110765-RU DOCUMENT OF THE WORLD BANK GROUP Public Disclosure Authorized FOR OFFICIAL USE ONLY Public Disclosure Authorized RUSSIAN FEDERATION SYSTEMATIC COUNTRY DIAGNOSTIC: PATHWAYS TO INCLUSIVE GROWTH DECEMBER 16, 2016 EUROPE AND CENTRAL ASIA REGION Public Disclosure Authorized Public Disclosure Authorized This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. i CURRENCY EQUIVALENTS Exchange Rate Effective December 6, 2016 Currency Unit – Ruble US$ 1 = Ruble 63.9242 FISCAL YEAR [January 1 – December 31] ABBREVIATIONS AND ACRONYMS ALMP Active labor market programs GCI Global Competitiveness Index ANS Adjusted net savings GDP Gross domestic product ASI Agency for Strategic Initiatives GOST State standard (gosudarstvennyy standart in Russian) AVTODOR Russian Highways State Company GNRI Global Networked Readiness Index B40 Bottom 40 percent of the income GMM Generalized Method of Moments distribution statistical methodology BEEPS Business Environment and GRECO Group of States against Corruption Enterprise Performance Survey BRICS Brazil, Russia, India, China, and GVC Global value chains South Africa (emerging economies) CBR Central Bank of Russia HBS Household Budget Survey CIT Corporate income tax ICT Information and communications technology ECD Early childhood development IEA International Education Association DAI Digital Adoption Index IFC International Finance Corporation DIA Deposit Insurance Authority IFFs Illicit financial flows EACU Eurasian Customs Union IFRS International Financial Reporting Standards EBRD European Bank for INDC Intended Nationally Determined Reconstruction and Development Contributions ECA Eastern and Central Europe IT Information technology EEU Eurasian Economic Union LCA Latent class analysis FAS Federal Antimonopoly Service LFS Labor Force Survey FBS Federal Bailiff Service LITS Life in Transition Survey FDI Foreign direct investment LNG Liquefied natural gas FTS Federal Tax Service LPI Logistics Performance Index MFN Most favored nation RVC Russia Venture Corporation MIGA Multilateral Investment RZD National railway company Guarantee Agency NCD Noncommunicable disease SCD Systematic Country Diagnostic NDC National Defined Contribution SEZ Special economic zone ii NPLs Nonperforming loans SMEs Small-and medium-sized enterprises NTB Nontariff barriers SOE State-owned enterprise NTM Nontariff measure SPS Sanitary and phytosanitary OECD Organization for Economic Co- STI Science, Technology, and Innovation operation and Development OOP Out-of-pocket T60 Top 60 percent of the income distribution PAYG Pay as you go TBT Technical Barriers to Trade PCM Price-cost margin TFP Total factor productivity PIACC Program for the International TFPQ Physical TFP Assessment of Adult Competencies PIRLS Progress in International Reading TFPR Revenue TFP Literacy PISA Program of International Student TVET Technical and vocational education and Assessment training PIT Personal income tax VAT Value-added tax PPP Purchasing power parity VEB Vnesheconombank PPPs Public-private partnerships WDI World Development Indicators R&D Research and development WTO World Trade Organization RLMS Russia Longitudinal Monitoring Survey IBRD IFC Regional Vice President: Cyril Muller Global Client Services Vice President: Dimitris Tsitsiragos Country Director: Andras Horvai Regional Director: Tomasz Telma Senior Director: Carlos Felipe Jaramillo/Ana Revenga Regional Strategy Head: George Konda Practice Manager: Miria Pigato/Carolina Sanchez Task Team Leader: Iuliia Mironova Task Team Leader: Birgit Hansl/ Emily Sinnott iii Acknowledgments The Russian Federation Systematic Diagnostic: Pathways to Inclusive Growth was written by a team co-led by Birgit Hansl (Lead Economist) and Emily Sinnott (Senior Economist). It was prepared by a team from across the International Bank for Reconstruction and Development (IBRD) and the International Finance Corporation (IFC), under the guidance of Cyril Muller (Vice President, Europe and Central Asia), Dimitris Tsitsiragos (Vice President, Global Client Services, IFC), Andras Horvai (Country Director) and Tomasz Telma (Regional Director, IFC). The IFC contributions to the report were provided by a team from industry and advisory services departments led by Iuliia Mironova (Strategy Officer, IFC). Dorota Nowak (Country Program Coordinator) and George Konda (Regional Strategy Head, Principal Economist, IFC) provided guidance and support throughout the process. The team appreciates the advice received throughout the preparation process from Ana Revenga (Deputy Chief Economist), Satu Kahkonen (Director), Miria Pigato (Practice Manager) and Carolina Sanchez Paramo (Practice Manager). Ambar Narayan (Lead Economist) from the SCD Advisory Group provided