 was conducted by the International Budget Partnership, an international NGO advocating government transparency. It assesses whether the central government in each country surveyed makes eight key budget documents available to the public, as well as whether the data contained in these documents is comprehensive, timely, and useful and give opportunities to citizens to participate in the budget process at the national level. The survey uses internationally accepted criteria to assess each country’s budget transparency. In the 2012 ranking, Russia took 10th place, jointly with Slovenia. This compares to 21th place in 2010, 22nd place in 2008 and 27th place in 2006. Russia improved in the ranking even though the number of countries participating rose from 56 in 2006 to 100 in 2012. The progress was possible due to the following reforms. First of all, Russia has improved in terms of presentation of the budget proposal by basing the functional classification of expenditures on international standards. Second, the budget proposal includes more information on the composition of government debt. Third, the budget proposal also discusses the impact of policy proposals on expenditures. Fourth, expenditures are now broken down by economic classification, sector-level expenditure data for all expenditures and estimates of aggregate expenditures of the previous budget year are presented in line with international standards. However, the ranking also highlights a number of weaknesses in Russia. First, the budget proposal could present more detail on expenditure estimates for previous budget years. Second, the budget includes little information on issues beyond the core budget such as quasi-fiscal activities, financial and non-financial assets, and expenditure arrears. Third, assessing budget performance is difficult as explanations of why outcomes differed from plans are not provided in the year-end report. Fourth, opportunities for public participation in the budget discussion are still limited. For example, there is no a user-friendly format for presenting budget for a broader public. In addition, a large part of the budget expenditures are dedicated to secret items relating to, for instance, national security and defense. There are also no mechanisms in place for citizen participation during budget execution or budget audit. Source: http://survey.internationalbudget.org 27 III. Trends in Regulatory Burden and Corruption Using data from BEEPS and other Enterprise Surveys, studies have shown that firm entry, growth and productivity are impeded by corruption and overly burdensome regulation. Cross-regional variation in corruption and regulatory burden in Russia are potentially important factors in explaining differential performance in private sector development, income levels and growth rates. In the longer run, sustained growth that is more balanced, both geographically and across a more diverse set of sectors, will likely require a steadfast focus on improving Russia’s regulatory climate for private investment and enterprise. This report assesses trends over time in 4 corruption and the regulatory burden in Russia, draws comparisons with emerging economies from Europe and Central Asia (ECA) region as a whole, and for the first time uses BEEPS to make comparisons across 37 Russian regions –from Moscow to Primorskiy Kray and from Kaliningrad to Rostov Oblast – accounting for the majority of 5 economic activity, value-added and population in the country. It also identifies regions where the private sector confronts the most serious challenges, and regions where problems are much less severe. A. National Trends Since the previous round of the BEEPS conducted in 2008, Russia has made significant progress in addressing the administrative burden imposed on firms by regulations, tax and court Figure 1: Regulatory obstacles to doing business administration, etc. Overall, trends in (percentage of respondents indicating issue is NO obstacle) the administrative burden are favorable, as measured by the BEEPS: Corruption 21% 40% Tax administration 51%  The average “time tax� is 24% significantly lower in 2011 with Access to land 37% 65% 17% of senior management time 68% Customs and Trade regulations 