Growth with moderation and

uncertainty
Russian Economic Report 23
November, 2010

THE WORLD BANK GROUP

 The World Bank in Russia

Russian Economic
Report 1
№ 23
November, 2010

With heightened uncertainties and moderating global and Western European growth and oil
prices, and volatile capital flows, Russia is likely to grow by 4.2 percent in 2010, followed by
4.5 percent in 2011 and 3.5 percent in 2012 as domestic demand expands in line with gradual
improvements in the labor and credit markets. Unemployment situation is likely to get worse
before it gets better later in 2011. Fiscal risks have risen with likely expenditure pressures and
downside risks to oil. While there is huge diversity across regions in the patterns of labor market
recovery, smaller regions with a larger share of SMEs, better investment climate, more FDI,
and stronger financial sector presence tend to show a more robust recovery.

Growth with moderation and uncertainty

WORLD BANK

http://www.worldbank.org.ru

1 The report was prepared by a World Bank team consisting of Sergei Ulatov (Economist), Karlis Smits (Economist), Olga
Emelyanova (Research Analyst), Victor Sulla (Economist), and Zeljko Bogetic (Lead Economist for Russia and the team
leader). Annette de Kleine, and Shane Streifler (Senior Economists) contributed on the international environment and the
global oil market. Victor Sulla (economist) and Ken Simler (Senior Economist) authored the note in focus on unemploy-
ment. The team expresses gratitude to the World Bank Global Economic Prospects team lead by Andrew Burns (Manager,
DECPG) for close collaboration and discussions on global economic environment and its linkages with Russia.
 C O N T E N T
__________________

I. Recent Economic Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

II. Economic and Social Outlook for Russia 2010–2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

III. In Focus: Unemployment and Recovery Across Regions . . . . . . . . . . . . . . . . . . . . . . . . . 21

 I
Recent Economic Developments
Summary. The global economy has returned to moderate growth amid uncertainty, but the feared
‘double dip’ recession remains unlikely. The Europe and Central Asia region—hardest hit by the
crisis—is growing slower than the rest of the world. In Russia, growth is being led more by domestic
demand–consumption and investment–and credit is beginning to flow. But the way Russian
policymakers manage the short-term macroeconomic risks of fiscal spending and inflation—and the
long-term challenge of competitiveness and diversification under tighter budget constraint—will
determine the medium-term prospects.

Global trends – moderate growth

Global industrial production and trade have recovered to pre-crisis levels in recent
months but growth has been moderate (figure 1.1). Industrial production has slowed world-
wide (from 11.7 percent, annualized, in the first quarter of 2010 to 8.7 percent in the second),
and the bounce-back in global trade has ended (figures 1.2–1.3). Growth in the value of mer-
chandise trade decelerated from 25 percent in the first quarter to just 2.5 percent in the second,
raising concerns about a double dip. While growth will be slower in the next few quarters, a
double dip is unlikely. This moderate growth will not make big inroads into high unemploy-
ment and spare capacity.
In developing countries, growth is also easing but remains robust in developing Asia.
China’s growth eased from 11.1 percent in the first half of 2010 to a still vibrant 9.6 percent
in the third quarter (on a seasonally adjusted annualized basis), with industrial production
slowing in tandem from 18 percent to 7.9 percent. In India growth slowed from 11.2 percent
in the first quarter to 10 percent in the second. Other large middle-income countries including
Brazil, South Africa, Malaysia, and Thailand show similar trends. Excluding China, industrial
production for developing countries has stalled, slipping from 10.2 percept growth in the first
quarter 2010 to minus 0.5 percent in the three-months ending in August.
Non-bank capital flows to developing countries (such as bond issuance) continue to
recover, but bank flows remain weak. CDS spreads for developing countries with good
credit histories and conditions (including Russia) have not risen, while those of more vul-
nerable developed countries have increased (figure 1.4). Since May 2010 bond spreads have
narrowed, and bond issuance by sovereigns and emerging market corporations has picked
up (figure 1.5). With large repayments and limited new flows, however, net bank flows to
developing countries are likely to be negative this year. Equity flows to developing coun-
tries reached USD 72 billion over the year to date, 50 percent above 2009 levels—mostly
to China. FDI flows to developing countries so far remain close to the second half of 2009.
They are expected, however, to reach USD 438 billion in 2010, up from USD 364 billion in
2009. But outward FDI from middle-income countries has remained more resilient that that
from high-income countries.

I. Recent Economic Developments | 3

 Figure 1.1. Domestic demand strength in U.S. and Europe… offset or amplified by external trade
Domestic demand growth Foreign trade
growth at seasonally-adjusted annualized rates contribution to growth a annualized rates

Source: World Bank, DEC Prospects Group.

Figure 1.2. Global Industrial production Figure 1.3. Global Trade

Output momentum fading across Global trade growth is slowing rapidly as
all developing regions industrial production, pre-crisis levels regained
% seasonally adjusted annualized rate

Source: World Bank, DEC Prospects Group.

Figure 1.4. Selected CDS spreads Figure 1.5. Capital flows to developing countries
5-year sovereign credit-default swaps,
basis points (bps), 2010

Source: Global prospects, World Bank.

Most countries in the Europe and Central Asia (ECA) region–which was hardest hit by
the crisis–returned to growth, albeit less robust than in other regions. Growth in the region is
driven by the bounceback of external trade but domestic demand is also growing, especially
4 | Russian Economic Report. № 23. November, 2010
in the largest regional economies, Russia, Poland, and Turkey. Metals prices, important for
exporters such as Russia, are back to pre-crisis levels, as are many food prices. Capital inflows
rose to about 10 percent of the region’s GDP (from just over 7 percent) on account of official
flows, FDIs, and other private flows. However, this moderate growth in most countries is
unlikely to make a big dent in the high unemployment, especially in the Central and Eastern
European countries, while in the CIS countries, unemployment is lower, but continues to rise
in several countries.

Figure 1.6. Most economies in the Europe and Central Asia contracted in 2009
(real GDP growth, %)

Source: WB staff estimates.

Figure 1.7. And most returned to growth in 2010

Source: WB staff projections.

