RUSSIA’S ECONOMY LOSES MOMENTUM AMIDST COVID-19 RESURGENCE; AWAITS RELIEF FROM VACCINE 44 RUSSIA ECONOMIC REPORT DECEMBER 2020 Overview RUSSIA’S ECONOMY LOSES MOMENTUM AMIDST COVID-19 RESURGENCE, AWAITS RELIEF FROM VACCINE SPECIAL FOCUS: RUSSIA INTEGRATES: DEEPENING THE COUNTRY’S INTEGRATION IN THE GLOBAL ECONOMY 44 RUSSIA ECONOMIC REPORT DECEMBER 2020 Russia Economic Report| № 44. December 2020 This report is produced twice a year by World Bank economists in the Macroeconomics, Trade and Investment (MTI) Global Practice. The team that prepared this edition was led by Apurva Sanghi (Lead Economist for the Russian Federation) and Olga Emelyanova (Economist, MTI), and consisted of Irina Rostovtseva (Research Analyst, MTI), Lucie Wuester (Consultant, MTI), Katerina Levitanskaya (Senior Financial Sector Specialist, FCI), Peter Stephen Oliver Nagle (Senior Economist, EPGDR), Collette Mari Wheeler (Economist, EPGDR), Damien Matthias Valentin Boucher (Consultant, EPGDR), Samuel Freije-Rodriguez (Lead Economist, POV), Mikhail Matytsin (Data Scientist, EPVGE), Anya Vodopyanov (Public Sector Specialist/ Economist, EECG2), and Alberto Leyton (Lead Public Sector Specialist, EECG2). The focus note on Russia’s participation in GVCs was produced by the World Bank team co-led by Apurva Sanghi (Lead Economist) and Ian Gillson (Lead Economist). The core team consists of Olga Emelyanova (Economist), Lucie Wuester (Consultant), Calvin Djiofack (Senior Economist), Jagath Dissanayake (Consultant), Deborah Winkler (Senior Consultant), Karen Muramatsu (Consultant), Irina Rostovtseva (Research Analyst), Laura Gomez-Mera (Consultant), Yue Li (Senior Economist) and Priyanka Kher (Private Sector Specialist). Peer reviewers included Sjamsu Rahardja (Senior Economist, EECM1, MTI) and Yaroslav Lissovolik (Chief Managing Director, Head of Analytical Department of Global Markets, Sber CIB, Russia). The team would like to thank Renaud Seligmann (Country Director for the Russian Federation), Sandeep Mahajan (Practice Manager, MTI Global Practice), Asli Demirguc-Kunt (Chief Economist, ECACE), Michael Lokshin (Lead Economist, ECACE) for their comments, advice and support. The team also would like to express their gratitude to the Department for the budget policy and strategic planning of the Ministry of Finance for the collaboration. The report was edited by Christopher Pala (Consultant). This report went to press on December 16, 2020. For queries, please contact Apurva Sanghi at asanghi@worldbank.org. TABLE OF CONTENTS ABBREVIATIONS AND ACRONYMS.................................................................................................................................... VII OVERVIEW.......................................................................................................................................................................... IX PART 1. RECENT ECONOMIC DEVELOPMENTS.....................................................................................................................1 1.1 Global activity: COVID-19 resurgence threatens to interrupt the incipient recovery............................................................. 2 1.2 Russia: Russia’s GDP contracted in Q2 and Q3, with negative momentum expected through Q4 amidst rising cases and re-installment of restrictions........................................................................................................................................... 6 1.3 Balance of payments: Pressures from lower energy export receipts, financial markets volatility and increased geopolitical risks resulted in capital outflow and ruble depreciation................................................................................... 10 1.4 Monetary Policy: The CBR paused its accommodative policy actions.................................................................................. 17 1.5 Financial sector: the Russian banking sector is weathering the pandemic, but the worst may lie ahead........................... 19 1.6 Fiscal policy: Countercyclical policy with deficit mostly financed through domestic debt issuance as revenues are being strained by the pandemic..................................................................................................................................... 22 1.7 Labor market: COVID-19 reduces employment, but policies seem to blunt impact on poverty.......................................... 26 PART 2. OUTLOOK: VACCINATION SPREAD IN 2021 IS EXPECTED TO PUT THE ECONOMY ON THE PATH OF SUSTAINED RECOVERY.................................................................................................................................................. 33 PART 3. RUSSIA INTEGRATES: DEEPENING THE COUNTRY’S INTEGRATION IN THE GLOBAL ECONOMY.................. 39 1. Motivation.............................................................................................................................................................................. 40 2. Russia’s participation in GVCs................................................................................................................................................. 42 3. Opportunities for GVCs to drive Russia’s future economic growth........................................................................................ 48 4. Policy recommendations for Russia to seize the gains from GVC opportunities.................................................................... 53 References.................................................................................................................................................................................. 62 LIST OF FIGURES Figure 1: Almost all global commodity prices rose in Q3 2020, although with some divergence between commodities............... 