59% 2011 spent on dealing with regulations, compared to 22% in Business licencing and permits 30% 69% 2008 6 2008. Labor regulations 71% 52%  Among the various regulatory Courts 35% 77% and administrative sub-sectors, licensing, courts and tax 0% 20% 40% 60% 80% 100% administration are the areas where perceptions have improved the most (Figure 1). Fewer firms in 2011 cite tax administration as an obstacle to their current operations. In 2008, 24% indicated tax administration was not a problem, below the ECA average of 33%. The figure for Russia more than doubled to 51% in 2011. In 2008, 63% of firms reported they were subject to at least one such meeting or inspection, slightly higher than the 58% average for ECA. In 2011, as shown in Figure 2.1, only 49% of Russian firms were required to meet with or be inspected by tax officials. Figure 2.2, shows that among firms required to deal with tax officials, 7 the average number of meetings or inspections declined, from 3.2 in 2008 to 2.6 in 2011. In comparison, the ECA average for 2008 was slightly higher, at 3.4. The share of firms citing labor regulations, and customs and trade regulations, as obstacles to their business operations also declined, but only slightly, between 2008 and 2011 (see Figure 2). On both of these indicators Russia’s values were very close to the ECA average in 2008. 4 Definitions of regulatory burden and different types of corruption analyzed in the report are given in Annex 1.1. 5 The list of 37 regions is shown in Annex 1.3 and mapped in Annex 1.4. 6 All reported differences between the 2008 and 2011 estimates for the various measures are statistically significant at 10%level or better, unless indicated otherwise. 7 This difference is not statistically significant 28 Figure 2.1: Percentage of firms inspected Figure 2.2: Average number of visits and by tax officials (last year) inspections by tax officials (last year) 80 4 63.0 3.2 60 3 2.6 48.8 40 2 20 1 0 0 2008 2011 2008 2011 While respondents see these areas as less problematic than before, the survey results also suggest areas for further improvements (Figure 3):  Evidence regarding licensing, permits and utility connections suggests that while fewer firms cite licensing and permits as an obstacle to their business, in some cases (e.g., new electrical connection) they have to endure 8 longer average waiting times in 2011 than in 2008.  Similarly, fewer firms report that courts are an obstacle, but the reasons for this trend are unclear. Firms in 2011 are less likely to agree that court decisions will be reliably enforced, perhaps partly explaining why fewer firms report having used courts either as a plaintiff or defendant, in 2011 (32%) than in 2008 (43%). However, court usage in both years was higher than the ECA average of only 27% for 2008. Figure 3.1: Average time needed to obtain Figure 3.2: Perception of courts (percentage of selected permits and licenses, 2008 and 2011 respondents stating that they agree or strongly 140 (days) 130 agree) 120 2008 75 120 64 104 2008 2011 100 49 2011 80 50 59 54 57 57 60 47 29 31 27 27 36 40 30 25 20 0 - Electrical Water Construction Import Operating The court system is The court system is The court system is Connection Connection Related License License fair, impartial and quick able to enforce its Permit uncorrupted decisions Overall, trends in the administrative burden imposed on Russian firms by regulations, tax and court administration are favorable, as measured by the BEEPS: 1. The average “time tax� is significantly lower in 2011 than in 2008. 2. Among the various regulatory and administrative sub-sectors, licensing, courts and tax administration are the area where perceptions of positive trends - measured by the share of firms stating that these are not an obstacle, are most unambiguous. 3. Evidence regarding licensing, permits and utility connections is somewhat mixed: firms report longer average waiting times in 2011 for electrical connections, but fewer of them cite licensing and permits as an obstacle to their business operations. 