I. Recent Economic Developments | 5

Russia’s output – manufacturing and domestic demand-led growth
With stronger domestic demand, the Russian economy regained momentum in the
second quarter 2010 with the real GDP expanding by 5.2 percent, compared to 3.1 percent
in the previous quarter (table 1.1). In the first half of 2010, the Russian economy expanded
by 4.2 percent, year-on-year, mostly due to the base effect, but seasonally adjusted quarter-
to-quarter growth suggests that the growth momentum was regained in the second quarter.
Tradable industries and manufacturing led this growth, supported by non-tradables, such
as transport and communication. Retail and wholesale trade, by contrast, was flat in the
first quarter and grew by 5.3 percent in the second, reflecting the recovery of domestic
demand. With limited access to long-term credit and bankruptcies of many construction
companies, construction sector continued to contract although at a slower pace than during
2009. The financial sector–another labor intensive industry–also failed to expand, beset by
the large share of bad loans. In contrast to Russia, robust growth in Turkey has reflected
rapid recovery of the construction and financial sectors, comparatively less vulnerable
before the crisis.
Investment demand, particularly inventory restocking, was the main factor contribu-
ting to output growth in second quarter 2010. According to Rosstat national account statis-
tics, gross capital formation contributed about 5.6 percent to the aggregate GDP growth in
Q2-2010 (figure 2.2), with as much as 3.8 percent accounted for by the inventory restocking.
Household consumption was the second most important factor of GDP expansion, con-
tributing 2.5 percentage points to aggregate growth. By contrast, net export’s contribution
became negative as import volumes (especially of services) surged with rising real wages
and incomes.

TABLE 1.1. GDP growth by main sectors (value added): 2006–2010

2006 2007 2008 2009 Q1-2010 Q2-2010
GDP growth ................................................................................... 8.2 8.5 5.2 -7.9 3.1 5.2
Tradable sector ............................................................................. 3.0 3.5 0.3 -10.1 11.9 10.3
Agriculture, forestry ...................................................................... 2.7 1.3 7.3 0.2 2.7 1.1
Extraction industries ..................................................................... -2.9 -2.2 1.7 -0.9 11.7 5.2
Manufacturing .............................................................................. 6.6 7.5 -2.2 -15.8 13.4 15.3
Non-tradable sector ....................................................................... 12.5 12.8 9.1 -7.2 -0.3 3.5
Electricity, gas, water production and distribution ........................ 4.5 -3.4 -0.3 -4.3 9.0 3.7
Construction ................................................................................. 12.8 13.0 11.2 -17.2 -8.9 -0.3
Whole sale and retail trade ........................................................... 14.1 11.7 9.4 -10.3 -0.1 3.7
Transport and communication ...................................................... 9.7 4.8 5.1 -3.0 9.5 9.6
Financial services ......................................................................... 25.4 29.1 13.5 2.4 -7.3 -1.2
Source: Rosstat; World Bank staff estimates.

Most recent output data for the third quarter suggest that domestic demand is
beginning to replace external demand as the main growth engine. The industrial sector,
supported by a gradual pickup in investment, and inventory restocking in particular,
has continued healthy growth in the third quarter (6.4 percent) led by manufacturing
(9.5 percent). Gradually recovering domestic demand has finally provided a welcome
boost to non-tradable sectors, with retail trade growing in the third quarter by 5.9 percent
and construction by 2.2 percent in Q3-2010. This is good news for the small and new
businesses that often populate these sectors, but it is clear that they suffered considerably
during the crisis (Box 1).

6 | Russian Economic Report. № 23. November, 2010

Labor market — a temporary decline in unemployment
With the ongoing output recovery and a seasonal increase in employment, unemploy-
ment fell from January to June 2010 and has since remained broadly stable, if elevated.
Unemployment in Russia fell from 9.2 percent in January 2010 to 6.6 percent (5.0 million
people) in September, based on the ILO definition (table 1.3 and figure 1.8)), but it is likely
to increase with the onset of the winter and remain high in 2011. Moreover, many long-term
unemployed dropped out of the labor force. So, Russia’s labor market conditions remain dif-
ficult, mimicked in the sharp drop in net migration to Russia from Central Asia.

Box 1. The Impact of the Crisis on New Firm Entry

Like many upper-middle and high income countries, Russia experienced a sharp drop in new
firm registrations during the financial crisis. Between 2008 and 2009, new firm registrations dropped
37 percent. Even with this precipitous drop, new firm entry density – calculated as newly registered firms
as a percentage of the working age population, normalized by 1,000 – in Russia remained higher than
most upper-middle income countries.
According to an index of crisis turbulence calculated by Calderon and Didier (2009), the impact of the
crisis on the Russian economy was nontrivial – a value of –0.31 on a scale of –2(worst) to 2(best) – and
the drop in new firm registrations was broadly in line with the severity of the crisis (Box Figure 1). This
index of “financial turbulence” measures the degree to which a country has been affected by the crisis. It
is calculated as a principal component of three measures: (a) variation in the real effective exchange rate
in March 2009 (% year-on-year), (b) rate of change in the aggregate stock price index in March 2009 (%
year-on-year), and (c) change in the country credit rating from Institutional Investor (variation in March
2009 vis-а-vis March 2008). Higher values of the turbulence index indicate the country was less affected
by the crisis. It appears that this turbulence measure has a significant impact on new business registra-
tion across 95 countries in the sample, even while controlling for country fixed effects and economic and
financial development.

Box Figure 1. The crisis turbulence in Russia was worse than average but the impact on new
firms much more pronounced

Source: Klapper, L. and Love, I. “The impact of the financial crisis on new firm registration,”
World Bank’s Policy Research Working Paper No. 5444, 2010/20/12, World Bank.

I. Recent Economic Developments | 7

Figure 1.8. Unemployment (left panel) and labor force aggregates (right panel)

Source: Rosstat.

A more detailed look at the hiring and firing of workers suggest that only a few sectors
resumed significant hiring. These data and the replacement ratio of the number of hired and
fired workers in major sectors suggest that the economy is not absorbing enough labor to
make a sustained dent in the unemployment rate. Finance is the only sector in which hiring
rates now exceed the firing rate, after a period of large job losses. Manufacturing, energy and
gas, transport, and communication are gradually improving, if still with fairly low replace-
ment ratios (figure 1.9). Vacancy data also indicate that manufacturing is the only major sector
looking for qualified workers (figure 1.10). And the coming winter season is bound to result
in seasonal increase in the overall unemployment.

Figure 1.9. Hiring and firing in the economy (left panel) and major sectors (right panel)

2
Replacement rate (hiring/firing) by selected sectors

1
май.09

0 дек.09

апр.10

авг.10

Source: Rosstat, WB staff calculations.

Figure 1.10. Vacancies in the economy (left panel) and by sectors (right panel)

400

350
thousands

300

250

200
dec. 08
feb. 09
apr. 09
jun. 09
aug. 09
okt. 09
dec. 09
feb. 10
apr. 10
jun. 10
aug. 10

Source: Rosstat.

