World Bank urges continued reform as it cuts Russian growth forecast

By bne IntelliNews February 27, 2013

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The World Bank has lowered its 2013 growth outlook for Russia, saying falling oil prices, sluggish investment and domestic demand, coupled with stubbornly high inflation will likely act as a drag on the economy.

Released on February 26, the World Bank dropped its forecast for Russian GDP growth this year from 3.6% to 3.3%. However, it retained its outlook for 2014 at 3.6%, which is well below the government's estimate of 4.3%, despite suggestions from analysts that the call is too high.

Such pessimism was reinforced on February 25 when Deputy Economy Minister Andrei Klepach said the economy contracted 0.3% month on month in January, the first time that has happened in ten months. Particularly worrying was the sharp contraction in retail sales (-1.5% on month), which has been one of the main growth drivers in the years since the 2008 global crisis.

"The poor January 2013 GDP growth of 1.6% [year on year] was probably one of the triggers for this downgrade," write analysts at Alfa Bank. "That said, while cutting its 2013 growth forecast, the World Bank kept unchanged its 3.6% forecast for 2014, which we see as overly optimistic."

The World Bank said its new outlook on the country stems from a recent cut to its forecast for oil prices. The international institution says it expects the average crude price to drop to $102 in 2013, from $105.8 seen last year. It also references a less favourable external economic background than previously expected.

The report also suggests factors closer to home influenced its move. The slowdown in Russian economic growth in late 2012, coupled with the persistently low level of investment through the year, sluggish domestic demand, and inflation that looks to be decreasing more slowly than expected, all fed into the reduced estimate, the bank said.

In terms of recommendations, the World Bank makes three main policy suggestions that will be familiar to many, particularly advocates of former finance minister Alexei Kudrin, who lost his job in 2011 after clashing with then-president Dmitry Medvedev (now prime minister) over a plan for massive defence spending. The report repeats calls for Russia to maintain prudent spending plans and save oil revenues; focus monetary policy on low inflation; and strengthen banking supervision to control consumer lending.

The insistence that inflation targeting should remain the focus of monetary policy is also a clear rallying call for supporters of the hawkish governor of the Central Bank of Russia, Sergei Ignatiev, who has been resisting demands from the government to cut rates in order to stimulate growth. With the governor set to step down in the summer, the market is concerned that President Vladimir Putin will appoint an inflation dove as the new chief.

The old chestnut of accelerating structural reform is also raised by the World Bank as key to improving growth potential. Reducing the state's footprint in the economy; 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, are all still desperately needed, World Bank Country Director Michal Rutkowski says.

Analysts at Alfa Bank are not holding their breath. "The structural inefficiency of the Russian economy, which the World Bank points to as a fundamental reason behind the downgrade, is unlikely to be resolved soon," they write. "Russia's Cabinet is still trying to identify instruments to boost demand, while the economy deeply needs adjustments on the supply side in order to become more competitive."

The continued delay in reforms, coupled with the search for shorter-term measures such as the pressure for monetary easing, is likely to provoke further reductions in forecasts, Alfa analysts suggest. "As we are seeing no progress in this area, we expect that the market will downgrade both the 2013 and 2014 growth estimates. We anticipate poor February growth of 1.3-1.4% y/y, and this level would likely trigger more 2013 growth rate cuts. Adjustments to 2014 growth forecasts are likely to come in [the second half of the year]."

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