4. Similarly, fewer firms report that courts are an obstacle, but the reason for this trend is unclear. Firms in 2011 are less likely to agree that court decisions will be reliably enforced, perhaps partly explaining why fewer firms report having used them. 8 The differences in water connection, construction permits, import and operating licenses are not statistically significant. 29 Corruption was ranked by firms in the 2008 BEEPS as the 3rd most serious problem doing business in Russia. In 2011, corruption moved up to 2nd on the list of most frequently-cited problems, moving ahead of “inadequately educated workforce� and behind only “tax rates.� This does not necessari ly mean corruption worsened. In fact, fewer firms cited corruption as a major or very severe problem in 2011 (33.5%) than in 2008 (50%). Rather, the improvements in areas other than taming corruption were even larger. Further complicating interpretations of the trends in this question is that corruption can take many forms. Fortunately, the BEEPS includes more detailed questions on some (but not all) specific forms of corruption as experienced or perceived by business firms, allowing for more nuanced conclusions.  A summary “Graft Index� representing the share of all interactions between firms and Figure 4: Unofficial payments to "get things done", public officials in which a bribe was 2008 and 2011 (percentage of respondents expected has also improved. In 2008 the reported payments are needed at least frequently) 30 index value was 0.18, i.e. about every fifth 26 2008 transaction would involve a bribe; in 2011 25 21 Russia’s value improved to 0.081 (one in 2011 20 twelve transactions involves a bribe). By comparison, the ECA average in 2008 was 15 0.15, but in 10 Eastern European countries 10 8 9 the ratio was 1 in 20 or less. 10 6 7  The “bribe tax� or percentage of annual 5 3 sales spent on bribe payments has also 0 decreased from 1.7% of sales (above the overall bribe bribes in dealing bribes in dealing bribes in dealing ECA average of 1.0%) to 0.9% of sales in frequency with with courts with taxes and 9 2011. customs/imports tax collection  Among those firms reporting positive payments, however, bribes as a percentage of sales increased from 4.5% of sales in 2008 to 7.3% in 2011. Payment of bribes thus became more concentrated over time: fewer firms report paying them, but those that do pay more.  A more general question about bribe frequency shows that a somewhat greater share of firms in 2011, 10 compared to 2008, indicates that bribes are frequently (or always) necessary (Figure 4).  Bribe requests were marginally more frequent in 2011 relative to 2008 for obtaining electrical and water 11 connections, and lower for operating and import licenses , construction permits, and meetings with tax officials (Figure 5). Figure 5: Percentage of respondents stated that an informal payment was expected or requested when obtaining a specific permit, license or utility connection, 2008 and 2011 50 43 2008 40 37 2011 30 21 17 18 19 20 15 11 11 10 10 5 3 0 Electrical Connection Water Connection Construction Permits Tax Insp./Meetings Import License Operating License Public procurement is one final category of firms’ interactions with public officials covered by the BEEPS. This type of interaction is considered separately from the others, because it applies only to a subset of firms that seek to obtain government contracts. In contrast, all firms are subject to taxes and licensing requirements, and nearly all must obtain utility connections. 9 Marginally statistically significant (P=0.12) 10 The difference is statistically significant for firms that paid something, but not significant for all firms that attempted to secure a contract 11 None of these changes were statistically significant. 