May 22, 2018, 12:27 am / Comments

Will we fulfill the May decree?

EBRD Chief Economist Sergei Guriev on the systemic problems of the slow growth of the Russian economy

Sergey Guriev , professor of economics at Sciences Po, Paris, president of the Society for Institutional and Organizational Economics (SIOE) in 2016-2017.

In May, the European Bank for Reconstruction and Development (EBRD) published its new macroeconomic forecast. For our region as a whole, we have raised our 2018 GDP growth forecast from 3.0% to 3.3%. In the case of Russia, we slightly reduced the projected growth rates: from 1.7 to 1.5%. Our forecast is in line with the consensus among international financial institutions – and the consensus of financial market participants. This consensus is based on the expectation that the economic policies of the previous six years will continue in the coming years; Therefore, we should not expect a significant acceleration in economic growth.

Officially, the EBRD assesses and forecasts economic development in only the 37 economies in which we operate, but our analysis naturally includes forecasts for both developed economies and developing economies outside our region. Overall, we share the IMF's view that the world economy is currently growing at its fastest pace in a decade, at almost 4% per year. This helps the EBRD's countries of operations also grow – they grew by 3.8% in 2017. This is also the fastest growth rate in the post-crisis years. This is not surprising - most of our countries cooperate closely with Western Europe, America, and Asia - both in terms of trade and investment.

However, in 2018 and 2019 we expect a slight slowdown in growth – to 3.3 and 3.2%, respectively. This is due to several factors. First, some countries (most notably Turkey) have overheated economies, so today's high growth rates are unsustainable. Secondly, many of our countries are oil exporters. Current oil prices – due to global economic growth, the OPEC+ deal and geopolitical risks – are at a very high level. Over the next couple of years, as US shale oil production expands, prices will likely fall to $50-60 per barrel, which will consequently lead to slower growth in oil exporting countries. Third, interest rates in the US are likely to rise in the coming years. This will lead to capital flight from emerging markets and a stronger dollar. A stronger dollar will, in turn, increase the debt burden in EBRD countries, where many corporations are forced to borrow in dollars rather than local currencies.

Executors of the fourth term

Opinions / Editorial

In 2018–2019 Russia will be the slowest growing country among the EBRD's countries of operations. We forecast that Russia's GDP will grow at a rate of 1.5% per year - and therefore will lag behind the global economy (which will grow at a rate of almost 4% per year). This forecast is in line with those of other international financial institutions (IFIs) and most investment banks. We regularly review our previous forecasts. It turns out that the accuracy of the EBRD's forecasts (as well as other IFIs) is quite high, while errors occur in both directions (both up and down). This was also the case in 2017, when all MFIs predicted growth rates of 1 to 2%, while some government analysts and some investment banks believed that growth would be more than 2% (or even more than 3%). Despite the significant increase in oil prices in 2017, IFI forecasts turned out to be more accurate.

What is the consensus forecast of 1.5% Russian growth based on? The consensus includes two elements: firstly, it is a factual statement that without reforms, today's growth rates reflect the growth potential of the Russian economy, and secondly, it is the expectation that there will be no reforms in the near future.

Why is the current 1.5% the growth potential (i.e., the growth rate that can be sustained in the long term without overheating or high unemployment)? There are no signs of overheating or recession in today's Russian economy. Inflation is within the target range. Unemployment is low – it was at 5% all last year. The level of economic activity of the population is very high (the share of the active population in the total population of working age is 64% - slightly higher than in developed countries). Of course, both the level and rate of growth in labor productivity and the level of investment are low, but this is a sign of economic inefficiency and proof of the need for reforms, and not evidence that growth can be quickly accelerated through monetary or fiscal policy.

Economics of revolution

Opinions / Analytics

Is it possible to stimulate rapid growth without reforms? As the example of the Turkish economy in 2017 shows, over a one-year horizon, short-term growth rates can indeed significantly exceed potential growth rates, but this leads to overheating of the economy and the rapid accumulation of financial imbalances. Last year, Turkey launched an extensive credit stimulus program (Loan Guarantee Fund totaling almost 10% of GDP). The GDP growth rate in 2017 was 7.4%. But this growth rate is unsustainable - it is expected to decline to 4.5% already this year (which is the normal growth rate for the competitive and dynamic Turkish economy). Overheating led to inflation rising to double-digit levels and a sharp devaluation of the lira (by 20% over the past 12 months). Rising inflation, in turn, has made it impossible to develop long-term financing instruments denominated in lira - thus forcing Turkish companies to borrow in dollars and become even more vulnerable to devaluation. The uncertainty of foreign investors in the predictability of economic policy led to a significant increase in the current account deficit of the balance of payments. Getting out of this vicious circle is not easy - at best, inflation will drop to 7% per year within two years, which will still not allow the creation of a developed domestic financial market.

Therefore, the main task of economic policy in any country is not to exceed, but to increase the rate of potential growth. This requires increased productivity and investment. In May 2012 decrees, then-President Vladimir Putin promised a 50% increase in labor productivity in 2011–2018. and investment growth to 25% in 2015 and to 27% in 2018 (from 21% at the 2012 level). Taking into account the fact that the employed population in Russia has not grown in recent years, productivity growth of 1.5 times over seven years implied a GDP growth rate of an average of 6% per year. In reality, the rate of productivity (and GDP) growth was less than 1% per year. Over the past six years, investment has remained at 21% of GDP.

In his May 2018 decree, Putin set more modest goals - GDP growth faster than the world average, i.e. 4% or higher. So far, the consensus among macroeconomists and market participants is that these promises will not be fulfilled, just as the promises of 2012 were not fulfilled; The Russian economy will not move from growth rates of less than 2% to growth rates of more than 4%.

The author is Chief Economist of the European Bank for Reconstruction and Development