8 | Russian Economic Report. № 23. November, 2010

 TABLE 1.3. Labor productivity, disposable income, wages, and unemployment, 2006–2010
2006 2007 2008 2009 2010
Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan – Sep Sep
GDP growth, percent, year on year .................................... 8.2 8.5 5.2 -7.9 4.2a n/a
Total employment, million people ...................................... 68.8 70.5 70.9 69.4 69.7 71.1
Employment growth, percent, year on year ........................ 0.8 2.4 0.5 -2.1 0.3a -0.1
Labor productivity growth, percent, year on year .............. 7.3 6.0 4.7 -5.9 3.9a n/a
Real disposable income growth, percent, year on year ...... 13.5 12.1 1.9 1.9 4.8 1.5
Real wage growth, percent, year on year ........................... 13.3 17.2 11.5 -2.8 5.0 5.1
Average monthly wage, USD .............................................. 392.5 533.2 692.1 593 678.2 703.2
Unemployment (percent, ILO definition, e-o-p) ................. 6.9 6.1 7.8 8.2 6.6 6.6
Source: Rosstat.
a Data for the first half of 2010.

Balance of payments – improved, but then deteriorating due to a rapid

growth in imports
The external current account balance improved in the first half of this year due to higher
oil prices and sluggish imports, but deteriorated in the third quarter as imports picked up.
According to the preliminary estimates from the Central Bank of Russia (CBR), the current
account surplus amounted to USD 60.9 billion in the first three quarters of 2010, up from only
USD 33.3 billion in the corresponding period of 2009, mainly because of higher-than-expected
oil and resource prices (figures 1.11–1.12). But in July-September, import growth accelerated,
and the trade balance narrowed considerably despite relatively high oil prices. According to
preliminary estimates, the current amount surplus narrowed to only USD 8.7 billion in the
third quarter, compared with USD 33.5 billion and USD 18.7 billion in the first two (table 1.4).
The current account surplus is likely to narrow further in the last quarter of 2010, reflecting
further import growth supported by economic recovery.

TABLE 1.4. Balance of payments (USD billions), 2006–2010

2006 2007 2008 2009 H1-09 H1-10 Q3-2010a
Current account balance ....................................... 94.7 77 103.7 49.4 17.9 52.2 8.7
Trade balance ...................................................... 139.3 130.9 155.4 111.6 43 86 28.5
Capital and financial account ................................ 3.3 84.8 -131.3 -43.49 -29.3 -2.3 -4.4
Errors and omissions .......................................... 9.5 -12.9 -11.3 -2.6 -4.9 -7.2 -1.6
Change in reserves (+ = increase) ........................... 107.5 148.9 -38.9 3.4 -16.3 42.7 2.7
Source: CBR a Preliminary estimates.

With a lower current account surplus and downside risks for capital account, the balance
of payments position could deteriorate toward year-end. Net capital outflows from Russia
fell during the first nine months of 2010, allowing the balance of payments to strengthen and
the CBR to accumulate USD 51 billion in international reserves. According to the CBR pre-
liminary estimates, the capital account registered an outflow of only USD 6.7 billion during
the first nine months of 2010 compared to USD 56.3 billion in the corresponding period of
2009. But disaggregated data convey a more mixed picture: capital flows remained volatile,
with net inflows into the banking sector but sizeable outflows from non-banking corporations
(table 1.5). With the uncertain global growth and capital flows to emerging markets, Russia’s
balance of payments position could deteriorate further toward year-end, becoming more vul-
nerable to a new terms-of-trade shock due to a drop in oil prices.

I. Recent Economic Developments | 9

Figure 1.11. Oil prices and the trade balance Figure 1.12. Current account balances and the real
effective exchange rate

Source: CBR and World Bank staff estimates. Source: World Bank staff calculations based on Rosstat and CBR data.

TABLE 1.5. Net capital flows (USD billions), 2006–2010

2006 2007 2008 2009 H1 2009 H1 2010 Q3 2010
Total net capital inflows to the private sector ................. 41.4 81.7 –133.9 –56.9 -31.6 -11.8 -4.2
Net capital inflows to the banking sector ..................... 27.5 45.8 –56.9 –31.4 -12.8 7.6 8.3
Net capital inflows to the non banking sector ............... 13.9 35.9 –77 –25.4 -18.9 -19.5 -12.4
Source: CBR.

External debt – Private sector repaying its debt

Official debt statistics suggest that massive deleveraging in the banking sector in 2009
slowed down. According to CBR, the outstanding external debt of the banking sector declined
only marginally to USD 120.1 billion by end-June 2010, from USD 125.7 billion at end-December
2009 (in 2009 the banks’ total outstanding debt fell by almost USD 40 billion, or 24 percent). As
expected, no major defaults on foreign debt obligations by banks were reported in this period.
Although the banks’ aggregate rollover capacity might have improved, the banks seem to
have restarted short-term borrowing. Their outstanding short-term liabilities increased to USD
30.3 billon by end-June 2010, up from USD 27 billion at the end of 2009 and USD 24 billion at
the end of Q3-2009. It is likely that the banks are using (at least partly) short-term borrowings
to pay off their long-term liabilities. In the second half of 2010 the banks have to pay about USD
24.3 billion (including interest payments), most in the third quarter.
The external debt exposure of private nonfinancial corporations fell in the first half of
2010, likely reflecting limited rollover capacity. According to the CBR, the outstanding ex-
ternal liability of private non-financial corporations fell to USD 234 billion at the end of June
2010, from USD 249 billion at the end of 2009. So, many companies were forced to delever-
age their balance sheets. Thus the aggregate external debt exposure might fall further by
year-end. According to the CBR, private non-financial corporations have to pay almost USD
50.3 billion in the second half of 2010 (including interest), with USD 24 billion falling due in
the last quarter of the year.