3 Figure 2: In May, OPEC+ have implemented a historic production cut (change in OPEC+ crude oil production since January 2020)........................................................................................................................................................... 3 Figure 3: Global industrial production and manufacturing PMI experienced an initial rebound..................................................... 3 Figure 4: After stabilization of new daily COVID-19 cases, a resurgence of the virus began in Q4 2020......................................... 3 Figure 5: Global goods trade volumes improved but services trade remained depressed.............................................................. 4 Figure 6: Equity markets gradually recovered from earlier lows but experienced bouts of volatility.............................................. 5 Figure 7: Remittances inflows to EMDE regions are projected to face steep declines, particularly in Europe and Central Asia.....5 Figure 8: After relaxing stringency measures, the euro area was forced to re-introduce restrictions due to a surge in new COVID-19 cases...................................................................................................................................................... 5 Figure 9: The recovery in China has been robust, particularly investment...................................................................................... 5 Figure 10: The second wave of Covid-19 hit Russia in September................................................................................................... 6 Figure 11: Excess mortality has been relatively low in Russia, compared to other countries.......................................................... 6 Figure 12: In Q2, faced with domestic supply and demand, and terms of trade shocks, Russia’s GDP dropped by 8 percent, y/y............................................................................................................................................................. 7 Figure 13: Energy exports registered growth partly due to rebound in China and base effect........................................................ 7 Figure 14: Compared to the EU-27, both industrial sectors and services sectors in Russia were more resilient to the shocks induced by the COVID-19 pandemic......................................................................................................... 7 Figure 15: Negative momentum is expected in Q4.......................................................................................................................... 8 Figure 16. An increase in general government spending was concentrated in health, social policy and support to economy categories..................................................................................................................................................... 8 Figure 17: PMI indexes point to more robust resumption of economic activity in Russia’s services than in other countries:........8 Figure 18: The number of SMEs fell by 4.2 percent between October 2018 – 2020....................................................................... 9 Figure 19: The current account declined sharply, mostly due to lower goods exports.................................................................. 11 Figure 20: Merchandise exports and imports value fell sharply in 2Q 2020 and 3Q 2020, y/y...................................................... 11 Figure 21: Goods exports values remained below 2019 levels in the first three quarters of 2020................................................ 11 Figure 22: Travel and transport services exports dropped sharply in Q2 and Q32020.................................................................. 11 Figure 23: Commodity prices picked up in the third quarter of 2020............................................................................................ 12 Figure 24: Oil exports volumes to China rose in 2Q2020, y/y, but fell again further in 3Q 2020................................................... 12 Figure 25: Exports to the EU fell sharply, trade with China showed a more moderate decline amidst an earlier recovery (y/y, percent change)..................................................................................................................................... 13 Figure 26: Imports declined most sharply in 2Q2020, with some recovery in 3Q 2020 (y/y, percent change)............................. 13 Figure 27: RTS index did not restore to the pre-pandemic values................................................................................................. 13 Figure 28: Increased capital outflow amidst financial volatility and geopolitical risks put pressure on the ruble exchange rate............................................................................................................................................ 14 Figure 29: The CBR paused its accommodative policy actions....................................................................................................... 17 Figure 30: In October, the annual headline CPI inflation reached the CBR’s target of 4 percent................................................... 18 Figure 31: The de-dollarization of bank balance sheets reduces FX risks...................................................................................... 20 Figure 32: Banks’ key credit risk and performance indicators remained largely stable, supported by large-scale regulatory forbearance measures................................................................................................................................. 