PRESS CONFERENCE WITH IMF MOSCOW OFFICE HEAD PAUL TOMSEN, INTERFAX, JUNE 3, 2005
Source: www.fednews.ru
Moderator: Good morning, dear colleagues. The IMF mission has completed its work and is leaving Moscow. Today we will be able to find out the results of the mission's work.
Let me introduce the participants: Paul Tomsen, the IMF mission head, Lorenzo Figliuoli, the head of the Russia branch, Neven Mates, the head of the IMF's Moscow office, and Alexei Mozhin, IMF executive director representing Russia. I am giving the floor to Mr. Tomsen.
Tomsen: Thank you very much. First, thank you for the opportunity to explain the mission's findings. By way of introduction, let me explain that we are here to undertake what we in the IMF call the annual Article 4 consultation. It's a kind of mission we have in all our member countries where we discuss their economic policies and prospects.
I will briefly summarize our main findings and then we can take question afterwards.
As to recent developments in the economy, developments in the middle of last year when we had our last consultation mission, it is clear that there has been a notable slowdown in GDP growth. Interestingly, this slowdown in growth last year took place despite the fact that total demand actually increased, both domestic demand and foreign demand. But this increasing demand entirely spun over into higher imports and somewhat increased inflationary pressures. This suggests that the economy after five, six, seven years of robust growth but still relatively low level of investments might be experiencing some constraints on the supply side. I see that by way of introduction because we do not -- we believe that what's happening, what happened last year, is certainly not due to a lack of demand in the economy. Looking forward, we believe that GDP will grow by about 5.5 percent in 2005. This is close to the government's revised estimate. Now, let me stress that this projection is subject to unusually high uncertainty because of uncertainty regarding oil exports and about the investment climate.
Let me move to a discussion of economic policies. AS you know, the government decided this week to amend the 2005 budget. It's planning a major increase in expenditures. The original 2005 budget already entails some relaxation of fiscal policy. This amendment will significantly increase this relaxation. At the same time, as the government was discussing what to do with the 2005 budget, it is also considering the budget for 2006, and the preliminary plans discussed with us will entail a further significant relaxation in 2006. In effect, what is happening is that Russia is now speeding up significantly the pace at which it is spending oil windfalls. We asked ourselves at what oil price would the budget have been balanced in 2004, 2005 and 2006.
In 2004, it was an oil price of $23 per barrel that we would have had a balanced budget. In 2005, it is $28 per barrel. And that is even before we consider the further -- second amendment of the budget that might take place in the second half of the year. And next year it will increase to $31 per barrel. And keeping it to $31 will in our view be an ambitious task because of the promises to increase pensions and wages, the plan to increase investment while at the same time trying to adhere to the target of actually lowering total non-interest expenditures relative to GDP.
Now, we believe that such a major relaxation of fiscal policy at a time when the private sector demand is already significantly outpacing the economy's growth potential will translate into higher inflationary pressures. It will also spill over into much higher imports. Now, high inflationary pressures at this time will mean a faster real appreciation of the ruble and eventually will require higher real interest rates. So where this fiscal adjustment do little to help growth in the short run because limitation on the growth potential, it could actually damage growth in the long run by accelerating the pace of real appreciation and causing high real interest rates.
Thus, the current cycle composition of the economy and the current relatively strong demand pressure suggest to us that the government should reconsider the pace at which it is relaxing fiscal policy.
Allow me to look at the same issue in a somewhat longer-term perspective. The relaxation of fiscal policy that is taking place is almost entirely for the purpose of increasing pension, wages and other recurrent expenditures. These are expenditures that will not increase the potential growth rate of the economy. Due to the slowness of reforms, and I will come to that later, the oil wealth is not being spent to support an accelerated modernization of the economy.
We fear that at best, if this policy of relaxation for the purpose of increasing current expenditures continues, Russia will miss an opportunity to advance its modernization, to accelerate its modernization. At worst, it could require painful and prolonged fiscal tightening if oil prices were to drop in the future. Thus, while this is certainly a case for spending more of the oil windfall gains over the medium term, we believe that they should continue to be saved in the Stabilization Fund with a largely unchanged benchmark price until the government is ready to use this money in support of structural reforms.
Let me stress that I think that if we look back at the last three or four years, macroeconomic policy has been quite successful in slowing the real appreciation. Considering the size of the balance of payment surplus, there was a risk of a much faster real appreciation and much higher inflation and much lower growth as a result of a fast real appreciation. But because of what was a very prudent fiscal policy of largely saving the oil revenue and prevent overheating in the economy, the recovery was prolonged, and to a large extent because of this prudent fiscal policy. And I think this policy has served Russia well and should be preserved until reforms take hold and the growth potentials pick up.