30 In 2008, 36% of Russian firms reported that they secured or attempted to secure a government contract over the last year, far exceeding the ECA average of only 19%. In 2011, only 27% of Russian firms reported obtaining or seeking to obtain a government contract (Figure 6.1). In 2008, 40% of Russian firms that attempted to or secured government contracts reported that some payment would typically be needed. However, the corresponding figure for 2011 was only 23%. The average “kickback tax� for all firms responding (including the 0% responses) was 4.6% in 2008, more than double th e ECA average of 12 2.1%. For 2011, the average payment was 3.5% of the contract value. Among only those firms indicating that some payment was required (i.e. with the 0% responses dropped), however, the average payment rose from 11.5% 13 of contract value in 2008 to 15% in 2011 (Figure 6.2). Figure 6.1: Percentage of firms that attempted to Figure 6.2: Percentage of government contract value secure government contract and those among them paid to secure such contract, 2008 and 2011 that indicated that a unofficial patyment was made 20 in the process, 2008 and 2011 15.2 45 39.9 2008 2011 36.4 2008 15 11.5 30 26.9 2011 10 22.9 4.6 5 3.5 15 0 Percent of contract value paid Percent of contract value paid 0 to secure the contract - all to secure the contract - firms Firms that secured or Among them, % of firms attempted firms that paid something attempted to secure indicated that some payment Government contract was made Administrative corruption is not necessarily the most damaging form of graft for economic growth and private sector development. The 2011 BEEPS witnessed the return 14 Figure 7: Private payments/gifts to public officials of several questions on “state capture� that were included in the 1999, 2002 and 2005 BEEPS, but dropped to gain advantages have NO impact (percentage from the 2008 survey. 90 of respondents) 2005 83 2011 The perceived impact of state capture increased between 81 2005 and 2011. As shown in Figure 7, the percentage of 80 77 76 75 76 firms claiming no impact of these practices declined, by 6 and 5 percentage points for questions state-level officials 70 in the elected executive offices, but increased by about 1 percentage point for local/regional level officials. 60 Viewing responses from the other end of the scale, the adverse trend appears more serious. The percentage of firms claiming a major or decisive impact doubled for the 50 latter category of official and tripled for the former two. Parliamentarians Government officials local/regional officials B. Regional Comparisons The 2012 Russia survey is the first BEEPS designed to be representative at sub-national levels within a country. In most of the 37 regions included in the survey, about 120 firms are represented. Results show that the business environment differs significantly across these regions. The region in which firms are located turns out to have fairly stronger implications for the degree of administrative corruption, state capture and the regulatory burden they confront than other firm characteristics such as size, age, ownership, industry, and major product or service provided. There is a large regional variation in BEEPS indicators of administrative burden and corruption. The “time tax� indicator exemplifies the dramatic variation across regions in many of these indicators. The mean “time tax� varies from 1% for Primorsky Kray to 49% for Stavropol Kray. Moscow is in the middle of the distribution, at 19%. 12 Not statistically significant difference 13 The difference is statistically significant for firms that paid something; and not significant for all attempted firms 14 The World Bank’s first Anticorruption in Transition report defined �state capture� as “the actions of individuals, groups or firms both in the public and private sector to influence the formation of laws, regulations, decrees and other government policies to their own advantage as a result of the illicit and non-transparent provision of private benefits to public officials.� 31 Although regions differ significantly from each other, the same regions that rank at or near the top on some indicators – perhaps surprisingly - rank at or near the bottom on others. Smolensk Oblast ranks best on waiting time for electrical connections, with an average of only 8 days, while waiting time for Primorsky Kray is 730 days, nearly double the time for any other region. On the other hand, Primorsky Kray has the shortest average wait for water connections, at only one day, while Smolensk Oblast was in second place at 1.8 days average wait. In order to summarize various aspects of business-government interactions, a statistically reliable composite index of Administrative Burden was constructed from questions pertaining to seven potential obstacles