Monetary policy and credits—in search of a fine balance

Monetary conditions remained loose in the third quarter as the CBR kept its key policy
rates unchanged despite an inflation scare from rising food prices. Gradual loosening of mon-
etary conditions in 2009 and 2010 resulted in a 33 percent increase in money supply (M2) by
10 | Russian Economic Report. № 23. November, 2010
August 2010 (y-o-y). Given the recovery in money demand, the observed rapid monetization
of the economy could have been excessive and led to a buildup in inflationary pressures. The
situation was complicated by rising food prices in August-September 2010 due to a severe
drought in the European part of Russia. According to Rosstat, the declining inflation trend
reversed in August, with 12-month CPI inflation rising to 7.0 percent in September, up from
5.5 percent in July (figure 1.18). Also, in September 2010, producer prices increased by 8.2 per-
cent relative to December 2009 (by 10.5 percent in manufacturing). But despite rising infla-
tionary pressure the monetary authorities kept the refinancing rate unchanged, but revised
its end-year inflation target up by 1 percentage point to 7.5 percent—to account for a one-off
effect of food prices.
The CBR is currently facing a difficult trade-off between keeping the main policy rates
low and a potential buildup of inflationary pressure. The problem with the currently low
rate is that even with the rapid monetization of the economy (M2 increased by 33 percent
in August 2010, year-on-year) and considerably improved liquidity in the banking sector,
credit activities remained very weak during 2010. Net credit to the private sector increased
slightly in April-August 2010 (figure 1.14). But most of this increase is due to new credits to
enterprises, while net credits to households remained limited. With real policy rates now in
negative territory, the observed marginal recovery in credits suggests supply constraints in
the banking sector.
Banks have been keeping wide spreads between the refinancing rates and effective lend-
ing rates (figure 1.13). This suggests that most banks still perceive credit risks of potential
borrowers (especially households) as very high. Given the slow economic recovery and low
profitability, prevailing interest rates on new loans for firms and households remain high (ef-
fective rate for consumer loans may vary from 18 to 40 percent). Under these conditions, some
monetary tightening might not affect credit, but may limit inflationary pressure.
The recovery in credits depends, among others, on strengthening of bank balance sheets
and increases in borrower profitability—and this will take time. Data from the CBR suggest
little or no improvement in the share of non-performing loans during 2010, although their
rise has slowed substantially. On October 12 Moody’s Investors Service raised the outlook
for Russia’s banking sector to “stable” from “negative,” citing its “improved liquidity” and
“loan-loss provisioning buffers.” Interestingly, many banks restructured a large share of de
facto non-performing loans during 2009 and 2010 although the nature of such restructuring
varies widely. The Russian banking system is relatively well provisioned (18 percent of total
loans), but the long term performance of many restructured loans remains uncertain, which
means that such banks may be under-provisioned and some under-capitalized.

Figure 1.13. Lending rates and inflation in Russia Figure 1.14. Stock of credits to companies and
2006–2010 households in 2007–2010

Source: CBR; World Bank staff estimates.

I. Recent Economic Developments | 11

 Faced with balance of payments pressures and remaining volatility in oil prices, CBR
has further widened the exchange rate corridor. In March 2010 the CBR, moved to a more
flexible exchange rate management, smoothing volatility but not defending the absolute
levels of the targeted corridor for the Euro/USD currency basket. This made the CBR policy
more effective in avoiding a possible carry-trade and destabilizing speculation against the
ruble. However, with deteriorating balance of payments and capital account volatility, CBR
prudently decided in October to widen the exchange rate corridor and further reduce the size
of interventions in a move to make the exchange rate more flexible and less predictable in the
face of volatile external conditions.

Fiscal policy – rising fiscal risks

The fiscal outcome for 2010 is likely to be better than expected as a result of favorable
oil prices. According to preliminary Minfin estimates for the first nine months of 2010, the
Federal budget was executed with a deficit of only 2.2 percent of GDP, down from 4.0 per-
cent of GDP in the same period in 2009 and a budgeted deficit level of 5.4 percent of GDP for
2010. This is mainly due to higher revenues from oil: in Jan-Sep of 2010 revenues amounted
to 18.3 percent of GDP, up from the budgeted 17.3 percent for 2010. Similarly, expenditures
in the first nine months of this year were only 20.5 percent of GDP, down from 22.7 percent
of GDP in the budget. But budget execution will accelerate in the final quarter of the year,
resulting in the higher deficit than so far in the year, but lower than budgeted.
The Government is now planning a gradual fiscal adjustment to eliminate the federal
deficit by 2015. The draft Federal budget law for 2011–2013 indicates a commitment to reduce
the federal budget deficit from 5.4 percent of GDP in 2010 to 2.9 percent in 2013 (table 1.6).

TABLE 1.6. Medium-term fiscal parameters (as a share of GDP

2009 2010 2011* 2012* 2013*
Revenues (Consolidated) ....................................................................... 34.4 33.4 35.0 34.0 32.8
Of which Federal budget ......................................................................... 18.8 17.3 17.4 16.5 16.1
Expenditures (Consolidated) ................................................................... 40.6 39.1 38.7 37.0 35.2
Of which Federal budget ......................................................................... 24.7 22.7 20.9 19.6 19.0
Federal budget Non-oil deficit ................................................................. -13.6 -13.7 -11.6 -10.5 -9.8
Federal budget balance ........................................................................... -5.9 -5.4 -3.6 -3.1 -2.9
Consolidated budget balance ................................................................. -6.2 -5.7 -3.7 -3.0 -2.4
* Draft Budget.
Source: World Bank staff estimates based on draft budget documents, the Ministry of Finance.

On the expenditure side, despite sizable changes in expenditure priorities, Russia faces
additional expenditures to close the infrastructure gap, support diversification, and imple-
ment military reform. According to the draft federal budget for 2011–2013 aggregate expendi-
ture reductions total 3.7 percent of GDP. And the federal government has an ambitious plan
to increase fiscal space to almost 6 percent of GDP over the next three years by reprioritizing
and optimizing existing expenditure structure. Although this is ambitious, it might not be
enough to address additional spending pressures likely to emerge over the medium term.
Russia’s well documented demographic trends—declining population, aging, and increasing
demand for pension and health services and the changing structure of demand for educa-
tion—will increase social expenditures by 3.5 percent of GDP in 2016–2020.21
2 Bogetic, Zeljko, Karlis Smits, Nina Budina and Sweder van Wijnbergen (2010). “Long-Term Fiscal Risks and Sustainability in
an Oil-Rich Country: The Case of Russia,” World Bank Policy Research Paper No. 5240, 2010/03/17, World Bank, Washington
D.C. Available at the World Bank’s external website www.worldbank.org.

12 | Russian Economic Report. № 23. November, 2010

 TABLE 1.7. Preliminary estimates of additional funding needs in 2011–2013 (as a share of GDP)
2011 2012 2013 Total
Net Expenditure Measures ........................................................................................... -1.8% -1.3% -0.6% -3.7%
1. New spending pressures .......................................................................................... 1.2% 0.3% 0.6% 2.1%
Transport .................................................................................................................. 0.1% 0.1% 0.1% 0.3%
Military ..................................................................................................................... 0.1% 0.0% 0.4% 0.5%
International events* ................................................................................................ 0.0% 0.3% 0.4% 0.7%
Health ....................................................................................................................... 0.5% -0.1% -0.2% 0.2%
Modernization/Innovation ......................................................................................... 0.5% 0.0% -0.1% 0.5%
2. Reprioritization of existing expenditures .................................................................. -3.0% -1.6% -1.3% -5.8%

Net revenue measures ................................................................................................. 0.0% -0.8% -0.4% -1.2%

Oil revenues ............................................................................................................. -0.3% -0.7% -0.5% -1.4%
Non-oil revenues ...................................................................................................... 0.3% -0.2% 0.1% 0.2%

Net consolidation ......................................................................................................... 1.8% 0.5% 0.2% 2.5%

* Sochi Olympic games in 2014, APEC summit, Summer University in Kazan.

