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Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized The LongJourneytoRecovery The WorldBankintheRussianFederation 35 | April 2016 35 | Russia Economic Report The Long Journey to Recovery I. Recent Economic Developments II. Economic Outlook III. In Focus: Export Competitiveness and Foreign Direct Investment This report is produced twice a year by World Bank economists in the Macroeconomics and Fiscal Management Global Practice. The team that prepared this edition was led by Birgit Hansl (Lead Economist and Program Leader in Russia, bhansl@worldbank. org) and consisted of Sergei Ulatov (Senior Economist), Olga Emelyanova (Research Analyst), Mikhail Matytsin (Consultant), Michael Edwards (Lead Financial Sector Specialist), Katerina Levitanskaya (Operations Officer), Christian Eigen-Zucchi (Senior Economist), John Baffes (Senior Economist), and Irina Rostovtseva (Program Assistant). Birgit Hansl authored the focus note on export competitiveness and foreign direct investment together with Michael Ferrantino (Lead Economist) and Gabriela Schmidt (Consultant) based on a World Bank paper titled Export Performance and Foreign Direct Investment Performance across Russia’s Regions. Peer reviewers included Eric Le Borgne (Lead Economist), Christos Kostopoulos (Lead Economist), and Praveen Kumar (Lead Economist). The report was edited by Sean Lothrop (Сonsultant), and the graphic designer was Robert Waiharo (Сonsultant). The team would like to thank Cyril Muller (Vice President of the Europe and Central Asia Region), Hans Timmer (Chief Economist of the Europe and Central Asia Region), Andras Horvai (Country Director for Russia), Miria Pigato (Practice Manager, Macroeconomics and Fiscal Management Global Practice), and the Russia teams at the European Bank for Development and Reconstruction, and the IMF for their advice and support. This report went to press on April 4, 2016. TABLE OF CONTENT ABBREVIATIONS AND ACRONYMS ...................................................................................................................... i EXECUTIVE SUMMARY ........................................................................................................................................ ii I. RECENT ECONOMIC DEVELOPMENTS: ........................................................................................................... 1 1.1 Growth - Economic Recovery Delayed .............................................................................................................. 2 1.2 Balance of Payments – Swift Import Adjustment Supports the Current Account............................................. 8 1.3 Monetary Policy and the Financial Sector – Addressing Policy Tradeoffs ........................................................ 12 1.4 The Government Budget – Uncertainty in the Face of Unresolved Medium-Term Challenges ....................... 18 1.5 Income and Poverty Trends – The Labor Market Weakens .............................................................................. 22 II. OUTLOOK – AN UNCERTAIN PATH AHEAD ...................................................................................................... 25 2.1 Growth Outlook – A Shift in Adjustment Challenges ........................................................................................ 26 2.2 Poverty and Shared Prosperity Outlook – Fortunes Reverse ............................................................................ 35 2.3 Risks and Policy Challenges – Prevailing Headwinds ........................................................................................ 37 III. EXPORT COMPETITIVENESS AND FOREIGN DIRECT INVESTMENT – THE COMPLEX PUZZLE OF DIVERSIFICATION ........................................................................................................................................... 45 3.1 Introduction ...................................................................................................................................................... 46 3.2 Russia’s Export Profile and the Challenge of Diversification ............................................................................. 48 3.3 Attracting FDI in a Challenging External Environment ..................................................................................... 56 3.4 Foreign Investment, Export Performance and Regional Development ............................................................ 58 3.5 Conclusion ........................................................................................................................................................ 61 REFERENCES ......................................................................................................................................................... 63 Annex I: Main Macroeconomic Indicators ............................................................................................................. 64 LIST OF FIGURES Figure 1: GDP growth, year-on-year, percent ............................................................................................................... 2 Figure 2: Demand composition of GDP growth, year-on-year, percent ....................................................................... 3 Figure 3: GDP growth, year-on-year and quarter-on-quarter, seasonally adjusted, percent ....................................... 3 Figure 4: Global industrial production and trade growth, percent change .................................................................. 4 Figure 5: Gross capital flows to developing countries, US$ billions ............................................................................. 4 Figure 6: Global energy prices, US$/mmbtu ................................................................................................................ 5 Figure 7: Crude oil supply growth, mb/d ...................................................................................................................... 5 Figure 8: Contribution to GDP growth by sector, percent ............................................................................................ 7 Figure 9: Growth in tradables, value, added, year-on-year, percent ............................................................................ 7 Figure 10: Fixed investment growth by sector, 2015, year-on-year, percent ................................................................. 7 Figure 11: Employment growth by sector, 2015, year-on year*, percent ...................................................................... 7 Figure 12: Goods imports, the REER and oil prices ........................................................................................................ 8 Figure 13: The composition of the current-account balance, percent of GDP ............................................................... 8 Figure 14: Oil prices and the trade, services and investment-income balances ............................................................ 9 Figure 15: Russia’s 5-year CDS spreads .......................................................................................................................... 9 Figure 16: Debt to non-residents, US$ billion ................................................................................................................ 10 Figure 17: Remittance outflows, Q1-3 2015 .................................................................................................................. 11 Figure 18: Remittance inflows, Q1-3 2015 ..................................................................................................................... 11 Figure 19: Exchange-rate dynamics in Russia, Kazakhstan and Azerbaijan (2014 = 100) ............................................... 13 Figure 20: Changes in oil prices and the nominal exchange rate ................................................................................... 13 Figure 21: Key policy rates, percent ............................................................................................................................... 14 Figure 22: CPI inflation components, year-on-year, percent .......................................................................................... 14 Figure 23: Money-supply dynamics ............................................................................................................................... 15 Figure 24: Broad monetary base dynamics, 3-month moving average ......................................................................... 15 Figure 25: Credit growth, year-on-year, percent ........................................................................................................... 15 Figure 26: Profitability and credit risk, percent ............................................................................................................. 15 Figure 27: Capital adequacy ratio, end-of-period, percent ........................................................................................... 16 Figure 28: Distribution of banks by capital adequacy ratio, 2015 ................................................................................. 16 Figure 29: Federal revenue and budget balances, 2007-2015, percent of GDP ............................................................ 18 Figure 30: Federal primary expenditures, 2014, percent of GDP .................................................................................. 18 Figure 31: Unemployment rates in resource-rich countries, one-year