to firm operations and growth. The top 5 regions having the lowest values of this index are: Smolensk, Belgorod, Stavropol, and Irkutsk Oblasts and Republic of Mordovia. The bottom 5 regions are (starting with the worst): Rostov, Leningrad, and Samara Oblast, Krasnodar Kray, and St. Petersburg City. able 1 shows this index along with three other statistically reliable composite indexes. Table 1 also shows regions ranked best and worst on two indexes constructed from BEEPS questions pertaining to administrative corruption. One is the Graft Index, defined above as the share of firms’ reported interactions with officials in which they report needing to pay a bribe. A second index, the “Administrative Corruption Index,� is constructed from responses to the “bribe frequency� question as well as three similar questions that ask more specifically about whether it is common for “establishments like this one� to pay bribes in dealing with customs, courts and taxes. Stavropol Kray ranks at the top on this Administrative Corruption Index, followed by Ulyanovsk Oblast, Lipetsk Oblast and the Republic of Mordovia. Smolensk Oblast ranks 8 th-best among the 37 regions, Primorsky Kray ranks at the bottom, just above Tver Oblast, Rostov Oblast, and Chelyabinsk Oblast. Rankings on the Graft Index look quite different, despite the fact that both indexes pertain to administrative bribery. The difference between them is that one is based on questions about the firm’s reported experiences related to a set of specified transactions, while the other is based on questions about respondents’ perceptions, namely what they think happens with similar firms, for a similar (but not identical) set of specified interactions. These subtle distinctions in how questions are asked have surprisingly large implications for firms’ responses: correlations between the two types of indicators turn out to be extremely low. None of the top-ranked regions on the Administrative Corruption Index appears among those highly-ranked on the Graft Index. Smolensk Oblast is the top-ranked region on the Graft Index, followed by Novosibirsk Oblast, St. Petersburg, Moscow City, and Primorsky Kray. The regions at the bottom of the list are also entirely different. Voronezh Oblast, the Republic of Bashkortostan, and Krasnodar Kray are the regions ranked worst on the Graft Index. The policy implications of perceptions questions vs. experiential questions may also differ. For example, perceptions of corruption in two jurisdictions with the same incidence of actual corruption may differ, if there are more effective channels of communication in one jurisdiction than in the other. Freedom of information laws and a more independent and competitive media can worsen perceptions of corruption (e.g. Costa, 2012). Table 1. Composite Indexes of Regional Performance - Regions in the top and bottom quintiles Administrative Burden Administrative Top performers Graft Index State Capture Index Index Corruption Index 1 Smolensk Oblast Stavropol Kray Smolensk Oblast Khabarovsk Kray 2 Belgorod Oblast Ulyanovsk Oblast Novosibirsk Oblast Kursk Oblast 3 Stavropol Kray Lipetsk Oblast Saint Petersburg Ulyanovsk Oblast 4 Irkutsk Oblast Republic of Mordovia Moscow City Republic of Mordovia 5 Republic of Mordovia Tomsk Oblast Primorsky Kray Omsk Oblast 6 Rep. Bashkortostan Republic of Tatarstan Leningrad Oblast Tomsk Oblast 7 Tomsk Oblast Rep. Sakha (Yakutia) Chelyabinsk Oblast Voronezh Oblast Poor performers 31 Volgograd Oblast Moscow City Samara Oblast Kaluga Oblast 32 Kaliningrad Oblast Krasnodar Kray Yaroslavl Oblast Belgorod Oblast 33 Saint Petersburg Irkutsk Oblast Perm Kray Tver Oblast 34 Krasnodar Kray Chelyabinsk Oblast N. Novgorod Oblast Krasnodar Kray 35 Samara Oblast Rostov Oblast Krasnodar Kray Rostov Oblast 36 Leningrad Oblast Tver Oblast Rep. Bashkortostan Irkutsk Oblast 37 Rostov Oblast Primorsky Kray Voronezh Oblast Primorsky Kray 32 Table 1 shows the best and worst ranked regions on a State Capture index, constructed as the mean of these three indicators. Khaborovsk Kray, Kursk Oblast, and Ulyanovsk Oblast are the top-ranking three regions on this index. All three of them rank in the middle among regions on the “Administrative Obstacles� index. The