Let me briefly comment on other issues. Monetary policy. Monetary policy continues to suffer from a pursuit of objectives that are actually inconsistent, namely the attempt to slow the appreciation, while at the same time bringing down inflation. We believe that over the medium term it is not possible for monetary policy to prevent real appreciation of the ruble in the face of a strong balance of payment surplus. Only tight fiscal policy can prevent such a real appreciation. Trying to prevent it by resisting normal appreciation is just causing higher inflation, and the real appreciation takes place through inflation, higher inflation, rather than through normal appreciation.
Now, the Central Bank officials are of course aware of these dilemmas, they live with them every day. We believe what is needed is a greater emphasis on inflation reduction, broad political support for the Central Bank deciding to give higher priority to inflation reduction, which will require during times when inflation is sort of under upward pressure that the Central Bank step back or scale back its foreign exchange interventions and allow some more appreciation of the ruble. So, what we are suggesting is what we have said before: there is a need for somewhat more flexibility in the exchange rate policy.
As to the official target of 8.5 percent, achieving this would be, should I say, very challenging. It's obviously -- it appears to be very difficult to achieve. But the more important point is not so much the target as a policy that clearly says that a steady reduction in inflation is a priority of the Central Bank.
Finally, a few words on structural reforms. Since we were here last year, there have been further improvements in the banking system in the context of the assessment by the Central Bank of which commercial banks can be admitted to the new deposit insurance scheme. But outside the banking system, and leaving aside the social sector reforms, which while there were problems in implementation, were certainly reforms in the right direction, we think that there has been very limited progress in structural reforms.
Most of the reforms that are priority to the new government -- housing, health, education -- are running well behind schedule with no progress in some areas. This is, of course, an assessment that is shared by many people, and it's an assessment that doesn't come as a surprise to our interlocutors in the government. So, I am not saying anything particularly insight for them.
The government knows that in many ways the challenge it is facing is to accelerate reforms, particularly those reforms that promise to improve the investment climate, which clearly has been impaired somewhat by the sense of the lack of direction in structural reform policies and by the YUKOS affair. I think I'll leave it at this for the time being and take any questions you might have.
Tomsen: Let me just -- I should have introduced my colleagues. Mr. Mates is our resident representative in Moscow, who is available when we are not here to answer your questions. Mr. Figliuoli is the head of the Russia division at the IMF headquarters. And Mr. Mozhin doesn't need any introduction. He is director representing Russia at the IMF's Executive Board.
Q: You mentioned uncertainties with regard to the Russian investment climate. What do you think would be the impact of the Khodorkovsky verdict on Russia's investment climate?
Tomsen: Well, I cannot speculate about the impact of the verdict. I think it is clear that this affair, rightly or wrongly, has left the impression of increased interventionism, perhaps of heavy-handedness by some regulatory agencies. Now, the investment climate is something that actually you cannot measure. What we can see is that investments did slow in the course of 2004. And although they have recovered somewhat, they are only below what they were, let's say, a year ago. Whatever the reason, I think that it should be a priority to send positive signal on structural reforms and make it clear that rules and regulations will be enforced in an open and even-handed manner.
Let me stress that the slowdown of GDP that we are projecting from 7.1 last year to 5.5 according to our estimate, and 5.8 according to the government, is mostly due to lower export volumes and not mainly due to lower investments.
Q: I have two small questions. First, when will the big mission arrive because I understand this is a preliminary mission? And also, are IMF recommendations binding on the government? And second, given the current situation that you have described, do you think it would be proper for some people to raise the issue of removing Russia from the Group of Eight?
Tomsen: On the first question, on the mission, this was the big mission. No, IMF recommendations are not binding on member countries. It's a dialogue with the government and hopefully our views and our advice will help the government take the right decision regarding the implementation of macroeconomic policy.
On the second question about G-8, this is outside our area of expertise. It's a political question, and I'll pass on that.
Q: What do you think about tax policies and particularly tax administration and control measures that the government intends to introduce to the State Duma? And in particular, about the suggestion to replace the VAT with a sales tax.
Tomsen: On the other part of your question, replacing the VAT with the sales tax, first this has not been proposed in our discussions with the Russian government as far as I am aware of. There is a long-standing plan to reform the VAT and particularly to cut VAT rates. As you know, this plan was put on hold for the time being because of the pressures on the expenditure side. Although I understand that one hopes to return to the issue of VAT reforms as soon as possible.
We believe that the VAT is one of the best taxes in that it doesn't distort economic decision-making. It's an efficient tax from that point of view. It's also a tax that is more difficult to evade than some other taxes. For that reason, I believe it would be a mistake to replace this tax with a sales tax. As to the reforms of the VAT, we continue to see merit in unifying the VAT rates, getting rid of the dual rates and of the exemptions. But given the pressures on fiscal policy at this moment, in our view, it would be a mistake to reform the VAT in a manner that would entail a loss of revenue and we believe it's important to unify the rates at a level that would not be a source of loss.