Oil and gas revenues are expected to decline by a cumulative 1.4 percent of GDP in the
medium term due to flat output not offset by higher mineral prices. A drop in oil revenues
presents two challenges. First, the non-oil revenue base remains narrow and is unlikely to
offset oil revenue shortfalls without additional increases in excise taxes or broadening of
the non-oil base. Second, and more important, the draft federal budget is based on a favor-
able oil forecast – the price of Urals is estimated to be USD 75 per barrel in 2011, USD 78 in
2012, and USD 79 in 2013. Although this forecast is broadly consistent with market expecta-
tions—the World Bank oil price forecast (Dubai, Brent & WTI) is USD 73.2 a barrel in 2011,
USD 73.1 in 2012 and USD 74.6 in 2013—such oil prices make Russia more vulnerable to a
new, sudden drop in oil prices (figure 1.15). If, for example, oil prices fall to USD 60 a bar-
rel (close to the long-term historical average), oil revenues could fall by 2.0 percent of GDP,
pushing the deficit in 2011 well above 5 percent of GDP and raising the issue of financing
such a large deficit.

Figure 1.15. Initial oil price assumed in the draft budgets vs. actual price and
World Bank forecast

Source: State Duma database, Bloomberg, WB

I. Recent Economic Developments | 13

 Box 2. A sizeable but temporary grain shock

In 2010, Russia has experienced the worst drought in decades, contributing to higher food
prices. The lack of rainfall in Central Russia and in the West along the Volga river caused a massive
drought affecting many food items. The harsh weather has destroyed close to 40 percent of crops in the
affected regions producing grains, meat and potato. Bloomberg noted that the drought led to the biggest
jump in the price of wheat since 1973, affecting a range of food prices (e.g., meat and dairy products).
So prices of grains and related products have been soaring since July, 2010. During June-October, buck-
wheat prices more than doubled and potato prices rose by 30 percent. Prices of meat, eggs and cereals
have increased more than typical during the summer period (Figures 1-2.). As the world’s third largest
grain exporter, the drought also played a role in global food developments, but less than feared.

Figure 1. Changes in prices of selected Figure 2. Domestic buckwheat price shock:

food prices Ten most affected regions

Source: ROSSTAT. Weighted by share of household Source: ROSSTAT, June 4 – October 7th period.
consumption for each item.

Figure 3. Poverty increase due to changes
in grain prices
Twenty seven (out of 88) regions in Russia have
declared emergency at the onset of the drought.
The prices increases spread all over the country, but
regions in Central and Western Russia were particularly
affected. The largest increases in buckwheat prices
were observed in the Moscow oblast (149 percent),
Vladimirskaya oblast (148 percent), and in Kostroma
oblast (147 percent). In Russia, one-time increases in
food prices are somewhat confused by the public as
a return of sustained inflation and this “inflation scare”
was no exception. So for this reason and for reasons
of policy, it is useful to understand just how deep and
sustained was the impact on household welfare?

Source: World Bank staff estimates using household

survey data.

To this end, we use a micro-macro simulation method to estimate the impact of the food
price shocks on the household consumption and poverty. The net effect of the price shocks on the
households’ consumption has been estimated as a loss in real household income due to an increase in
expenditures as result of higher food prices. Figure 3 illustrates the impact of the drought on selected
population groups, categorized by the sector of employment. It appears that the net direct and indirect
effect of the drought will result in 1.0 percentage point increase in poverty rate in the entire country – more
than 1.4 million people may have temporarily fallen into poverty (on top of the 13.6 percent of the Russian
population in poverty in 2010), holding all other factors constant, including any increases in wages and
salaries that may take place since the beginning of the shock. This is not a marginal impact even though
it is a one-time shock likely to dissipate over time with increases in household incomes. Pensioners and
others on fixed incomes are the most vulnerable group with a 2.6 percentage point increase in poverty.
In sum, the household income loss and the impact on poverty was sizeable but temporary. This is an
important finding in a debate to formulate appropriate policy (Box 3).

14 | Russian Economic Report. № 23. November, 2010

 Box 3. Policy debate – effectiveness of the temporary export ban on grain.

On August 5, in response to the escalating grain prices, the Russian government imposed a
temporary export ban on wheat, barley, rye, maize, wheat and wheat-and-rye flour from August
15 to December 31 2010; on October 20 the Russian government extended export ban on grain
till the end of June 2011 yet flour export ban was not extended. The export ban is a response
to the drought induced shortfall in the grain harvest and the associated rapid grain price increases.
According to the preliminary official estimate for October 20 farmers harvested 62.3 mln tons of grain,
a decline of 36.8% compared to 2009, resulting in sharp increases in grain prices in domestic as well
as in international markets.
The export ban is aimed to insulate Russia from highly volatile world grain prices by reducing
exports in 2010-11 to the 3 million tons already shipped, resulting in a drop of nearly 12 million
tons compared to initial projections for the year. Nevertheless, given the current production estimates,
and domestic consumption estimated at 78m tons, it is likely that Russia will become a net importer of
grain, depending on the use of reserve stocks1.
In these circumstances, the export ban will be largely ineffective in reducing domestic prices
as they will continue to be influenced by world grain prices. For Russia, an export ban could also
have unintended and often undesirable side effects such as undermining Russia’s long-term policy goal of
becoming an important player in the global grain market; encouraging hoarding in expectation of the ban’s
removal; distorting prices and affecting the investment and production responses.
Alternatively, domestic inflationary pressures and food security could be addressed in the
short term by
• Using global markets to fill any temporary grain shortfalls.
• Protecting the poor through reducing taxes and tariffs on key food products.
• Making full use of the grain intervention fund to reduce pressures in the domestic market.

And in the medium to long run by:

• Targeting cash transfers to vulnerable groups. Various kinds of cash transfer programs are currently
used in many countries including Brazil, China, Mexico, and South Africa. Cash transfers are effective
in ensuring income transfers to vulnerable population segments and, unlike export restrictions, do not
reduce farm-gate prices and induce a negative supply response.
• Improving transport and logistics. In many countries, transport and logistics costs are a key com-
ponent of food prices and are generally far higher than OECD benchmarks of around 9 percent.
While countries can do little to reduce ocean shipping costs, they can act to lower the overall cost of
domestic distribution. Severe difficulties with exporting the 2008 bumper crop in Russia highlight the
importance of sufficient and efficient transport and distribution infrastructure.
• Encouraging a more robust agricultural insurance framework. Russian farmers have keen perceptions
of risk, but they are concerned about high premium costs and inadequate claims settlements; on the
whole, they remain seriously underinsured. It would also boost investment in infrastructure such as
on-farm storage, making natural disasters somewhat more manageable.
• Increasing priority to public investment programs to support (a) agricultural productivity improvements
(b) national irrigation development and rehabilitation program and (c) nation-wide price market price
information services.
• Strengthening capacity for food policy formulation.