Republic of Mordovia is the only region ranking in the top 5 on both the State Capture index (4th) and on the Administrative Obstacles index (5th). It is also one of only two regions (along with Ulyanovsk Oblast) to rank in the top 5 on both State Capture and Administrative Corruption. Despite its top ranking among the 37 regions on both the Administrative Obstacles Index and Graft Index, Smolensk Oblast ranks only 20 th-best on the State Capture index. There is also some congruence between firms’ experiences and perceptions in the BEEPS, and citizens’ experiences and perceptions in these household opinion surveys. For example, a 2011 Public Opinion Foundation (FOM) survey asked whether or not a public official has requested an “unofficial payment� or favor from them in the last 1 or 2 years. Among regions represented in the BEEPS, the percentage of citizen respondents who had been asked for a bribe ranged from a low of 6% in Tomsk to a high of 31% in St. Petersburg. Figure 8 shows the relationship (correlation = 0.35) between this FOM question and firms’ reports of “bribe frequency,� i.e. whether or not it is frequently necessary for similar firms to make unofficial payments “to get things done.� The FOM indicator is also positively correlated (at 0.35) with firms’ perceptions of the impact on their businesses of state capture at the local and regional level. Cross-country studies on corruption, including those 3.5 Figure 8 using cross-country BEEPS results, often find positive PRM correlations with per capita income and other 3 MOS RSV TVR Average of firms' assessment CHL measures of socioeconomic development. A study IRK KSN LEN SPT NZN MRM published in World Politics in 2005 by Phyllis Dininio 2.5 BSK VRN of bribe frequency KRV MSC VGG and Robert Orttung analyzed 40 Russian regions, and SVD YRS KRA SAM KNG BLG showed that higher gross regional product (GRP) per 2 OMS TRT KLG SML PER NOV KHA KRS TOM KEM MRD LPT capita is associated with lower administrative ULY corruption, as measured by surveys of experiences of 1.5 STV citizens and entrepreneurs. Their survey data were collected in 2002 (by Transparency International and 1 the INDEM Foundation), and only 27 of their 40 5 15 25 regions are represented in the 37-region BEEPS % of citizens who have encountered a survey. Most regional-level indicators of regulatory government official expecting a gift or favor burden and corruption in the BEEPS are not significantly correlated with per capita GRP. In the few cases where a significant relationship is found, the correlation is actually positive. The regional values for GRP per capita and regional means for the BEEPS corruption-as-an-obstacle question have a positive relationship, but it appears to be sensitive to the case of Moscow, a rather extreme outlier on GRP per capita. When Moscow is dropped, the relationship remains positive but is weaker and not statistically significant. Figures 9.1 and 9.2 respectively show that regions where firms report tax administration as a more serious obstacle also tend to be regions where firms report a higher number of meetings with tax officials (Figure 9.1), and a greater need to pay bribes in connection with paying taxes (Figure 9.2). Moreover, firms reporting a higher “bribe tax� also tend to report a higher “time tax�. It is consistent with the view that an excessive regulatory burden is imposed in many cases as a deliberate strategy to extract rents from firms. Figure 9.1 Figure 9.2 2 RSV Average degree to which tax admin 2 RSV Average degree to which tax admin. Is an obstacle KSN CHL SAM VGG KRS KRV SAM CHL KSN KRV is an obstacle KEM MRM SVD KRS VGG SPT KEM MRM SVD TVR MOS YRS LPT SPTLPT 1 MSC KNG TRTTOM PER VRN OMS ULY 1 YRS TRT MSC MOS TVR PER VRN KNG ULY TOM OMS KLG YAK YAK LENNOV KRA BSK MRDNZN KHA KRA MRD KHA KLG BSK LEN NOV NZN IRK IRK PRM STVBLG PRM STV BLG SML SML 0 0 1 2 3 4 5 6 1.0 1.5 2.0 2.5 3.0 Averate number of tax inspections Average tax-related bribe frequency 33 Firms that report interacting with officials in more of the six “sub -sectors� measured in the Graft Index (tax, utility applications, operating licensing, etc.) tend to report a higher “time tax,� greater perceptions of bribe frequency, a higher “bribe tax,� and more frequently cite licensing and permits as an obstacle to their operations. They also report paying bribes in a greater proportion of these interactions – as measured by the Graft Index – not merely in a larger absolute number of them. These results are consistent with the common anti-corruption policy prescription of instituting reforms that limit the number of opportunities for officials to solicit bribes. The World Bank’s first Anticorruption in Transition report, based on BEEPS data, introduced a corruption Figure 10 typology that distinguished between “administrative PRM corruption� and “state capture.