As for the proposals in the area of tax administration, as far as I understand, they have not been discussed with our experts during this mission in any details. So, I would not comment on them here.
Q: I have a rather general question because the question of VAT versus sales tax is only a part of the whole picture. Mr. Dvorkovich has suggested that basically the tax burden should be shifted from corporations to individuals. What is your view of this? And my second question is what was the government officials' response to your suggestions?
Tomsen: Let me pass this question on to my colleague who has a background in fiscal policy and tax issues.
Figliuoli: I think my colleague is too generous, but anyhow I'll try to answer. As far as I understand, first of all, the comments from Mr. Dvorkovich were in fact comments, they were not yet a formal proposal. And it's very difficult to comment on comments. To the extent that there will be a formal proposal with details about what is intended to do, then we can make formal comments and make observations, recommendations and give our specific ideas.
Second, concerning the shifting of -- possible shifting of burden of taxation from corporations to individuals, I think one must admit that in countries in transition normally the taxation in the corporate sector tends to be a bit higher than it is in advanced economies. However, once you take into account also that the level of taxation for individuals depends also on the income per capita of the country that we are talking about, I think that Russian has gradually moved over the years towards increasing the taxation of individuals already and although the income per capita has increased, at this stage I think it's difficult to make a clear statement as to whether the taxation of individuals should contribute significantly more to the take of the government.
My personal sense -- but is not an official position of the IMF -- is that there might be some additional rule, but when there is a specific proposal, we'll be able tow work out the details and see whether there is such a rule.
Finally, on the issue of the sales tax versus the VAT. As you know, the VAT as Paul was saying just a few minutes ago, is probably one of the least distortionary taxes that exist. Behind the proposals to replace the VAT with the sales tax lies the idea that sales taxes are easier to implement than the VAT because there is no this crediting multistage system that goes with the VAT. However, normally countries which have a sales tax which are fewer and fewer around the world try to prevent the distortions that go with the sales tax. And in order to avoid this distortion, you end up with a sales tax that is not simpler to administer than the VAT. Indeed, it may be more complicated. That's all.
Mozhin: There was another question regarding the attitude by the Russian authorities, the reaction of the Russian authorities to the IMF position.
Tomsen: Let me say we are not, first, telling the government something that many people in the government are not aware of. There is clearly concern within the Ministry of Finance that the fiscal relaxation is very large and that, as a result, inflationary pressures could rise. And clearly the Central Bank officials are aware of that relaxation will make it more difficult to conduct monetary policy and make it more difficult to bring down inflation.
Q: You have mentioned that structural reforms have slowed down in sectors other than the banking sector? What reforms should be priorities?
Tomsen: We believe that there are many reforms that still lie ahead. The government should give priority to those that are most important for the investment climate. This includes administrative reform and reform of the civil service, reforms of the natural monopolies -- the natural monopolies are still a big drag on the economy because they are inefficient. But we also believe that the social sector reforms, health and education, are important because more efficient public sector spending is crucial as we go forward and because these reforms are improving the level of education and healthcare, which will have an impact on the growth potential over the very long run.
I think the real message here is that all of these areas are on the government's agenda, long-term agenda. I am not aware of one single area where we think that reforms should be, where there is a need for reform where the government does not have a very comprehensive plan for reform. I would go even further: in all of these areas, the objectives and broad conceptual framework for reforms are, in our view, entirely appropriate.
But despite the fact that we think that the agenda is right and the plans are right, the issue is that the actual progress in preparing and adopting and implementing reforms is very limited.
Q: What are your inflation projections? What is your view of the results of the Paris Club deal? And what are the threats the Russian economy is facing?
Tomsen: First, on inflation, as I said, I believe it will be very difficult to achieve the official target. And it is a more important issue to steadily bring down inflation. Given that inflation is running right now at 13.7 or something like that year on year, I think it would be very difficult to get it down to single digits. And I think it would be an achievement if inflation gets down to 10.5-11 percent.
Secondly, on the Paris Club prepayment, we fully support it, we think it's a very sensible move, it makes sense, good sense from an economic point of view to do this.
And the last part of your question, the major threat to Russia, I am sure most people would say, expecting to say that that is low oil prices. But I am not saying that. I think the real threat to Russia is that it spends oil revenue windfall, the use of oil revenue wealth that it's receiving right now, that it spends it in the wrong manner, in a way that if oil prices decline, it would be very difficult to deal with results of the decline. I think this is a real challenge facing Russia, how to spend this oil wealth over the medium term, not spend it now on wages, pensions, recurrent expenditures, but spend it over the medium term on reforms that will help lift the growth potential and make the economy more flexible and better prepared to deal with lower oil prices. Thank you very much.
And just to illustrate how good we are at predicting, I will tell you that I was told it would be completely impossible to get Russian journalists to show up for a press conference at nine o'clock in the morning. We proved them wrong. Thank you very much for coming.
Moderator: Thank you very much.