20 Figure 33: Credit growth has been maintained due to the public support measures (Ruble credit growth, y/y)..........................21 Figure 34: As a result of the government program, the share of mortgage loans in total bank loans issued to households increased sharply................................................................................................................................... 21 Figure 35: The number and volume of mortgage loans issued by the banks significantly increased............................................ 21 Figure 36: The federal budget surplus turned into deficit in the first ten months of 2020............................................................ 23 Figure 37: In January – September 2020, spending on the National Projects was relatively slow, but it accelerated by end-November......................................................................................................................................................... 23 Figure 38: Government bond yields spiked in March..................................................................................................................... 24 Figure 39: Regional budget moved into deficit as expenditure rose, revenues increased on the back of transfers...................... 24 Figure 40: Debt burden rose in the majority of regions (debt/tax and non-tax revenue).............................................................. 24 Figure 41: Russia’s fiscal impulse in 2021 – 2022 suggests deeper consolidation than for other EMDEs and MICs......................25 Figure 42: Labor force participation rates have not changed noticeably, but employment rates decreased................................26 Figure 43: The unemployment rate has increased by two percentage points over the year......................................................... 26 Figure 44: The unemployment rates increased in all federal districts........................................................................................... 27 Figure 45: Job losses concentrated in three economic activities: manufacturing, construction and retail/hospitality services........................................................................................................................................ 27 Figure 46: Disposable Income and its allocation to consumption at lowest levels since 2014 during the 2nd quarter of 2020............................................................................................................................................................. 28 Figure 47: The National Poverty Rate has increased in the first half of the year, but is still below the comparable period of previous two years........................................................................................................................................ 28 Figure 48: Social policies compensate for the increase in poverty rate......................................................................................... 29 Figure 49: Simulations of changes in disposable income for year 2020 show important differences across demographic and geographic location groups.............................................................................................................. 30 Figure 50: The pandemic is anticipated to have a prolonged impact on oil consumption, which is expected to remain 5 percent below its pre-pandemic levels by the end of 2021 (crude oil demand forecasts)........................ 34 Figure 51: High levels of spare capacity among OPEC+ countries reduces the likelihood of a sharp rise in prices (spare production capacity among OPEC+ countries)..................................................................................... 34 Figure 52. The second wave of COVID-19 is more.......................................................................................................................... 35 Figure 53: Biweekly cases per million people started rapidly growing since September............................................................... 35 Figure 54: Stringency index increased in September in Russia, but remained below March levels............................................... 35 Figure 55: The growth forecast for Russia suggests a recovery in 2021 (real GDP growth, percent)............................................. 36 Figure 56: The share of manufacturing exports in Russia is about three times less than the global average................................ 42 Figure 57: The value of Russia’s goods exports far exceeds those of services, billion US$............................................................ 43 Figure 58: Russia’s FDI is largely driven by its natural resource endowments and originates more from tax havens................... 43 Figure 59: Russia is second-tier in the global FDI network............................................................................................................. 44 Figure 60: Russia’s backward participation is lower compared to its peers, but its forward participation is higher..................... 45 Figure 61: Russia’s goods export basket has moved closer to final demand, while imports have moved slightly upstream......... 46 Figure 62: The contribution of broad sectors to value-added in Russia......................................................................................... 46 Figure 63a: Russia’s trade openness is lower than expected given its national income level (2018)............................................ 47 Figure 63b: Russia’s commercial services trade is lower than expected given its national income level (2018)........................... 47 Figure 64: Russia has the potential to trade more with some large economies, including China.................................................. 47 Figure 65: Russia’s manufacturing exports show more diversified linkages to domestic upstream sectors.................................. 