Putin Must Choose: Spend Now or Save for Later

6 MINS READSep 29, 2014 | 21:57 GMT
It can be difficult to separate the important from unimportant on any given day. Reflections mean to do exactly that — by thinking about what happened today, we can consider what might happen tomorrow.

The Russian government will submit its draft of the federal budget for 2015-2017 to the State Duma on Tuesday. The draft has been postponed for weeks while the elites within the Kremlin battled over what the government's priorities should be at a time when the Russian economy is slumping near recession.

Previews of the budget suggest a fairly optimistic strategy in the Kremlin. The economy is currently projected to grow by 0.5 percent in 2014; foreign investment into Russia has dropped 50 percent compared with 2013; and capital flight is projected to reach $100 billion by the end of the year. Negative attitudes toward Russia, combined with Western sanctions against the country because of the crisis in Ukraine, are the primary factors behind Russia's economic decline.

But the upcoming budget forecasts 1.2 percent gross domestic product growth in 2015, followed by 2.3 percent and 3 percent in the next two years. The budget also projects the deficit to stay at around 0.5 percent. Finally, it expects the central bank and Finance Ministry to return to borrowing and trading on the international markets, a development that would require the European Union and United States to ease sanctions. Overall, the draft budget shows that the Kremlin believes the worst of the pressure from the West over Ukraine is behind it. Whether that's true is unclear.

Priorities and Popularity

The Kremlin's priorities, as reflected in the draft budget, were the source of a brutal battle within the Kremlin in recent weeks. Moscow has been divided over defense spending, whether to bail out Russian firms affected by sanctions, oil price forecasts and what is a tolerable level of debt and inflation for Russia.

Something that has not been under debate is the government's focus on social spending. The Kremlin is still prioritizing social spending with a series of projects: new infrastructure, cultural projects, pension reform and even expanding Wi-Fi access in Moscow's subways. Russian President Vladimir Putin understands that at this point in his leadership, he must maintain an overwhelming level of popularity among the people.

Putin understands this better than Boris Yeltsin did. Yeltsin's disregard for social spending was one reason the public turned against him in the 1990s. Putin may rule Russia with an iron fist, clamping down on media and foreign businesses, but he knows his ability to rule depends on his popularity. Russia is a land of revolutions, a fact that hit home in 2011-2012 when hundreds of thousands of people across Russia protested against Putin. It is not that Putin believes such an upsurge will directly overthrow him, but as long as he has popular support, his own elite within the Kremlin cannot force him out. His legitimacy within the Kremlin at the moment comes from the people. 

It is becoming more and more important for Putin to preserve his popularity. Divisions within the Kremlin related to everything from the failures of the security services to the crisis in Ukraine and the draft budget are leaving Putin increasingly isolated within his own government. Putin is constantly concerned that he could be ousted by his own inner circle as former Soviet leader Nikita Khrushchev was.

Spending on Defense and the Energy Sector

Beyond social spending, the government must decide how it will parse out funds for its two other primary focuses: defense and energy.

The Kremlin originally planned on a massive increase in defense spending — some $770 billion between 2014 and 2024. Because of increased budgetary demands resulting from Russia's economic decline and higher spending on issues such as Ukraine, the plan to boost the defense budget was postponed earlier this year. The increased spending plan was unlikely to pass because many within the Kremlin, particularly within the Economic and Finance ministries, were opposed to such a lofty scheme. In early September, however, Putin shifted decision-making on Russian defense spending under his office, quashing the Cabinet's ability to continue postponing the increased spending.

It is unclear how the Russian budget will work with increased defense spending, but with security crises along its borderlands and with pressure from NATO building, Russia has no other option but to bolster its defenses.

Defense spending will not be the only major financial burden on the Russian government next year. The government is debating how it will financially assist its energy sector with sanctions on many of the country's energy firms limiting their ability to borrow on international markets. In addition, decreased investment in Russia is starting to plague the energy sector. Rosneft, Novatek and LUKoil have all asked for financial assistance totaling more than $50 billion thus far. The Russian government has started to draft a bailout for Rosneft, and a decision on Novatek's request is due in October.

Russia's energy sector, particularly its oil exports, is the lifeblood of its economy. Energy exports account for 25 percent of the country's GDP and approximately 50 percent of the government's budget. There is no choice for the Kremlin but to assist the sector or risk financial ruin should energy exports decline and revenues dry up.

With both the defense and energy sectors needing more cash in the years to come, Putin will probably draw on Russia's massive reserve funds rather than depend on the state's budget. Russia has approximately $641 billion in reserves: $467.2 billion in currency reserves, $87.32 billion in the National Wealth Fund and $87.13 billion in the Reserve Fund.

But these funds are intended to be used when oil prices fall below $100 per barrel in the 2015 budget ($114 per barrel in the current budget). With the budget pinned on such a high price point, the robustness of these funds and conservative use of them have always been critical to the stability of the Russian government. In 2008, the Russian government sped through more than $200 billion in the reserves to stabilize the economy during the financial crisis. Moreover, there is no guarantee that oil prices will remain in the triple digits in the years to come.

Putin has been left with a choice. He can use the reserve funds now to bolster Russia's defenses and maintain the robustness of the energy sector while risking the country's future financial stability. Or he can leave Russia vulnerable in the short term in these critical sectors to have cash on hand in the future. Based on what we know, Putin appears to be focusing on the present.  

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