After a decade of high growth, rising real incomes, and poverty reduction, the global crisis has severely hit Russia on the growth, employment, and poverty fronts. The impact of the crisis worldwide is proving far deeper and broader than previously thought. The impact on Russia has been accentuated by its structural vulnerabilities: dependence on the oil and gas sector, a narrow industrial base, and a limited small and medium-size enterprise sector. Early labor market and poverty impacts have been severe. As a result, Russia’s real GDP is now likely to contract 4.5 percent in 2009 and unemployment will probably rise to about 12 percent by the end of the year, with attendant impacts on poverty. This is a massive deceleration from the 5.6 percent growth achieved in 2008, in the context of full employment until last September. Though large fiscal reserves and a low debt level will enable the government to finance a fiscal deficit, fiscal space for further support to the economy is rapidly shrinking. Against this background, the question arises: what has been the fiscal policy response so far––the main anti-crisis instrument at the government’s disposal––and what more can be done to cushion the impact of the crisis.

Fiscal Response: Targeting Banks and Firms Rather Than Households
Russia’s early fiscal policy response has so far focused on supporting the financial sector and enterprises, with rather limited support to households. The total fiscal cost of measures implemented in 2008 and planned for 2009 amount to more than 2.9 trillion rubles or about 6.7 percent of GDP. This is larger than that implemented in most G20 countries. These measures are aimed mainly at (1) strengthening the financial sector and (2) providing fiscal support for enterprises. As the crisis has progressed from the financial sector toward the real economy, afflicting domestic demand, growth, and employment, the policy focus has begun shifting in that direction.

The majority of measures (partly conditional) provide fiscal support to firms through a lower tax burden and direct support to key industries of strategic importance. The government of Russia has published a list of 295 strategically and 1148 regionally important firms that are eligible, in principle, for direct state support. In 2009, up to 276 billion rubles (about U.S. $8.1 billion) from the federal budget and 300 billion rubles (about $8.5 billion) in state guarantees (an off-budget item) will be allocated for direct state support to strategic firms. These companies are spread across various economic sectors, and about 75 percent are large firms. The support seems geared toward large, established firms.

Supporting the Vulnerable: Limited Interventions in the Labor Market
Fiscal stimulus measures include some support for labor market interventions, but this represents a small share of the total fiscal stimulus package. Labor market interventions include active labor market measures and higher unemployment benefits, but implementation will be a challenge because of regional capacity constraints. The planned active labor market measures include providing on-the-job training, creating temporary work programs for the unemployed, ensuring direct support to households, including facilitating internal labor mobility, and providing support for small and medium enterprises. Also, the upper limit for unemployment benefits was increased to 4,900 rubles a month, from 3,124 rubles a month, in January 2009. But given the paucity of the initial benefits, this increase is unlikely to provide much cushion to the unemployed. That fewer than a third of all unemployed are officially registered further limits the effectiveness of this measure.

Employment and poverty impacts have been severe. The impact of the crisis on households has worked through adverse effects on aggregate demand, labor demand, and asset prices. It is estimated that aggregate unemployment in Russia will increase by 2.7 million people in 2009, reflecting both a contraction in employment levels as well as changes in the sectoral structure of employment. The sectors most affected will likely be manufacturing, construction and retail trade (figure 2). Based on the growth outlook and household survey data, the number of poor people in Russia will likely increase by 2.75 million, wiping out much of the gains in poverty reduction in recent years. This translates into a likely end-2009 headcount poverty rate of 15.5 percent, an increase of 2.84 percentage points relative to the 2008 pre-crisis level. In comparison with the pre-crisis growth path, this implies that the number of poor people increased by around 1.1 million in 2008 and would increase by another 4.7 million in 2009 (figure 1).


Figure 1.
Projected number of poor people before and after the crisis (in millions), 2008-09

 

 

Figure 2. Projected loss of employment, by sector, in 2009c

Source: World Bank staff preliminary simulations based on aggregate output forecast and household survey data on employment and incomes.

Adjusting the Fiscal Policy Response: Targeting Households, Infrastructure, and Small- and Medium-Sized Enterprises
The social impact unfolding suggests that the focus of future policy should shift towards cushioning the impact on the poor and vulnerable. This target group has a high propensity to consume but cannot afford expensive imported goods or lacks savings balances that could be converted into foreign exchange. So, such pro-poor public spending would also support aggregate consumption at a time of collapsing demand. In practice, this means, a temporary increase (say, over a 12-month period) in social assistance spending (child allowance), unemployment benefits, and low-end pensions. The fiscal implications of such a possible package are not marginal, but the package is affordable.

A modest increase in government spending oriented to those most in need can produce significant poverty alleviation impacts. Increasing the budgets of three social protection programs by about 1 percent of GDP over a period of one year indicate that such a package would be affordable. It would raise the 2009 fiscal deficit by at most about 0.75 percentage point of GDP (because it would extend into early 2010) and would still be financeable from the reserve fund. If some unproductive expenditures could be cut to make room for this stimulus, the net impact on the budget would be even smaller. Simulations of the impact of the proposed temporary increase suggest significant potential to cushion the impact of the crisis on the poor.1 The headcount poverty rate would drop by 2.9 percentage points, to 12.6 percent, comparable with pre-crisis level, and about 4.1 million people would be lifted out of poverty. The size of Russia’s reserve fund allows it to finance its fiscal deficit this year, including this additional social assistance package and still have funds left for part of the next year under the current scenario outlined in the Russian Economic Report.

But there are three major risks to this economic and social scenario. First, if an additional social assistance package of this type is delayed and the social impact continues to unfold as anticipated, there is a risk of social tensions in regions that are particularly hard hit by the crisis. Second, if the impact of the real economy on the quality of bank portfolios develops more rapidly, there is a risk of a second-round impact on the financial sector with attendant, additional fiscal costs and pressure on the banks. And third, there is a global risk that the world economy recovery is delayed later in 2010 or even 2011, which would imply a prolonged period of low (or even lower) oil prices. If any or all of these risks materialize to a significant extent, Russia could be forced to implement significant fiscal adjustment earlier than anticipated, with challenges in terms of revenue, expenditure, and financing; yet, the latter should clearly be possible given Russia’s low debt level and creditworthiness.

 

This brief note was prepared by Zeljko Bogetic, lead economist for Russia at the World Bank.  This note is a resume of a larger, Russian Economic Report No. 18 (March 2009) analyzing recent economic developments and fiscal policy response in Russia.


1We assume an increase in child allowances by 220 percent, an increase of the unemployment benefit budget by 70 percent and an increase of 20 percent of the pensions of 30 percent of pensioners living on lowest pensions. These programs target the most vulnerable groups and have superior targeting characteristics compared to other parts of the social safety net. The temporary stimulus programs would run for the period from April 2009 to March 2010 and would automatically expire at that time under the assumption that the economic recovery (return to positive growth) would get under way, eliminating the need for extensions and extraordinary measures. Alternatively, if the recovery is delayed, the program could, in principle, be extended for another six months or a year.