MOSCOW BLOG: How realistic are Putin's promises to massively increase social spending?

MOSCOW BLOG: How realistic are Putin's promises to massively increase social spending?
The economic part of Vladimir Putin's address remained merely declarative and if anything showed the lack of consensus between the Kremlin, government and policy advisers on how to move forward. / Photo:
By Vadim Dumesh in Paris, Ben Aris in Berlin March 7, 2018

The militarism of Russian President Vladimir Putin's “guns & butter” state of the nation speech on March 1 has overshadowed the economic part of the speech, which sets out the Kremlin's  development strategy for the next six-year presidential term. Putin is due to stand for re-election on March 18 and is widely seen as a shoo-in for the job.

The economic part of the address remained merely declarative and if anything showed the lack of consensus between the Kremlin, government and policy advisers on how to move forward. There are several competing models and as usual the Kremlin is attempting to fudge policy to keep all the various factions – liberals, oligarchs, security services and state-owned enterprises (SOE) – happy.

"No direct calls to action were sounded. This is a collection of declarative statements. Not a word about the economy, but many ambitious goals are set and our military might is demonstrated," Alexandra Suslina of the Economic Expert Group commented to RBC portal's analysis of the speech.

Echoing a Moscow Blog analysis by bne IntelliNews, Andrey Cherniavsky of the HSE Centre of Development Institute told RBC that "one cannot have everything: improve the quality of life, develop infrastructure, and strengthen the military industrial complex".

In the global economy military technology is often considered a technological spill-over, but this is not the case in Russia, Suslina adds. 

Comparing the economic part of the address to the military part, chief economist of Alfa Bank Natalia Orlova commented on March 1 that it was "quite clear from the speech that stronger growth indicators are expected to generate enough budget revenues to enable continued defence spending".

However, even if the military and economic parts of Vladimir Putin's address did not appear coherently integrated and thoroughly developed, it is still worth looking at the main points as it might eventually result in ill-advised policy decisions much like the notorious presidential "May's decrees".

Unrealistic macro goals  

The big macroeconomic targets set out by Putin are unrealistic and some of them are demonstrably unachievable. These include increasing GDP per capita 1.5-fold by 2025, made possible by an increase in spending efficiency, private investment, securing a robust tax system, and structural changes in the economy. To achieve this goal Russia’s economy would have to grow by 7% a year for six years, according to bne IntelliNew’s calculations, whereas the official forecast for this year is 1.8% of growth and even the most optimistic forecast by US investment bank Goldman Sachs is for only 3.3% of growth in 2018.

Alfa Bank’s Orlova says that rising incomes this year will mean a limit on more Central Bank of Russia (CBR) interest rate cuts, or even some monetary tightening in the second half of the year, which will put a cap on growth, and she predicts only 1% economic expansion in 2018. The Kremlin’s own goal of improving tax collection will also act as an automatic cap on growth.

Still, this is election season and Putin has happily boasted about the end of a two-year long recession, the benefits of which are now finally starting to trickle down to the man in the street in the form of growing real incomes, so the promise of more growth is important to voters.

Other goals include productivity growth accelerating to 5% per year (since 2009, the average growth was only 1%) in the next decade, an increase in the share of small and medium-sized enterprises (SMEs) in GDP to 40% from the current level of 20%, and the number of people employed by SMEs growing from 19mn to 25mn people.

"However, how all these ambitious targets will be reached, remains a question to the government has yet to elaborate on," Orlova commented.

The growth target has caused some confusion. An unnamed federal government official estimated for Reuters on March 1 that increasing GDP per capita 1.5-fold by 2025 as promised would require a more modest 6% GDP growth annually. Analysts surveyed by RBC estimated the required growth was even less, at 5% per year, but see even that as unlikely without a radical improvement of the investment climate.

The leap needed to reach any of these levels of growth is clearly way beyond the 1.5% growth seen in 2017. The structural ceiling of 2% maximum growth that most international and domestic economists believe limits Russian economic growth in the medium-term won’t be easily breached without some sort of economic revolution. 

The goal appears unrealistic also thanks to the continuing sanctions regime imposed on Russia – something that is now very unlikely to be lifted in the near term after Putin effectively threatened the West with a raft of new space-aged nuclear weapons. Orlova argued that the second half of Putin’s speech "made it known that Russia is ready for a scenario where sanctions and geopolitical tensions remain a factor going forward".

Another major source of growth laid out by Putin is the growth of investment's share in GDP to 25-27% from the current 20-21%. "Investors need to be attracted by quality of the rule of law, [business] environment, and not the presentations of military power," Nalalia Akindinova of the HSE Centre of Development Institute commented.

At the same time, infrastructure and road spending should be boosted to RUB11 trillion ($195bn) in the next six years from RUB6.4 trillion during his current term, according to Putin. That is equivalent to 16% of Russia’s entire GDP and almost double the current spending rate. How this enormous increase in spending will be funded was not explained.

In fact in recent years infrastructure spending has been declining: in 2017 it was cut by 24% to RUB550bn as compared to 2014, analysts of InfraOne estimated, cited by Vedomosti. All the state and private investment in infrastructure does not exceed RUB4.3 trillion, according to the estimates.

