By Daniel Hunter

Real GDP growth in Russia has slowed, amid weak investment and external demand, according to the International Monetary Fund (IMF). Yet, the economy remains close to full capacity, with unemployment at historic lows and capacity utilization at pre-crisis highs.

Short-term indicators are mixed, but on balance suggest some recovery of activity in recent months, indicating a stronger growth outlook for the second half of this year. Inflation has remained above target on the back of food prices and regulated tariff hikes, but has started to decline gradually since June.

Recent global financial market turbulence has put some pressure on the exchange rate, the local bond market, and equities, and may have contributed to an acceleration of capital outflows. The current account surplus has been shrinking, reflecting growing imports and deteriorating service and income account balances.

The near-term outlook is for moderate growth and inflation at the upper end of the target range of the Central Bank of the Russian Federation (CBR). Staff projects real GDP growth at 1.5 percent in 2013 and 3 percent in 2014, assuming that the global environment improves as expected, and no downside risks are realized. Inflation is projected to abate to 6.2 percent (year-on-year) by end-2013 as the effects of temporary supply-side shocks fade, but to remain above the authorities' target range of 4 to 5 percent next year.

The fiscal policy stance has turned roughly neutral. The general government balance was in surplus in 2012, but is turning negative in 2013 as revenue growth has shown some weakness, but expenditure restraint has kept the non-oil balance roughly unchanged from last year. The Reserve Fund balance has increased following deposit of 2012 oil savings, but remains well short of the government's 7 percent of GDP target.

Against the backdrop of continued high inflation, the monetary policy stance has remained on hold throughout the first half of 2013. The CBR has gradually lowered some secondary rates on longer-term facilities in an effort to strengthen monetary transmission. Money market rates edged up in 2013:Q2 and liquidity conditions have been volatile, driven by the budget cycle and seasonal factors. The increased flexibility of the exchange rate should help maintain external balances in line with medium-term fundamentals.

Overall credit growth has slowed, but unsecured consumer lending continues to expand at a rapid pace. The slowdown in corporate credit has been mainly demand-driven, reflecting low investment and working capital financing, due to slower economic activity, while declining bank capitalization and tightened prudential regulations beginning to constrain the supply of credit.

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