48 Figure 66: Russia’s IP payments and receipts as percentage of GDP grew strongly over 2005-2018............................................. 49 Figure 67: Traditional services and markets dominate Russia’s services exports (composition of Russia’s services exports, 2018)................................................................................................................................................. 50 Figure 68: Russia’s share of domestic services in non-services exports is lower compared to its peers....................................... 50 Figure 69: The share of modern services used for manufactured exports in Russia is relatively low (Composition of domestic services value added in manufactured exports, Russia and comparator countries, 2015)............................................................................................................................................................ 51 Figure 70: Multinationals are larger, more productive and more successful in tapping into GVCs................................................ 51 Figure 71: Spillovers from foreign firms to domestic firms in Russia are positive in sectors with more competitive markets......52 Figure 72: While many firms in Russia spend on R&D, few firms innovate.................................................................................... 53 Figure 73: Import tariffs on primary and manufactured products in Russia have fallen but they remain higher compared to some comparator countries......................................................................................................... 54 Figure 74: Russia faces the longest times and highest costs to trade across borders.................................................................... 55 Figure 75: Reductions in non-tariff trade costs would deepen Russia’s integration in RVCs and GVCs......................................... 56 Figure 76: Russia is services trade restrictive (average STRI across all sectors, 2018)................................................................... 56 Figure 77: Russia’s trade costs in services are the highest among peers....................................................................................... 57 Figure 78: Perceptions of low institutional and regulatory quality in Russia deter FDI................................................................. 59 LIST OF TABLES Table 1: Balance of payments accounts, US$ bln........................................................................................................................... 14 Table 2: A gradual rebound is projected in 2021 - 2022 (Major macroeconomic Indicators)........................................................ 36 LIST OF BOXES Box 1: The Covid-19 crisis has affected regions through external and internal demand channels to varying extents based on exposure to the pandemic, pre-existing conditions and the type of activity......................................................... 9 Box 2: China’s share in Russia’s trade turnover continues to rise, especially in oil, as the Covid-19 crisis reinforces pre-existing trends.............................................................................................................................................. 15 Box 3: The US dollar share in Russia’s exports is declining, notably in trade with China and India............................................... 16 Box 4: Central Bank of Russia is exploring central bank digital currency....................................................................................... 22 vi Russia Economic Report | № 44. December 2020 Recent Economic Developments and raising the progressive personal income tax (PIT). According to data from the World Inequality Database, about 0.5 percent of Russian adults have a taxable income of Rub 5 million per year. With an adult population of about 114 million people, this means Russia has 570,000 people who could potentially pay this increased tax (counting only those receiving an income exceeding Rub 5 million). These measures could bring the government 0.4 - 0.5 percent of GDP per year35. At the same time the tax burden for SMEs and IT companies would be reduced. In 2021, about 1.1 percent of GDP will be spent on the plan of actions aimed at restoring economic growth and growth of disposable incomes from the federal budget, mainly on social benefits and infrastructure projects. Expenditures on National Projects will be reduced by 0.1 and 0.2 percent in 2021 – 2022 (-583 billion rubles in 2021 – 2022), compared to the pre-pandemic plans. The substantial part of the cut (about 37 percent) are infrastructure expenditures. The government expects the federal budget deficit to be 2.4 percent, 1.0 percent, and 1.1 percent of GDP in 2021 – 2023. In 2022, the government plans to return to the usual fiscal rule practice: a primary deficit of about 0.5 percent of GDP at the threshold oil price to be mostly compensated through domestic borrowing. 1.7 Labor market: COVID-19 reduces employment, but policies seem to blunt impact on poverty The unemployment rate has increased noticeably from 4.6 percent in October 2019 to 6.3 percent in October 2020 - the highest in the last eight years. The combination of job losses and lower wages led to a decline in average dis- posable income with two important consequences: on allocation of incomes and on poverty. Allocation of disposable incomes changed markedly. The national poverty rate increased from 12.3 percent at the end of 2019 to 13.2 percent in the second quarter of the current year. The economic deceleration may lead to an increase of the poverty rate of up to 14.2 percent in 2020, but compensatory measures may fully compensate for this increase. T he labor force participation rate declined slightly during the first five months of year 2020, but it bounced back in June, reaching 75 percent in October (Figure 42), just below the level for the same month last year (75.6 percent). In contrast, the employment rate, after also declining during the first half of the year, has not fully recovered yet. The employment rate in October 2020 reached 70.3 percent – almost two percentage points lower than in October 2019 (Figure 43). Figure 42: Labor force participation rates have not Figure 43: The unemployment rate has increased by changed noticeably, but employment rates decreased two percentage points over the year Source: Rosstat and Haver Analytics. Source: Rosstat and Haver Analytics. 