Will Russia be able to implement "financial import substitution": long-term scenario forecast Renat Akhmetov, Oleg Solntsev, Vera Pankova, Elizaveta Cepilova Center for Macroeconomic Analysis and Short-term Forecasting (CMASF) April 12, 2019

Research tasks Determination of the optimal depth of the financial sector in accordance with the objectives of achieving higher and sustainable economic growth, ensuring price and financial stability Finding a way to develop the Russian financial sector towards optimal size and structure Identification of priorities of state policy from the point of view of the transition capabilities of the financial sector to the optimal model

Literature review: evaluation of the comparative effectiveness of various state policies stimulating the development of the financial sector Priority areas of state policy Attributions Ensuring reliable disclosure of information Barth et al. (2001); Djankov et al. (2007); La Porta et al. (2006) Protection of the rights of financial market participants (investors, creditors) Djankov et al. (2007); Danilov (2016) Protection of property rights La Porta et al. (1998); Esho et al. (2001) Development of access to financial services (development of financial literacy, creation of infrastructure) Beck, de la Torre (2006); Beck, Feyen (2013); Danilov (2016) Regulation of interest rate inflexibility Lee, Chang (2015); Beck, de la Torre (2006); Beck, Feyen (2013) Entry of foreign banks into the banking system Beck, de la Torre (2006); Lensink et al. (2008); Beck, Feyen (2013); Danilov (2016) Changes in the share of the state in the financial sector Danilov (2016); De Serres et al. (2007) Regulation of competition in the financial market Beck, de la Torre (2006); Beck, Feyen (2013); De Serres et al. (2007) Regulation of the tax burden on financial markets Beck, Feyen (2013) Trade liberalization Danilov (2016)

Methodology for determining the optimal financial sector model for Russia Two approaches were used to determine the optimal model of the Russian financial sector, taking into account the mutual influence of the development of its various segments The first approach is to build a composite financial development index using the principal components method: models assessing the impact of changes in the composite financial development index on the achievement of four macroeconomic policy objectives; models assessing the dependence of the development of each segment of the financial sector on the composite index of financial development; scenario models determining the range of values of indicators of development of different segments (under the framework scenarios) corresponding to the optimal values of the composite index of financial development The second approach is based on the selection of the most influential segments of the financial sector in terms of their impact on other segments (based on the correlation criterion of their dynamics): models assessing their combined impact on the achievement of key macroeconomic policy goals; models assessing the dependence of the development of other segments of the financial sector on the development of the most influential pairs The final assessment of the optimal values of indicators of development of all segments of the financial sector is obtained by averaging the results obtained in the framework of these two approaches, as well as the evaluation results obtained in the evaluation of the optimum for each sector separately 4

Data Period: 1980-2014 Sample of countries: 63 (including Russia) Variables Data source World Bank IMF (IFS, FSI) Bankscope Doing Business Fraiser Institute Heritage Foundation DICE Macroeconomic Financial Demographic Institutional 5

Determining the optimal financial sector model for Russia: the first approach

Principal component analysis Segment of the financial sector Credit to the private sector Stock market capitalization Pension Funds Insurance companies assets 1 0.62 Pension funds assets 0.49 0.58 0.36 0.50 0.37 Segment of the financial sector First principal component Second principal component Third principal component Fourth principal component Credit to the private sector 0.506 -0.367 -0.633 0.457 Stock market capitalization 0.555 -0.056 -0.117 -0.822 Pension funds assets 0.496 -0.328 0.765 0.248 Insurance companies assets 0.437 0.869 0.014 0.233

The impact of changes in the composite index of financial development for achieving the goals of macroeconomic policy 8

The impact of changes in the composite index of financial development for achieving the goals of macroeconomic policy 9

The results of the optimization of the utility function of the regulator

Determining the optimal financial sector model for Russia: the second approach

Results of optimization of the regulator's utility function for three pairs of the most influential markets (in % to GDP) Segment of the financial sector First pair Second pair Third pair Stock market capitalization 64.65 Outstanding domestic corporate securities market 10.06 Outstanding external corporate securities market 30.92 33.24 Credit to the private sector 58.62 Insurance companies assets 2.12

Transition of the Russian financial sector to the optimal model

Macroeconomic conditions Methodology for determining the direction of movement of the Russian financial sector to the optimal model The formation of scenario conditions covering the widest range of socio-economic development options, as well as possible options for state policy to stimulate the development of the financial sector and improve the business environment in the financial markets. Building a matrix of framework scenarios based on these options: Building a system of interrelated models of financial market segments and a composite index of financial development (the first approach) framework forecasts of the dynamics of the financial sector. Policy Macroeconomic conditions Favorable Adverse Stimulating 1 2 Inertial 3 4 14

Verification of results by different methods* in % to GDP * Results of modelling of individual segments are presented in Mamonov, M., Akhmetov, R., Pankova, V., Pestova, A., Solntsev, O. and Deshko, A. (2018). Identification of Financial Sector Optimal Depth and Structure from the Perspective of Economic Growth, Macroeconomic and Financial Stability. Russian Journal of Money and Finance, 77 (3), рр. 89-123 15

Verification of results by different methods * in % to GDP * Results of modelling of all segments separately are presented in Mamonov, M., Akhmetov, R., Pankova, V., Pestova, A. , Solntsev, O. and Deshko, A. (2018). Identification of Financial Sector Optimal Depth and Structure from the Perspective of Economic Growth, Macroeconomic and Financial Stability. Russian Journal of Money and Finance, 77 (3), рр. 89-123 16

Policy implications for the development of the financial sector In terms of impact on the overall level of development of the financial sector the most effective policy direction is to increase the protection of property rights The next most effective policy direction is to stimulate competition and reduce the level of government intervention in the activities of financial institutions Further liberalization of foreign economic activity, as well as tax incentives for financial investments will have a much more modest effect The possibility of exceeding some markets (bank loans, corporate bonds, stock market) across an effective border may require a change in the direction of certain types of policies in the long term (in particular, limiting excessive competition and avoiding tax incentives for financial investments) The impact of stimulating state policy on the development of the financial sector in adverse macroeconomic conditions is increasing 17