1 Grain stocks are estimated at 26.3m tones as of July 1, 2010, of which 9.6 m is part of government’s grain intervention fund.

The federal budget deficit is planned to be financed mainly from domestic borrowing
supplemented by a modest amount of external borrowing. In 2011 part of the deficit will be
financed by a drawdown of the reserve fund, but in 2012–2013 the deficit will be financed
mainly from domestic sources. The domestic financing sources include the privatization
revenues from the sale of state assets, about 0.5 percent of GDP a year, and the issue of
domestic bonds.

I. Recent Economic Developments | 15

 TABLE 1.8. Preliminary estimates of additional funding needs in 2011–2013 (as a share of GDP)
Draft Federal budget law
2008 2009 2010
2011–2013
Original Revised Actual
Actual Actual 2011 2012 2013
law law (Jan-June)

Total deficit ................................................... -4.1% 5.9% 6.8% 5.4% 2.0% 3.6% 3.1% 2.9%

1. Drawdown from the oil funds ..................... -4.8% 5.2% 5.2% 3.2% 1.9% 0.5% 0.0% 0.0%
2. Net external financing ............................... -0.3% -0.3% 1.0% 0.2% 0.6% 0.1% 0.1% 0.1%
3. Net domestic financing 1.0% 1.1% 0.6% 2.1% -0.6% 3.0% 2.9% 2.7%
Source: World Bank staff estimates.

Reliance on domestic financing of the deficit presents at least two sets of challenges.
First, although there is enough liquidity in the domestic market to finance an overall fiscal
deficit below 3 percent of GDP, even if the 2011–2012 budgets are implemented as planned,
there is a real risk that interest rates will rise and crowd out bond issues by SOEs or large
enterprises. Second, the fiscal adjustment on the expenditure side could become slower and
the deficit higher in the election cycle in 2011–2012, putting further pressure on the domestic
market, aggravating the interest rate and crowding out effects.
Given the fiscal constraints, some post crisis priorities might be financed by off-budget
vehicles, increasing contingent liabilities. The budget code limits the government’s ability
to lend directly to commercial entities, so the Vneshekonombank (VEB) has become a de
facto source of long-term financing for large investment projects in infrastructure and other
strategic sectors. It is expected in the medium-term that the VEB will support government’s
priorities in fostering innovation, modernization, and diversification (including addressing
the monotowns). The VEB is also supporting preparations for Sochi Olympic Games in 2014. In
recent years it has benefited from capital injections financed by the federal budget.32
Overall, fiscal risks have increased, suggesting the need to rethink the fiscal strategy in
the face of heightened uncertainty and downside risks in the oil market. First, the pace of fis-
cal adjustment in the 2011–2013 budgets is slower than initially envisaged, pushing the hard
decisions on expenditure adjustments into the future. As discussed in the RER22, a more
rapid adjustment would lead to a faster convergence of the non-oil fiscal deficit to a long-
term sustainable level of about 4.3 percent of GDP. Second, as in other countries, expenditure
pressures may increase in the election cycle 2011–2012 leading to further weakening of fiscal
adjustment. Third, with high budgeted price of oil close to the current forecast, Russia’s bud-
get has lost the cushion it had in previous years, becoming more vulnerable than in the past
to sudden drops in the price of oil. A sustained USD20 dollar drop from the current levels
could raise Russia’s fiscal deficit in 2011 by two percentage points of GDP.

3 RUB 180 billion in 2007, RUB75 billion in 2008, RUB121 billion in 2009.

16 | Russian Economic Report. № 23. November, 2010

 II
Economic and Social Outlook for Russia,
2010–2012
Summary: With moderating global and Western European growth, uncertain oil prices and capital
flows, Russia is likely to grow by 4.2 percent in 2010, followed by 4.5 percent in 2011 and 3.5 percent in
2012 as domestic demand expands in line with gradual improvements in the labor and credit markets.
With such moderate growth prospects, unemployment situation is likely to get worse before it gets
better later in 2011.

Preliminary updates to the World Bank’s forecast suggest global GDP growth of about
3.5 percent this year, slowing to 3.2 percent in 2011 before recovering to around 3.6 percent
in 2012. Developing countries are expected to continue outperforming high-income countries
by a wide margin, with GDP growth of about 6.6 percent in 2010 and just less-than 6 percent
in 2011 before firming somewhat in 2012 (table 2.1). This compares favorably with the
2.5, 2.3 and 2.8 percent anticipated for high-income countries. Excluding China and India,
developing countries are projected to grow at 5.2, 4.5 and 4.8 percent, with average growth
above 4 percent in all regions (except Sub-Saharan Africa), and above 7 percent in East- and
South Asia.

TABLE 2.1. The summary of the global outlook

2009 (actual) 2010 2011 2012
World ................................................................................... -2.1 3.5 3.2 3.6
High income countries ......................................................... -3.3 2.5 2.3 2.8
Developing countries ............................................................ 1.8 6.6 5.9 6.1
China .................................................................................... 8.7 9.5 8.5 8.2
Japan ................................................................................... -5.2 2.4 1.6 2.0
The United States ................................................................. -2.6 2.6 2.3 2.9
Euro area .............................................................................. -4.1 1.3 1.7 2.1
Russia .................................................................................. -7.9 4.2 4.5 3.5
Source: Global Economic Prospects, The World Bank.

The global transition from today’s very loose macro policies to a more neutral stance
is a key challenge for all countries. Too abrupt a tightening could cut into the recovery—too
slow a response could see demand outstripping supply. The latter point is of special concern
given uncertainty over potential output—especially in high-income countries at the heart of
the financial crisis. If recent research suggesting that financial crises tend to reduce potential
output by between 4 and 6 percent of GDP is correct, then the U.S. and European economies
could be close to their potential, with high structural unemployment. If so, an excessive de-
mand stimulus and low interest rates could be counterproductive, leaking out imports and
recreating earlier imbalances. For developing countries, many of them already at or closing
in on potential GDP, tightening may attract unwanted and potentially destabilizing capital
inflows, as the difference between their interest rates and the low interest rates in high-income
countries widen.