35 According to the estimate of the Ministry of Finance. 26 Russia Economic Report | № 44. December 2020 Recent Economic Developments Consequently, the unemployment rate has increased noticeably from 4.6 percent in October 2019 to 6.3 percent in October 2020, the highest in the last eight years. Similar rates have not been seen since the aftermath of the 2008 global financial crisis. This increase in unemployment started in the second quarter of 2020, when the effects of the pandemic were first felt. Despite Moscow representing the largest share of COVID-19 cases (26 percent of the cumulative infections as of December 8, 2020)36, all regions experienced a rapid rise in unemployment rates in the second quarter of 2020. This is evidence of a pervasive impact of the lockdown measures across all the territory of the federation, regardless of the incidence of the pandemic (Figure 44). The upward trend in unemployment continued during the third quarter, with the exception of the Far Eastern Federal District, which not only experienced one of the slowest increases in the second quarter, but also saw a decline in the unemployment rate in the third quarter. The Far Eastern federal district may have fared relatively better due to the lower incidence of cases37, but most likely because of the smaller share of employment in economic activities that have been particularly hit by the crisis. In particular, the region has a larger proportion of jobs in public administration than the national average (approximately 12 and 7 percent, respectively), and they are less affected by market fluctuations. In any case, given the larger population size of the Central and North Western federal districts (and the high incidence of COVID cases in their capitals of Moscow and Saint Petersburg) these regions, despite their relatively lower unemployment rates, represent the largest share of total unemployed as of September 2020 (29 percent) and the largest share of newly unemployed over the past year (38 percent). In contrast, job losses were concentrated in only a few economic activities. Total employment declined by 1.5 million jobs between the 2nd quarters of 2019 and 2020. Approximately half a million jobs have been lost in each of three large sectors: manufacturing, construction, and retail and hospitality services. These losses are explained by the lock- down measures and the difficulty of tele-working in these sectors. The other sectors have seen smaller changes – some declining, like agriculture and education, others increasing, like professional services, health and civil service. But they compensated each other in a manner that would have no impact on total employment (Figure 45). It was the job losses in manufacturing, construction, and retail/hospitality that constituted the main source of employment decline. The conditions of the labor market are still loose. Job postings from employers in employment agencies are still well below the total number of unemployed. As of September 2020, the ratio of unemployed to job posts was 2.7, whereas the ratio was 1.9 the same month last year. Interestingly, the number of job postings was not very different from a year ago (around 1.7 million jobs). It is the number of unemployed that has increased, suggesting that these unemployed may come from activities that do not use employment agencies to post job openings. Figure 44: The unemployment rates increased in all Figure 45: Job losses concentrated in three economic federal districts activities: manufacturing, construction and retail/ hospitality services Source: Rosstat. Source: Rosstat. 36  ata on incidence of the COVID 19 pandemic, here and in the rest of the note, from Johns Hopkins CSEE (https://gisanddata.maps.arcgis.com/ D apps/opsdashboard/index.html#/bda7594740fd40299423467b48e9ecf6 ) as of December 8, 2020. 37  For instance, the Primorsky krai has had a cumulative incidence of 1256 cases per 100,000 people, significantly lower than Moscow city with an incidence of 5319 cases per 100,000 people. Russia Economic Report| № 44. December 2020 27 Recent Economic Developments Informal employment has seen an important decline. This type of employment has fallen by 1.9 million jobs between June 2019 and June 2020, reducing the rate of informal employment from 21.5 to 19.4 percent in the period. Comparing this figure to the figure of total job losses suggests that it is informal workers who have borne the brunt of the crisis. Lacking proper labor contracts and concentrating in activities that cannot telework, informal workers have been most affected by the lockdown, underlining their vulnerability. A group particularly affected by lack of jobs and employment losses are migrant workers, who tend to concentrate on activities very affected by the pandemic (i.e., construction, retail/hospitality services) and work under informal contracts. The Russian authorities introduced a series of measures to delay or suspend visa/work permit requirements for migrants, and many of them have been able to keep working in their sectors or work in other sectors; but many others have lost their jobs and returned to their countries