valuable insights on the report. We also thank the peer reviewers: Deborah Wetzel (Senior Director); Sergei Shatalov (Lead Strategy Officer); Luis-Felipe Lopez-Calva (Lead Economist); and Nancy Benjamin (Senior Country Economist) for their excellent comments and inputs. Many staff contributed to this report, with inputs to specific chapters as well as the preparation of a series of background papers that helped inform this comprehensive diagnostic. Chapter 1: Macroeconomic and Shared Prosperity Trends was led by Birgit Hansl and Emily Sinnott, with contributions from Aurelien Kruse (GMF09); Giorgia Demarchi (GPVGE); Mikhail Matytsin (GPV03); Markus Brueckner (GMF04); Olga Emelyanova (GMF09); and Irina Rostovtseva (ECCU1). Chapter 2: Pathway One: Increasing Productivity for Diversified Growth was led by Birgit Hansl, with inputs from Sylvie Bossoutrot, (ECCU1); Rolf Behrndt (GMF09); Iuliia Mironova (CBCCE); Sergei Mytarev (CNGF8); Michael Edwards (GFM09); Juan Navas-Sabater (GTI09); Carlo Maria Rossotto (GTI11), Ana Paula Cusolito (GTCIE); Aurelien Kruse (GMF09); Mustapha Benmaamar (GTI03); Jung Eun Oh (GTI02); Daniel Alberto Benitez (GTI04); Natalija Gelvanovska (GTI09); Sanju Vaswani (CTTTT); Oleg Petrov (GTI09); Alexey Zhikharev (CA SEE); Justin Piers William Hill (GTCIE); Ljudmilla Poznanskaya (GTC10); Georgiana Pop (GTCTC); Gregory Kisunko (GGO15); Katerina Levitanskaya (GFM09); Kirill Vasiliev (GED03); Hernan Winkler (ECACE); Evgenia Epaneshnikova (GTI03); Tatyana Ponomareva (GTC10); Yanina Ermakova (ECCU1); Aleksandra Durova (GTI03); Mikhail Bunchuk (ECCU1); Olga Emelyanova (GMF09); Irina Rostovtseva (ECCU1); Greg Alton (CFGS8); Kristina Turilova (CASSC) and Antonio Skarica (CBCCE). Chapter 3: Pathway Two: Reducing Vulnerability by Deepening Human Capital Gains and Improving Access to Services was led by Emily Sinnott, with inputs from Aleksandra Posarac (GSP03); Ruslan Yemtsov (GSPDR); Zoran Anusic (GSP03); Aparnaa Somanathan (GHN03); Giorgia Demarchi (GPVGE); Sevil Salakhutdinova (GHN03); Mikhail Matytsin (GPV03), Dmitry Chugunov (GED03) Tigran Shmis (GED03) and Sergey Kozhukhov (CMGCS). Chapter 4: Requisites: Fiscal Sustainability, Good Governance and Better Natural Resource Management was led by Birgit Hansl, with inputs from Amitabha Mukherjee (GGO15); Iuliia Mironova (CBCCE); Emilia Battaglini (GEN03); Marianne Grosclaude (GFA03); Aurelien Kruse (GMF09); Artavazd Hakobyan (GFA03); Rajul Awashti (GGO28); Vladislava Nemova (GEN03); Eva Maria Melis (GGO15), Olga Emelyanova (GMF09), Simon Commander (ECACE); Izzah Akram Malik (GGO18), Natalia Kosheleva (CRKEU); Marina Frolova (CEUSB); Olga Schwartz (GGO15) and Irina Rostovtseva (ECCU1). Chapter 5: Policy Priorities and Actions was prepared by Giorgia Demarchi (GPVGE); Emily Sinnott; Birgit Hansl, with support from Irina Rostovtseva (ECCU1). iv The team would like to thank our counterparts in the Government of the Russian Federation, the private sector, academia and civil society, members of the World Bank Russia Country Team from all the World Bank Group Global Practices, and the IFC, who have participated in two substantive consultation events, and several follow-up meetings. We benefited greatly from their expertise and inputs in various forms. v TABLE OF CONTENTS Overview ....................................................................................................................................................... 9 Setting the Stage ....................................................................................................................................... 9 Pathway One: Increasing Productivity to Diversify Growth .................................................................... 13 Pathway Two: Deepening Human Capital Gains and Improving Access to Services ............................... 17 Requisites for Sustained, Inclusive Growth: Fiscal Sustainability, Good Governance, and Improved Management of Natural Resources ........................................................................................................ 22 Policy Priorities Emerging from the Diagnostic ....................................................................................... 27 Chapter 1. Macroeconomic and Shared Prosperity Trends ........................................................................ 31 Introduction ............................................................................................................................................. 31 Macroeconomic Stability during the Commodity Boom ......................................................................... 33 The Foundations of Stability and Growth ...........................................................................................