II. Economic and Social Outlook for Russia 2010–2011 | 17

 Box 2.1. World Oil Market: Recent Developments and Prospects

Developments. Oil prices (WB average) have been relatively stable over the past 13 months,
averaging around $77/bbl. Prices have been supported by strong demand in China and the U.S., and large
production restraint by OPEC producers. However, prices have been unable to rise sustainably higher
because of large stocks, substantial surplus capacity of oil production and refining, strong increases in
non-OPEC supply, and concerns about the outlook for the global economy. In October, prices rose above
$83/bbl, partly due to a weak dollar and tight distillate market. A strike at the large French Mediterranean
port of Fos-Lavera began September 27th, and spreading strikes closed most of France’s refineries, while
protestors blocked oil product depots resulting in fuel shortages at many of France’s petrol stations. So
far the impact has been local and had limited impact on global crude and product markets, a reminder
that supply is plentiful. Crude stocks on-land remain high, especially in the U.S., while much of the large
floating storage earlier in the year has been brought ashore. Product inventories remain high on-land and
at-sea, particularly middle distillates, but a lengthy strike in France could pull product stocks lower.
The price of Urals crude has fallen dramatically relative to Brent from its recent highs because of the
French strikes. With millions of barrels blocked at the French Fos-Lavera terminal, refiners are limiting
their spot purchases, and Urals sellers have to find alternative buyers.
World oil demand growth has been strong this year, with OECD demand turning positive in 2Q 2009
and joining very strong gains in non-OECD countries, particularly China. Global oil demand is projected
to increase by 2.1 mb/d or 2.5% in 2010, topping the pre-crisis peak in 2007, and recording the largest
volumetric increase in more than 30 years with the sole exception of 2004. Meanwhile, non-OPEC sup-
plies have recorded very strong growth, with output up more than 1 mb/d in the first three quarters of
year. Russia’s oil production has risen by 0.2 mb/d in each of 2009 and 2010 due to new fields coming on
stream, such as Rosneft’s Vankor field in East Siberia, and TNK-BPs Uvat project in West Siberia
OPEC producers have largely maintained their production cuts in an effort to keep prices within a
$70–80/bbl range, which they deem acceptable. OPEC’s spare capacity is around 6 mb/d, with about
5 mb/d of the surplus is in the Gulf, and nearly two-thirds of the total in Saudi Arabia.
Prospects. Oil prices are expected to remain relatively constant in real terms over the forecast period,
with the WB average currently projected at $76.4/bbl for 2010. Nominal prices are projected to drop to
$73.2/bbl, owing to a large drop in the WB MUV index. The market is expected to remain well supplied
going forward with large spare capacity in OPEC production and global refining. Oil demand is expected
to increase by 1.2 m/bd or 1.4% in 2011, with all of the growth in developing countries. Non-OPEC
supply is projected to grow by at least 0.5 mb/d, and OPEC NGLs are expected to increase by more than
0.6 mb/d. This leaves a very modest call on OPEC crude oil production, and thus the oil market balance
is not expected to change materially. This suggests that oil prices will continue trading around levels
of the past year. Downside risks would be slower growth in oil demand, a further climb in inventories,
and leakage of OPEC oil onto the market. Upside risks would include stronger demand in developing
countries—including emergency stock building in China when its new strategic petroleum tank capacity
comes online in the middle of next year—disappointing non-OPEC supply, further depreciation of the
dollar, and lack of an OPEC response should prices rise above the $70-80/bbl range.

Figure 2.1. World Bank oil price forecast; Average crude

(Brent, Dubai and WTI), simple average, $/bbl

Source: World Bank Staff

18 | Russian Economic Report. № 23. November, 2010

 With a slower-than-expected recovery in the first quarter of 2010 and remaining downside
risks to global economic recovery, we revised our real GDP projection to 4.2 percent in
2010, followed by a 4.5 percent growth in 2011, and 3.5 percent in 2012 (table 2.2). After a
disappointing first quarter in 2010, the growth momentum has been regained throughout Q2
and Q3, supported by recovery in household consumption and inventory restocking. In the
second half of 2010, the sources of growth are likely remain the same, while net exports are
expected to be a drag on growth, as import volumes pick up in line with economic recovery
(figure 2.2). We expect that the pace of economic growth in 2011 and 2012 will be constrained,
and will depend on sustained gains in consumption and the pace of recovery in longer term
credit to the private sector, needed to facilitate growth in fixed investment.

TABLE 2.2. Outlook for Russia, 2010–2012

2010 2011 2012
World growth, % ........................................................................................................................... 3.5 3.2 3.6
Oil prices, average, USD/bbl .......................................................................................................... 76.4 73.3 73.1
Russia
GDP growth, % .................................................... ..................................................................... 4.2 4.5 3.5
Consolidated government balance, % ....................................................................................... -4.4 -4.0 -3.1
Current account, USD bln. ......................................................................................................... 70 30 18
Capital account, USD bln. .......................................................................................................... -10 23 54
Source: Global Economic Prospects (World growth and oil prices), and Russian Economic Report, The World Bank.

Given the outlook for oil prices and rapid growth in import volumes, we expect the
current account to deteriorate in the last quarter of 2010, and further in 2011 and 2012. The
capital account, by contrast, is expected to improve through 2011-2012, while capital flows
are likely to remain volatile. If oil prices remain at their forecast levels, the surplus on the
external current account would amount to about USD 70 billion in 2010 (about 4.9 percent
of GDP) and would deteriorate to USD 30 billion in 2011 and further to USD 18 billion in
2012. Given the limited rollover capacity of the private sector in 2010, the capital account
is projected to have a deficit of about USD 10 billion. But reflecting an increase in non-debt
capital inflows, lower debt repayments, and improved borrowing capacity of banks and
non-financial corporations, we expect the capital account to improve to surpluses of USD 23
billion in 2011 and USD 54 billion in 2012. As the current account deteriorates in 2011 and
2012, the exchange rate will be increasingly driven by net capital flows, if oil prices remain
within the projected range.
An increase in fiscal revenues due to higher oil prices is likely to be partly offset by new
pressures from additional spending on infrastructure and modernizing the economy. We
project the fiscal deficit at 4.4 percent of GDP in 2010, 4.0 percent in 2011, and 3.1 percent in
2012, given the global oil price projections. With the reserve fund down to less than 3 percent
of GDP by the end of 2010 (figure 2.4) the expected budget deficit in 2011 and 2012 will have
to be also financed by domestic and (larger than planned) external borrowing. The downside
risks associated with highly volatile oil prices and global demand will remain.
Given the current trends, inflationary pressure could intensify toward year-end. But
tightening of the monetary conditions could contain inflation later in 2011 and 2012. CPI infla-
tion in 2010 is projected in the range of 8 to 9 percent, reflecting the substantial monetization
of the economy and a one-off effect of rising food prices. The upside risks for inflation will
remain in 2011, reflecting the lag between the current money supply growth and its impact
on prices, as well as possible monetization of the remaining fiscal gap. Thus we do not expect
CPI inflation to decline below 8 percent in 2011 or below 7 percent in 2012, unless the fiscal
stance is considerably tightened.

