Smart Macroeconomic Policies Essential but Not Sufficient for Economic Growth

A plenary on macroeconomics was held at the HSE's XVII April International Academic Conference on April 19, 2016.

Economy Has Struck a New Balance

According to First Deputy Chair of the Russian Central Bank Ksenia Yudaeva, the early stages of Russia’s adaptation to a new situation will be over in the coming quarter or so, thus the country's economic policies need to shift towards medium and long-term measures to encourage economic growth. Domestic economy requires pricing and financial stability to free up more resources for production and sustainable economic progress.

During the recent crisis, the country's monetary policies sought to reach a new equilibrium through a floating exchange rate. Following a peak in the first months of 2015, inflation then stabilised and started to decline, and by the end of this year, price increases are expected to go down to 2013 levels; however, this is not suficient to generate 'long money' for Russia's economy. According to Ksenia Yudaeva, the Central Bank will work to bring inflation down to 4% by 2017, which will require a cautious budgetary policy aimed at balancing revenues and expenditures to avoid exchange rate fluctuations and other types of volatility.

In addition to this, macro-prudential measures are necessary to discourage new 'bubbles' in the market. In recent years, extensive lending in foreign currencies has been a major risk underestimated by banks and borrowers alike. Starting in May 2016, the Central Bank intends to tighten up the rules for such lending.

Yet it would be wrong to expect the government and Central Bank to boost economic growth when its slowdown is due to structural rather than cyclical factors. According to Ksenia Yudaeva, a number of persistent structural imbalances had affected Russia's economy even before the fall in oil prices, and sustainable growth cannot be achieved without first addressing such imbalances.

A floating rate is like democracy: while not perfect, no better solution is available

Demographics is a major challenge: each year, the country's working population drops by 900,000; to make things worse, the domestic labour market is not ready to accommodate the aging workforce – no retraining programs are available for people over 40, and more broadly, Russian society lacks a culture of lifelong learning. Creating high-performance workplaces requires a competitive business environment where new companies replace obsolete and inefficient ones; however, this process of renewal is hampered in Russia.

Yet another challenge is poor export diversification; Russia continues to export commodities already in abundant supply in the global market, such as oil, coal, and metals. Integration into global production chains could facilitate an economic breakthrough similar to that already made by Asian countries, yet Russia ranks third from bottom among OECD countries in terms of foreign added value in its exports.

Better corporate governance in both private and in public companies is also essential. "Debt financing is prevalent here at a higher level than that considered safe," according to Yudaeva. It would be much safer to finance new investments mainly from profits and equity. Compared to debt, equity financing carries fewer risks for long-term growth, as can be seen from China's experience, among others.

Macroeconomics or Structural Reforms?

Evsei Gurvich, Head of the Economic Expert Group, discussed the evolution of Russia's monetary poicies over the past twenty years.

He compared the three major economic crises that hit Russia in 1998, 2008 and 2014 in terms of the government and Central Bank's responses. While the three recent crises shared one major cause – oil prices dropping by 35% year on year between 1998 and 1999 and by 47% between 2014 and 2015 – there were significant variations due to the fundamentally different states of public finance in the late nineties vs. recently.

Back in 1998, the government struggled to maintain the key macroeconomic indicators while lacking domestic reserves and investor trust, whereas in 2008 and 2009, they had at their disposal adequate gold and foreign currency reserves, as well as the Reserve Fund, and thus were able to increase rather than decrease their spending during that crisis.

This time, we are facing a different situation; since the 'oil bubble' has burst and is unlikely to recover soon, the government decided not to waste reserves but seek a new equilibrium instead. A floating ruble rate is a manifestation of this trend. According to Gurvich, a floating rate is like democracy: while not perfect, no better solution is available; this solution has enabled Russia's economy to begin to adapt to new circumstances.

But the process is far from over. In particular, wage increases and especially budget expenditures have significantly exceeded GDP growth over the recent decade. This means that challenging work still lies ahead to restore a macroeconomic balance.

Russia needs to become a 'boring' economy

Gurvich identified six key issues for the Russian government and Central Bank to address in the coming years. First, matching budget revenues and expenditures based on projected oil prices and economic growth rates is a must. This will require budget consolidation by 4 to 4.5 p.p. of the GDP before 2020. Second, replenishing the Reserve Fund by adding high-liquidity assets from the National Wealth Fund can protect the budget from new shocks. Third, fiscal rules need to be modified based on lessons learned from their application and should form the basis of fiscal policy. Fourth, long-term imbalances associated mainly with the pension system deficit need to be addressed. Fifth, steps need to be taken to build trust among all players concerning the Central Bank's inflation targets. And finally, the Central Bank's actions in the foreign currency markets need to be coordinated with the government's fiscal policy – specifically, the CBR's foreign currency trading should be synchronised with the government's steps to replenish or spend the reserve funds.

However, the Economic Expert Group did not support the popular idea of ​​using monetary emission as a source of investment and cheap credit. In such case, they explain, the CBR would assume the role of a development institution, which is "incompatible with a market economy" and characteristic of the former USSR, where a centralised distribution of loans did not help the economy. Brazil’s current situation t offers a similar lesson.

