Price of victory may be too high for Putin

MOSCOW Mon Mar 5, 2012 4:20pm IST

A man takes a picture of a screen showing the preliminary results of Russian Prime Minister Vladimir Putin in the presidential election at the building of the Central Election Commission in Moscow, March 5, 2012. REUTERS/Thomas Peter

A man takes a picture of a screen showing the preliminary results of Russian Prime Minister Vladimir Putin in the presidential election at the building of the Central Election Commission in Moscow, March 5, 2012.

Credit: Reuters/Thomas Peter

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MOSCOW (Reuters) - Vladimir Putin's emphatic win in Sunday's presidential election has come at the cost of hundreds of billions of dollars in spending promises that could sow the seeds of an economic crisis in Russia before his six-year term is out.

Putin, who received 64 percent of the vote with nearly all ballots counted, shored up his base by throwing money at everything from nuclear missiles to kindergartens, making the overburdened budget more dependent than ever on oil prices.

The 59-year-old premier, returning to the Kremlin for a third term, has put the cost of promised public sector pay rises at 1.5 percent of gross domestic product (GDP) - around $30 billion per annum - in the coming years.

When the other new social spending commitments are added, Finance Minister Anton Siluanov told Reuters, the full cost may be up to 2 percent of GDP each year. A ministry source says privately that the figure could reach 3 percent by 2018.

An independent assessment by London-based consultancy Capital Economics calculates the total bill for election-related promises will be even higher, reaching 4.8 trillion roubles per annum, or 4-5 percent of GDP, by 2018.

Whatever the true total, Russia's already overstretched budget will be hard-pushed to find it.

"The higher oil price gives them more money to throw around ahead of the elections and after the elections, but at what cost?" said Neil Shearing, chief economist at Capital Economics. "Russia can't keep relying on expenditure to sustain growth."

ELECTION SWEETENERS

Putin's campaign promises include pledges to raise salaries for doctors and university professors to double the regional average by 2018. Schoolteachers, meanwhile, have been promised pay at least in line with the average.

Other pledges include a boost in child allowances, higher student grants, and an end to kindergarten waiting lists.

An analysis by Russian audit firm FBK puts the cost of these social spending pledges at 9.9 trillion roubles through to 2018 , rising from 1.1 trillion roubles in 2012 to 1.7 trillion roubles per annum by 2018.

"It is troubling overall, definitely so," said Vladimir Tikhomirov, chief economist at Otkritie brokerage in Moscow.

"I'm not questioning the need for teachers and doctors to receive higher wages, but the question of course is how this could be met."

Over the last five years, total government spending has already risen from below 30 percent of GDP to almost 40 percent.

And it is now climbing even more rapidly, as Putin's government delivers on previous commitments, such as higher pay for the military and the police, made to coincide with the vote.

In the first two months of 2012, spending rose by 37 percent compared to a year earlier. That's more than twice the 14 percent increase pencilled in for 2012 - itself more than double expected inflation of 6 percent.

The official estimates of the additional spending required in the years ahead do not include previous spending commitments reiterated during the campaign, such as on defence.

Putin has committed to spend some 23 trillion roubles by 2020 to re-equip the military, as he cements support among the two million Russians who work in the sprawling military-industrial complex inherited from Soviet times.

These expenditures alone will require additional spending of 2.2 percent of GDP per annum by 2018, according to Capital Economics, similar to all of Putin's social spending commitments put together.

Another of Putin's oft-repeated electoral promises - not to increase Russia's pension age from its present 60 for men and 55 for women - represents another implicit burden on the budget.

Demographic pressures mean that Russia's pensions budget - already an excessive 10 percent of GDP - will keep rising, by around one percentage point of GDP every five years.

"If we don't implement bold pension reform, there will be substantial pressure to increase pension payments as a percent of GDP," said Evsey Gurvich, head of the Economic Expert Group that advises Russia's finance ministry.

"Our fiscal revenues are sensitive to oil price volatility - hence there are risks."

OIL PRICE RISK

On the face of it, Russia has fiscal leeway enabling it to afford higher spending. The federal budget ran a small surplus last year, and is officially forecast to run only a modest deficit of 1 percent of GDP this year.

Total government debt is only around 11 percent of GDP, and Russia has also accumulated $150 billion in two sovereign funds which could be tapped in an emergency.

But these numbers would look much less rosy without the good fortune of high - and in recent months, rising - oil prices. The break-even oil price, at which Russia's budget balances, has rocketed from just $34 a barrel in 2007 to $117 this year.

In a recent report, analysts at Citi warn that the break-even price will rise to $150 per barrel if Putin's spending policies are implemented.

"That type of uncertainty would likely drive a lower valuation (of the stock market) even if oil prices hold up, simply because (of) the increased cyclicality that it implies for the market," they wrote.

A further question is how long Russia's luck with the oil price will hold.

"It is critical to underscore the high level of the break-even for the oil price," said Plamen Monovski, chief investment officer at Renaissance Asset Managers. "If the oil price falls, there is very little room for manoeuvre."

PAINFUL CUTS

The optimistic view is that Putin's electoral pledges do not tell the whole story about his budgetary intentions.

Putin has also promised to make budget savings, in particular by reducing the massive waste and corruption in areas such as state procurement.

By eliminating widespread kickbacks, he wrote in a recent article, Russia could cut the federal budget by 5-10 percent, saving the equivalent of 1-2 percent of GDP annually.

Finance Minister Siluanov also says he is scouring the budget for cuts, pledging that by 2016 the budget will balance at a lower oil price of $90 per barrel.

But it is one thing to talk about tackling deeply ingrained corruption or making painful expenditure cuts - quite another thing to do so in practice.

"We can't wait any longer, otherwise our budget policy will be risky," Siluanov told Reuters. "Who needs that?".

(Additional reporting by Darya Korsunskaya, Editing by Douglas Busvine/Janet McBride)

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