� In general, the two Average "state capture" types were empirically correlated among countries in the IRK ECA region; however, the positive relationship was RSV TVR VGG KSN sufficiently modest in strength that several countries KLG BLG ranked highly on one concept but were ranked low on the BSK KRV LEN CHL MRM SPT SVDMSCNZN other. In the Russia regional BEEPS, the relationship NOV SML YRS TRT KNG STV LPT YAK PER OMS VRN MOS between state capture and administrative corruption KEM TOM ULY MRD KRS KHA SAM KRA appears to be stronger (Figure 10). 1.0 1.5 2.0 2.5 3.0 While regional patterns of firm behavior show highly Average of firms' assessment of bribe significant variation, results of the regional BEEPS frequency confirmed several important propositions:  Excessive red tape can provide public officials with more opportunities to deliberately slow down processing to increase the incentives for firms to pay bribes. The BEEPS data are consistent with this idea: regions with more burdensome regulation exhibit a higher incidence of corruption.  The need to pay bribes and the administrative procedures they are intended to circumvent both constitute significant obstacles from the standpoint of firms. Regions where firms report tax administration as a more serious obstacle also tend to be regions where firms report a higher number of meetings with tax officials, and a greater need to pay bribes in connection with paying taxes. Moreover, firms reporting a higher “bribe tax� also tend to report a higher “time tax�.  Firms that report interacting with officials in more “sub -sectors� – tax, utility connections, operating licensing, etc. – tend to report a higher “time tax,� higher perceptions of bribe frequency, a higher “bribe tax,� and more frequently cite licensing and permits as an obstacle. Moreover, they also report paying bribes in a greater proportion of these interactions (as measured by the Graft Index), not merely in a larger absolute number of them.  The earlier BEEPS showed that two types of corruption – administrative and state capture - were positively correlated among countries in the ECA region, although the relationship was only modest in strength. In Russia, the relationship between state capture and administrative corruption appears to be strong - bribe frequency is strongly correlated with the state capture at the local level, i.e. by regional and local officials. C. Conclusions There are several implications for regulatory and anti-corruption policies that emerge from the analyses:  Greater transparency and government dissemination of information can strengthen accountability and improve the business climate. More transparent regional government procurement system are associated with a lower average “kickback tax� firms report paying to officials. Perceptions of state capture and frequency of administrative bribery are lower in regions with higher newspaper circulation.  Streamlining regulation can reduce some aspects of regulatory burden experienced by firms. Interacting with officials in more regulatory areas, and being subject to more tax inspections and meetings, is associated with more frequent complaints about tax administration, licensing and permits, and a higher incidence of bribe paying. Further research can investigate the extent to which distortions in various regulatory and administrative areas and transactions may be redundant, in their effects on firm entry and growth. Reforms in a limited number of areas may show disappointing results, if there are remaining distortions sufficient to deter entry or expansion. Rent- seekers may be able to substitute one regulatory barrier for another in blocking competitors. 