or are stranded in Russia, negatively affecting life conditions for them and their families.38 Real wages increased 0.1 percent year-on-year as of August 2020. However, this apparent stability masks important differences across economic activities. Real wages increased in agriculture, communications, education and health services, but fell in most of the other sectors, with large declines in hospitality services (-11.0%), construction (-5.8%), retail (-4.1%) and manufacturing (-2.9%). The combination of job losses and lower wages led to an important decline in average disposable income. Recent data showed a year-on-year decline in real disposable income of 8.4 percent for the second quarter and of 4.8 percent for the third quarter of 2020. These were the largest declines in disposable income in many years. They had two important consequences. First, the allocation of disposable income changed markedly. For the second quarter of 2020, consumption expenditures represented only 83 percent of disposable income, leading to an increase in savings that reached 17 percent of disposable income, again a proportion not seen in many years (Figure 46). This is evidence of a sharp reaction by the public to increase their savings as a result of two factors. On the one hand, usual expenditures on travel and entertainment were postponed while, on the other hand, precautionary savings shot up on the back of the uncertainty created by the crisis. By the third quarter, however, savings returned to levels similar of previous years. The second impact of the decline in disposable incomes was on poverty rates. The national poverty rate increased from 12.3 percent at the end of 2019 to 12.6 percent in the first quarter and 13.2 percent in the second quarter of the current year. However, the first quarter increase in 2020 was much smaller than the ones observed in previous years. Consequently, the poverty rate in the second quarter of 2020 was still lower than in the same quarter of the previous two years (Figure 47). This is tentative evidence that the social policies adopted earlier in the year are partly compensating the severe impact of the crisis upon employment and disposable incomes. Figure 46: Disposable Income and its allocation to Figure 47: The National Poverty Rate has increased consumption at lowest levels since 2014 during the 2nd in the first half of the year, but is still below the quarter of 2020 comparable period of previous two years Source: Rosstat. Source: Rosstat. 38 Ivakhnyuk, I. (2020) “Coronavirus pandemic challenges migrants worldwide and in Russia”. Population and Economics 42(2) p.49-55.  28 Russia Economic Report | № 44. December 2020 Recent Economic Developments A projection of poverty rates for 2020 A series of policies designed to attenuate the impact of the COVID-19 pandemic on the labor markets were introduced in the second quarter of 2020. In the case of unemployment insurance, this meant an increase in the maximum level of unemployment benefits from Rub 8,000 (US$103) to Rub 12,130 (US$157) per month. Payment of the maximum level of unemployment benefits to all employees who lost their jobs due to COVID-19 introduced since the beginning of March for three months, and then extended till end 2020, also helped. The policy was introduced with the appropriate administrative facilities for people to register and to claim benefits. Preliminary evidence seems to indicate that these policies are indeed being rolled out. According to ROSSTAT data, by August 2020, 3.4 million out of 4.8 million unemployed workers, or 70 percent, were registered as unemployed and receiving unemployment benefits. This contrasts with only 16 percent of the unemployed being registered and receiving benefits by March 2020. Moreover, a series of family allowances and pension benefits were also introduced between January and June 2020 (a description of these is provided in the previous RER #43, pages 30 and 31). All these policies may explain the fact that poverty rates during the first half of 2020 were not higher than in years 2019 or 2018, despite the severe decline in employment and wages. A preliminary assessment of the impact of these shocks and policy responses makes use of RUSMOD, a Russian micro-simulation model that runs computer experiments for assessing changes in existing monetary tax-transfer policies implemented at the federal level for a nationally representative sample of the population (see Annex 1 for details and assumptions). The model was run based on projection of GDP decline of 4 percent in 2020 with the finding that the poverty rate for the year 2020 - using the official poverty line - could increase to 14.2 percent and the compensation policies would lead to a decline of the poverty rate to 11.6 percent, which would be below the counterfactual (Figure 48). As always, these projections need to be interpreted with caution. GDP projections for 2020 may fail to capture the rise of a new wave of infections observed since early October. Similarly, some benefits were lump-sums or of limited extension (usually three months), although unemployment insurance has been extended until December. But if take up rates are low or field implementation falls short, the compensatory impact may be reduced. For instance, a version of the model using a GDP fall of 5 percent of GDP would render a poverty projection of 12.1 by year’s end (slightly above the counterfactual). Even lower growth or less effective policy implementation would render higher poverty rates. Figure 48: Social policies compensate for the increase in poverty rate Source: World Bank staff calculations. Russia Economic Report| № 44. December 2020 29 Recent Economic Developments National averages in poverty rates hide some important differences across population groups. Our