II. Economic and Social Outlook for Russia 2010–2011 | 19

Figure 2.2. Demand sources of Russia’s Figure 2.3. Sectoral sources of Russia’s
real growth, by quarter, 2008–2010 real GDP growth by quarter, 2008–2010
(percent change year to year) (percent change year to year )

Source: Rosstat; World Bank staff estimates.

Figure 2.4. Balances of the National Welfare and Reserve Figure 2.5. Monthly Unemployment Rate Dynamics
funds in billions of USD (end of period) in Russia, 1999–2010

Source: Ministry of Finance. Source: World Bank estimates based on Rosstat data.
* End of the year estimate

Although borrowing conditions are likely to remain fairly tight in the short term, we do
not expect any major default by larger banks or corporations on their external debt obliga-
tions in 2010 or 2011. Banks and non-bank corporations will continue reducing their long-
term exposure while the net short-term debt might increase both in 2010 and 2011. The current
debt payment profile does not look worrisome. But if the private sector considerably increases
its short-term exposure, the refinancing risk would also increase, pushing up the cost of new
borrowings in the medium term. According to the CBR, banks will have to repay about USD
57 billion in principal and interest and corporations about USD 98.1 billion in 2010, but much
less–USD 29.4 billion and USD 54.9 billion respectively in 2011 (table 2.3).
TABLE 2.3. External debt service, including interest payments (USD billion)
2010 2011
2010 2011
Iq* II**q IIIq IVq Iq IIq IIIq IVq
All sectors ............................... 39.6 43.2 43.0 34.1 160.0 20.0 27.2 18.8 24.1 90.1
Government ............................. 1.6 0.5 1.6 1.1 4.8 1.6 1.0 2.0 1.2 5.8
Banks ...................................... 14.7 18.1 14.9 9.4 57.0 4.8 10.8 5.5 8.1 29.4
Other sectors ........................... 23.3 24.6 26.6 23.7 98.1 13.6 15.3 11.3 14.8 54.9
Source: CBR, schedule of payments as of July 1, 2010.
* – schedule of payments as of January 1 2010.
** – schedule of payments as of April 1 2010.

20 | Russian Economic Report. № 23. November, 2010

 III
In Focus: Unemployment and Recovery
Across Russia’s Regions
Summary. Regions that suffered most are the most developed, but they are not necessarily leading the
recovery. While there is huge diversity across regions in the patterns of labor market recovery, smaller
regions with a larger share of SMEs, better investment climate, more FDI, and stronger financial sector
presence tend to show a more robust recovery.

While the recovery is evident in the Russian labor market, the situation varies widely
across Russia’s regions. More than 60 percent of the regions have higher unemployment rates
than in 2008 (figure 3.1). Some regions still have unemployment twice as high as in 2008—
with the highest in Mordovia, Chelyabinsk, Yaroslval, Moscow, Orel, and Tver regions. But
Kamchatka, Karachaevo, and Tomsk have unemployment rates 30 percent lower than be-
fore the crisis. What accounts for this highly differentiated employment performance across
Russia’s space?

Figure 3.1. Unemployment changes across Russia’s regions, 2010* over 2008

Source: Rosstat; World Bank staff estimates. *Data for January – August.

Charting regional employment and unemployment trends before and after the crisis
reveals interesting patterns. Figure 3.2 shows the impact of the crisis on regional employ-
ment and unemployment during the crisis (left hand chart) and emerging results following
the recovery (right hand side chart). The bubbles represent Russian regions (with size of the
bubble proportional to the size of the population). The top-left quadrant contains regions
with worse outcomes, the lower-right regions where indicators have improved. Most regions
have experienced adverse effects, but the recovery process across regions (in the right chart)
is differentiated.
Most of the big regions did not improve during the output recovery, either in employ-
ment or unemployment. By contrast, several small and medium-size regions improved.
Interestingly, several regions are in the top-right quadrant, where employment rates and
unemployment rates both increased. This suggests that the process of growth and associated
labor absorption across the regions is simply not strong enough to generate sustained reduc-
tions in unemployment.

III. In Focus: Unemployment and Recovery Across Regions | 21

Figure 3.2. Employment and unemployment changes during crisis (left) and recovery (right)

Source: Rosstat; World Bank staff estimates.

While the richer regions more open to foreign trade were hardest hit, the regional pattern
of recovery is not symmetrical. There is a strong negative correlation between the initial level
of unemployment and the increase in unemployment in the first year of the crisis (figure 3.3,
left). But the pattern is not symmetrical. Regions, initially hit harder by the crisis are not nec-
essarily those where the unemployment rates are falling faster. Some of these regions are still
in deep recession, while others are growing faster.

Figure 3.3. Increase in unemployment compared with initial unemployment during crisis (left) and recovery (right)

Source: Rosstat; World Bank staff estimates.

The financial crisis had a strong impact on SMEs, but regions with sizable SME sectors
are also recovering faster. Small firms are particularly vulnerable due to their weaker financial
structure, heavy dependence on credit, and limited recourse to financial markets. But faced
with sharply tighter budget constraints, the response of the surviving SMEs seems to have
been in cutting costs, adjusting production to lower demand, searching for additional sources
of liquidity, and postponing or even canceling new business ventures. So while regions with a
higher proportion of SME employment had higher unemployment, they are recovering faster
than the rest of the country.

Figure 3.4. SME employment and changes during (left) and the crisis (right)

Source: Rosstat; World Bank staff estimates.

22 | Russian Economic Report. № 23. November, 2010

 Similarly, FDI flows to Russia (especially some of the larger regions) were significantly
affected during the crisis, but the recovery seems related to FDI and investment climate in
regions. During the crisis, FDI dropped everywhere. Regions with higher FDI in 2010 also
had higher industrial production. More developed regions that were more exposed to foreign
trade and foreign investments were most affected in terms of the loss of FDI. But some of
these same regions are only slowly recovering. Interestingly, some of the smaller regions with
a larger share of foreign direct investment and better investment climate show less unemployment
in the recovery (figure 3.5).

Figure 3.5. Foreign direct investment in Russia’s crisis and recovery

Source: Rosstat; World Bank staff estimates.

In sum, regions that suffered most are the most developed, but they are not necessarily
leading the recovery. Preliminary regressions of regional unemployment (explained vari-
able) on a number of correlates (explanatory variables) suggests important roles for higher
investment rates, higher GDP, openness, and the share of non-tradables in facilitating the
labor market recovery. But diversity is huge during the recovery. One tentative result is that
regions with a larger share of SMEs, better investment climate, more FDI, and stronger finan-
cial sector presence tend to show a more robust recovery. The crisis may have provided an
opportunity for reform and an impetus to rethink and accelerate public sector, financial, and
diversification reforms at the regional levels.

III. In Focus: Unemployment and Recovery Across Regions | 23

24 | Russian Economic Report. № 23. November, 2010
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