Stability is the main objective of macroeconomic policy and a necessary – but not sufficient – condition for economic development. Sustainable economic growth is not achieved by 'exotic' macropolicies, but requires good public institutions, such as the rule of law, protection of property and equal access to markets, asserts Gurvich.

What We Can Learn from Brazil

In dealing with this crisis, Russia has the privilege of being able to learn from the mistakes of other countries, according to Deputy Finance Minister Maxim Oreshkin, who followed Gurvich in citing the example of Brazil.

After 2010, Brazil’s national government made an attempt to stimulate the economy through budget spending, low interest rates and wage indexation. Yet such measures failed to produce good results; Brazil's GDP declined at a greater pace than Russia's, inflation continued to grow and investment activity came to a halt; in fact, the only thing the government achieved was capital reallocation to less efficient sectors. In Russia, a reduction in real wages and virtually unchanged unemployment rates have helped strike a new balance, while in Brazil, unemployment is on the rise and the budget deficit has increased from 2%-3% to 10%.

According to Deputy Finance Minister Oreshkin, Russia has achieved short-term stability, but the question remains: how sustainable is this new equilibrium? So far, no one can be certain, given Russia's continued dependence on oil prices and resulting vulnerability to external shocks. In addition to that, disparities persist in the labour market, such as excessive employment in the public sector and security companies.

It is time to stop writing reforms and start implementing at least one of them

The Russian government needs to act promptly to reduce the budget deficit. The Ministry of Finance is now preparing a new fiscal rule aimed at improving long-term macroeconomic stability. According to Deputy Minister Oreshkin, Russia needs to become a 'boring' economy.

Konstantin Noskov, Head of the Analytical Center for the Russian Government, commented on budgetary and labour market-related risks. According to Noskov, budgetary risk is underestimated, as  "we have been financing the budget from our Reserve Fund, and if we continue at this rate, the Reserve Fund may be depleted before the end of the year."

Low unemployment per se is not a positive indicator in what Noskov describes as a "distorted labour market" with millions employed as bureaucrats or security guards and entitled to early retirement.

He described the situation with foreign direct investment as 'catastrophic' and reminded the audience that in 2015, FDI decreased by 90% in Russia and increased by a third in the rest of the world.

Expensive Money Bad for Economy

Andrei Klepach, Deputy Chairman of VEB, and Evgeny Gavrilenkov, Chief Economist at Sberbank CIB, are not entirely in agreement with the current macroeconomic policy.

"For the country to develop and enjoy at least partial economic sovereignty, Russia’s macroeconomic policy needs to change," said Andrei Klepach. "We keep repeating the structural reform mantra, but who needs to be convinced anyway? We discussed structural reforms back in 2009, while pursuing a procyclical policy – both budgetary and monetary – at the same time."

According to Klepach, the current economic stagnation had started before the oil crisis. Recently, the government has been cutting budget spending and intends to cut it even further. “At the expense of what?” asks Klepach, “Education and healthcare? But what will they have left?” He believes that although public spending needs to be adjusted, it would be wiser to avoid shocks to the already declining economy; according to Klepach, there is an impression that “no one is thinking of growth and reforms as priorities” at the moment. 

Despite all the talk about supporting small enterprise and export diversification, the current loan interest rates make it impossible. Development institutions should provide refinancing, but they need the resources. According to the VEB Deputy Chairman, even minimal contributions from the Central Bank and public budget could "seriously accelerate investment in the short term."

Sberbank CIP Chief Economist Gavrilenkov agrees that high interest rates hinder economic growth in Russia. According to Gavrilenkov, "It is time to stop writing reforms and start implementing at least one of them. There is a potential for improving macroeconomic policies, and then perhaps structural reforms will work out as well."

As an example, he described "a purely macroeconomic story" of consumer lending, specifically that the rapid increase in consumer lending was a major factor behind the 'artificial' acceleration of economic growth in 2010 and 2011. At the same time, banks were lending at "indecently high interest rates," and by mid-2012, the amount of new loans issued each month was equal to interest payments on outstanding loans, and the average monthly increase in consumer loans was equal to interest payments on them. There is still a "great potential" for lending to become a driver of economic growth, but not at today's excessively high interest rates.

Like other speakers, Gavrilenkov expressed concern that the reserve fund as a source of liquidity could be depleted next year, and then "a return to the situation of mid-2013 may be possible," when the Central Bank "was pumping the system with long-term loans secured by non-marketable assets," leading eventually to "destabilisation of the foreign currency market."

Russia Compared to Other Countries

According to Marek Dabrowski, Chief Research Fellow at the Centre for Social and Economic Research in Warsaw, Russia is an economy which is not the most dependent on hydrocarbon exports, yet is one of the few oil exporters to have experienced a drop in GDP. Some other oil-producing countries have allowed a budget deficit, but such a solution "would not be so reasonable" for Russia with its limited possibilities of stimulus spending, particularly over the long term.

During this crisis, the Russian ruble experienced a deeper decline than the currencies of other emerging and oil-dependent countries. This has been the sixth or seventh currency crisis in Russia since the late 1980s, indicating their repetitive nature. What is causing them? Low trust in the domestic currency and the outflow of capital may be the key reasons. Russia has consistently been an exporter of capital, due to institutional rather than macroeconomic circumstances, such as the lack of protection of business and property rights, and low investor trust.