Welfare with no implementation plans 

The speech did finally throw some light on who is leading Russia’s policy initiatives. It has been clear since 2013 that Russia’s old petro-funded growth model was exhausted, after growth fell to zero even before the clash with the West over Ukraine got underway and when oil prices were still more than $100 per barrel.

Following the speech, analysts noted that many welfare and social policy goals are borrowed heavily from the policy recommendations of the Centre of Strategic Research of ex-Finance Minister Alexei Kudrin, packaged in his "Plan K".

Kudrin’s plan is seen by many more liberal economists as preferable to the Stolypin Club plan, championed by Presidential Ombudsman for Business Boris Titov, which advocates increased borrowing and spending to kick-start economic growth with a Keynesian-style stimulus package. Kudrin is pushing for investment not just into Russia’s physical infrastructure, but also into its human capital in the form of better health, education and social support, which pays dividends more slowly, but should have more benefit in the longer term.

Among the goals stated by Putin is one to invest RUB3.4 trillion in the next six years to overcome the decline in the number of people of working age, which has fallen by 40% in 2012-17, as well as to increase federal spending on healthcare by up to 4-5% GDP per year vs the current 3% GDP, and increased spending on education. 

The lacunae in all this is where the money will come from. Kudrin’s CSR suggests an overhaul to the taxation system with a "tax manoeuvre" and a cut in military spending to finance this spending. But with elections looming there is still no clear fiscal policy guidelines from either the Kremlin or the government on where the funding for all these programmes will come from.

The CSR suggested stripping the financing from state-controlled sectors such as security, defence, and governance to channel it to industry, but instead the simplest way to increase the tax-take would be to increase taxes on Russia’s credit-fuelled consumption. 

To the Kremlin’s credit it has already made enormous progress with improving tax collection and cutting down on corruption. The infamous fly-by-night scams, where shell companies are set up to take tax liabilities and bankrupted when the taxes come due, have been largely eradicated. Likewise, a huge overhaul of the tax system in the form of a new sophisticated IT system has also vastly improved tax collection, which is up some 40% since the start of 2017, according to bne IntelliNew’s sources. However, Russia’s ultra low income and corporate profit taxes, introduced by Putin shortly after taking office for the first time in 2000, remain sacrosanct for the time being.

"The considerable improvement of VAT collection and potential in improving its administration is a strong argument for raising this particular tax in the future," Natalia Orlova commented on March 1. 

One of the welfare goals set out by Putin that could actually be reachable is halving the number of people living below the poverty line from the current 13.8% of the population or 20mn people. Lilia Ovcharova of the HSE Institute for Social Policy estimated for RBC that one would need an extra RUB150bn-RUB200bn annually for targeted support to poor families with children and employment initiatives.

While Putin pledged to secure real pension growth (with pension indexation exceeding inflation), which in turn would support disposable income, the "untouchable issue" of raising retirement age for working Russian men and women was again skipped in the speech.

Housing building plans

Playing to another crowd pleasing theme, Putin also made grandiose promises for housing market growth goals. He promised to increase the number of families moving to better accommodation from the current 3.1mn a year to 5mn families per annum by 2025, which would mean commissioning 120mn square meters of housing annually, up from the current 80mn, and lowering the average mortgage interest rate to 7-8% from the current 9.6%.

Mikhail Men, head of the Ministry of Construction,  sees the goals as realistic, being the first government agency to adopt Putin's targets after the address.

This particular promise is more reasonable, albeit still ambitious. Mortgage lending is booming, partly thanks to a government subsidy on interest rates of over 12% in the last few years. However, in December the commercial rates fell below 12% on their own thanks to the falling cost of capital and the government ended the scheme. Mortgage loans' share in transactions has risen from single digits to up to three quarters of developers' deals in recent years and residential development is rushing ahead full steam, Sergey Gordeev, the CEO of the country’s biggest company PIK, told bne IntelliNews in a recent interview.

Still, to hit Putin’s targets industry experts surveyed by RBC believe that boosting housing construction by 50% without active involvement of the state is not possible. Currently developers are consolidating and small players are being pushed out. The state would have to compensate that by setting up state-controlled development structures and housing renovation funds in large cities.

Even given the space for housing market growth, the state would also need to take responsibility for transport, engineering, and social infrastructure development around the new construction projects, which are currently taken care of by the developers themselves.  

The bottom line is that despite the showcased missile display that took up half of Putin’s speech, the military modernisation phase of Russia’s development is being scaled back. Putin launched this programme in 2012 with a massive increase in military spending that meant sacrificing the prosperity Russians had been enjoying to finance his geopolitical showdown with the West. The political cost of that was visible this summer with a string of regional protests organised by anti-corruption blogger and opposition activist Alexei Navalny.

However, the focus on social investment means Putin is attempting to undo some of that damage by catering to the needs of the people again. Defence spending in the current budget has been cut to the point where some economists believe it will drag down industrial production. Even if it is not clear where the funding will come from, and even if many of the goals will be missed, as most Russians are mostly concerned with not losing what they have already gained, even a near miss will be good enough for most people.