34 Annex. Russian Federation: Main Economic Indicators, 2007-2013 2007 2008 2009 2010 2011 2012 2013 Output Indicators Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2012 Jan GDP, % change, y-o-y 1/ 8.5 5.2 -7.8 4.5 4.3 - - 4.9 - - 4.5 - - 3.9 - - 3.4 3.4 - Industrial production, % change, y-o-y 6.8 0.6 -9.3 8.2 4.7 3.8 6.5 2.0 1.3 3.7 1.9 3.4 2.1 2.0 1.8 1.9 1.4 2.6 -0.8 Manufacturing, % change, y-o-y 10.5 0.5 -15.2 11.8 6.5 4.8 6.3 2.4 3.6 7.0 3.4 5.7 4.1 3.3 3.0 4.0 1.5 4.1 -0.3 Extraction of mineral resources, % change, y-o-y 3.3 0.4 -0.6 3.6 1.9 1.4 3.7 0.8 1.2 -0.3 0.2 0.9 0.8 1.8 2.1 0.3 0.2 1.1 -1.2 Fixed capital investment, % change, y-o-y 21.1 9.8 -16.2 6.0 8.3 16.4 16.2 17.0 8.6 11.1 6.3 12.1 11.4 -0.2 4.9 1.2 -0.7 6.7 1.1 Fiscal and Monetary Indicators Federal government balance, % GDP 1/ 5.4 4.1 -5.9 -4.1 0.8 -0.5 -3.0 -0.9 -0.3 0.5 0.9 0.9 1.4 1.4 1.4 1.4 -0.1 -0.1 Consolidated budget balance, % GDP 1/ 2/ 6.1 4.8 -6.2 -3.6 1.6 10.8 2.8 4.1 3.6 4.7 4.2 4.4 4.3 3.7 3.6 3.2 0.4 0.4 M2, % change, p-o-p 3/ 51.3 27.2 -3.5 30.6 21.2 -3.5 0.7 0.8 0.8 0.8 1.3 -0.5 0.0 0.3 0.3 1.4 9.3 17.9 Inflation (CPI), % change, p-o-p 11.9 13.3 8.8 8.8 6.1 0.5 0.4 0.6 0.3 0.5 0.9 1.2 0.1 0.6 0.5 0.3 0.5 5.1 1.0 GDP deflator 1/ 13.8 18.0 2.0 14.2 15.5 - - 10.4 - - 8.6 - - 8.3 - - 8.1 8.1 - Producer price index (PPI), % change, p-o-p 25.1 -7.0 13.9 16.7 13.0 -0.3 1.1 2.1 0.6 -2.4 -0.8 -1.1 5.1 4.8 -1.6 -1.2 -1.1 7.2 -0.4 Nominal exchange rate, average, Rb/USD 25.6 24.8 31.7 30.4 29.4 31.5 29.9 29.4 29.5 30.7 32.9 32.5 32.0 31.5 31.1 31.4 30.7 31.1 30.3 Reserve Fund, bln USD e-o-p 137.1 60.5 25.4 25.2 61.4 62.4 62.3 62.2 60.2 60.5 59.9 60.5 61.5 61.4 61.4 62.1 62.1 86.2 National Wealth Fund, bln USD, e-o-p 88.0 91.6 88.4 86.8 88.3 89.8 89.5 89.2 85.5 85.6 85.2 85.9 87.6 87.2 87.5 88.6 88.6 89.2 Reserves (including gold) billion $, end-o-p 478 427 439 479 499 505 514 513 524 510 514 511 515 530 527 528 538 538 532 Balance of Payment Indicators Trade Balance, billion $ (monthly) 130.9 179.7 112.1 151.4 198.2 20.4 20.2 18.1 18.2 17.5 13.9 11.5 11.3 15.6 14.5 15.4 17.1 193.8 Share of energy resources in export of goods, % 61.5 65.9 62.8 63.5 65.5 - - 68.8 - - 66.9 - - 66.1 - - 65.4 65.4 Current Account, billion $ 76.6 102.4 48.9 70.3 98.8 - - 39.0 - - 18.2 - - 6.7 - - 17.3 81.3 Export of goods, billion $ 354.4 471.6 304.0 400.1 522.0 39.7 45.2 46.8 45.1 45.7 40.9 41.3 41.3 43.2 46.1 45.4 48.6 530.7 Import of goods, billion $ 223.5 291.9 191.9 248.7 323.8 19.3 24.9 28.7 26.9 28.2 27.0 29.7 30.0 27.6 31.6 30.1 31.4 335.4 Gross FDI, mln USD 1/ 27 797 27 027 15 906 13 810 18 415 - - 3 863 - - 7 598 - - 12 277 - - Average export price of Russia's oil, $/bbl 64.4 91.2 56.2 74.6 103.9 102.5 108.1 112.7 111.7 106.6 94.5 93.6 100.4 104.3 104.6 103.2 Financial Market Indicators Average weighted lending rate for enterprises, % 4/ 10.8 15.5 13.7 9.1 9.3 8.8 8.9 9.2 9.0 8.9 9.3 9.5 9.1 8.9 9.1 9.1 9.4 9.4 CBR refinancing rate, %, end-o-p 10.0 13.0 8.8 7.8 8.3 8.0 8.0 8.0 8.0 8.0 8.0 8.0 8.0 8.25 8.25 8.25 8.25 8.3 8.25 Real average rate for Ruble loans, % (deflated by PPI) -3.4 -6.8 -0.1 -6.5 -3.2 -1.4 0.9 0.4 1.6 5.1 3.9 4.2 2.0 -2.3 0.3 2.6 4.2 4.2 Stock market index (RTS, ruble term, eop) 2 291 632 1 445 1 770 1 382 1 577 1 735 1 638 1 594 1 242 1 351 1 377 1 390 1 476 1 434 1 437 1 527 1 527 1 622 Enterprises Finances Share of loss-making companies 1/ 23.4 25.2 30.1 27.8 28.1 34.0 33.2 35.0 32.9 31.4 31.0 29.3 28.2 28.3 27.0 26.3 Share of credits in capital investment 1/ 15.5 17.6 20.1 14.3 12.8 - - 13.4 - - 13.7 - - 13.8 Income, Poverty and Labor Market Real disposable income, (1999 = 100%) 245.6 251.5 259.3 272.5 274.7 203.0 252.7 252.7 274.2 258.3 289.8 270.4 280.7 278.1 277.0 295.0 416.9 279.6 Average dollar wage, US $ 532 697 588 698 806 782 830 869 879 813 838 829 796 840.8 850.1 883.7 1147.8 859 Unemployment (%, ILO definition) 6.1 7.8 8.2 7.2 6.1 6.6 6.5 6.5 5.8 5.4 5.4 5.4 5.2 5.2 5.3 5.4 5.3 5.3 6.0 Source: Goskomstat, CBR, EEG, IMF, staff estimates. 1/ Cumulative from the year beginning. 2/ Starting 2006 incl. extrabudgetary funds. 3/ Annual change is calculated for average annual M2. 4/ All terms up to 1 year.