simulations of the differential impact of the crisis across the economy, and the compensatory measures adopted, show that households of single individuals, couples with one child and mixed family structures have experienced a decline in disposable income, while households with two or more children, lone parents and pensioners have seen an increase in disposable income (Figure 49, left panel). This is mostly because of the importance of family-related allowances in recent compensatory measures. In terms of location, rural areas are projected to have increases in disposable incomes, whereas urban areas, particularly regional centers have experienced declines in disposable income (Figure 49, right panel). This is mostly due to our simulation projections of limited impact of the lockdown measures on agricultural activity. Appendix RUSMOD was built on the EUROMOD platform, using the Russian Longitudinal Monitoring Survey (see Matytsin, Popova and Freije, 2019; and Popova 2012). It defines a counter-factual scenario using the pre-pandemic projections of +1 percent of GDP growth in 2020 and involves three experiments. Experiment A assesses the distributional effect of social policy changes announced in January 2020. In particular, it includes the simulation of the following measures: (i) an increase in the coverage of the allowance for the first and second child, including, in each case, children up to 3 years of age in households with income below 200 percent of the regional Subsistence Minimum Level (SML); and (ii) a new allowance for children aged 3 to 7 in households with income below 100 percent of SML. Experiment B examines the effect of the declines in household income due to the pandemic crisis and the non- working days introduced in many Russian regions in April-May 2020. Experiment B was done under one scenario of household income contraction to reflect early World Bank staff early projection of GDP contraction of 4.0 percent for the year 2020, with differences across sectors (a 1.7 percent growth in agricultural GDP, but contractions of 3.4 and 4.7 percent in secondary and tertiary sectors, respectively). Given the recent data on wages and jobs up to June or September 2020, explained in the main text, we also assume that most of the shock translates into employment and real-wage losses among workers, but only in manufacturing, construction, and retail/hospitality services in urban centers (no impact in rural areas) and particularly among informal workers. An alternative projection using the more recent a forecast of 5 percent decline of GDP was also experimented and preliminary results are included in the main text. Figure 49: Simulations of changes in disposable income for year 2020 show important differences across demographic and geographic location groups. Source: Staff calculations using RUSMOD. For an explanation of experiments A, B, and C, see appendix. Regional centers refer to capitals of federal districts and other large cities. Note: Left axis refers to changes in disposable income. 30 Russia Economic Report | № 44. December 2020 Recent Economic Developments Experiment C measures the distributional impact of social policies related to the pandemic (in particular, changes to child allowances and Social Security contributions for SMEs). It includes the following measures: (i) a cash payment, from April to June 2020, of Rub5,000 per month for each child up to 3 years, (ii) a lump-sum payment of Rub10,000 for all children aged 3-16 years; (iii) an increase in the size of childcare allowance for the first child up to 1.5 years for non-working parents; (iv) cash payments for pensioners aged 65+ of Rub 4,000 in Moscow (Rub3,000 in Moscow Oblast); (v) a 6.6 percent increase in contributory pensions and a 5.1 percent increase in social pensions; (vi) reduced social contributions rates for those employees of small and medium enterprises (SME) whose earnings are over the minimum wage (Rub12,130 rubles), with reduced rates of 10 percent for pensions contributions, 0 percent for social insurance contributions and 5 percent for health-care contributions; (vii) a tax allowance equal to the minimum wage for the self-employed in the most affected sectors; (viii) cancelation of income taxes and social insurance contributions in the second quarter of 2020 for those employed at SMEs in the affected sectors; (ix) raising unemployment benefits up to the level of the minimum wage; (x) a new unemployment benefit equal to the minimum wage for those who became unemployed within the four most affected industries and locations indicated above, with additional top-ups of 3,000 rubles for each dependent child. Results shown in Figure 49 correspond to these three experiments using the early –4.0 percent GDP growth forecast. There are assumptions on the take-up for the new benefits. Given the statistics on increased coverage of registered unemployment, the unemployment benefit take-up is assumed to be 50 percent, while the universal child benefits are assumed to be received by 75 percent of the eligible population. There are also a number of other assumptions that drive the results of the model, notably that individuals and households will not change their economic behavior due to the changes in taxes and transfers. This assumption is mostly explained by the short-term nature of this assessment, which does not allow to quickly change the labor-market behavior. Another important assumption is that the economic incidence of all taxes, including labor taxes, falls entirely on workers. In reality, the economic incidence is spread between workers and employers, and thus the positive effect of SIC and tax reductions might be smaller, so the results of social-measure simulations could be seen as upper bounds. Russia Economic Report| № 44. December 2020 31