NEW YORK, June 25, 2013 — Russian President Vladimir Putin wants to spend Russia’s way out of its economic slump with a fiscal stimulus of up to $43.5 billion. The plan is a short term fix that does not resolve the core weaknesses in the economy. Instead, Russia needs a sustainable strategy that involves diversifying its energy-based economy and creating a more attractive investment climate.
Slow growth and high inflation is heading Russia’s once vibrant economy into stagnation. Putin’s solution is to finance three infrastructure projects and other government investments by using the country’s pension reserves. Yet, the International Monetary Fund’s first deputy managing director, David Lipton warns against using a fiscal or monetary stimulus.
“Our assessment is that there is no slack in the economy,” said Lipton.
Consequently, a fiscal expansion may lead to growth, but will eventually cause exchange rate pressure and even higher inflation. Lipton believes that Putin should be patient for growth and continue with his present monetary policy of keeping interest rates high to meet inflation targets. He also advised the Kremlin to diversify away from energy and move towards a technologically modern economy.
As the world’s largest energy exporter, Russia’s economic health is dependent on selling oil and natural gas. In 2012, these resources accounted for two-thirds of the country’s total exports. Half of government revenues and 20 percent of the GDP comes from oil and gas according to Fitch Ratings. This shows that Russia is vulnerable to the volatile energy market.
On Friday, Russia signed a $270 billion deal with China to supply oil to China for 25 years, but the new business will not make a major impact on the struggling economy. The decline of oil prices puts pressure on Russia’s public finances. Russian Finance Minister, Anton Siluanov forecasts a budget deficit until at least 2016. Oil prices need rise to $115 per barrel for a balance budget, but Brent crude, the benchmark grade for European prices is at $103 per barrel.
Alexander Novak, Russia’s Energy Minister, believes that energy reforms would boost the economy. Energy efficient technology would help Russia better compete in the global market. While Russia is the leader in shale oil reserves, technological innovations by US companies has made America the leader in shale gas reserves. This represents competition to Russia in the natural gas sector especially in Europe where it dominates the market.
The World Bank claims weak investment performance is the main culprit in Russia’s economic decline. Flat inventory levels and moderate expansion of fixed investments are the results of businesses being cautious of the future commercial climate. To aid growth, The World Bank suggests implementing structural reforms, which include reducing the role of government in the economy, improving transparency and strengthening measures to fight corruption.
The Heritage Foundation, a think tank based in Washington, also notes that corruption and the Kremlin’s dominance in many sectors through state-owned enterprises are economic impediments.
Government spending may give the country a competitive edge since some infrastructures have not been improved much since the Soviet era. Currently Putin wants to use at least $14 billion from the pension reserves on projects, which will better connect Moscow to other parts of Russia.
The Trans-Siberian Railway, the world’s longest rail line that connects Moscow to the Russian Far East, is proposed to be renovated. A new high speed railway is suggested to connect Moscow and Kazan, the eighth most populous city in the country. Moscow itself is recommended to have a super highway that rings around the capital city.
Putin’s plan offers confidence to those concerned that the country is leaning towards a recession. Russia had an average GDP growth of about 7 percent before the 2008 financial crisis. For 2013, the Russian government projected a 2.4 percent increase in the gross domestic product. Contradicting this expectation, the first five months of this year reveals a growth of only 1.8 percent in GDP. Inflation hit 7.4 percent as of May, compared to 3.6 percent in May 2012. Net capital outflow is over $25 billion during the first quarter of 2013, almost half of the total net capital outflow in 2012 which was $54.1 billion, according to the central bank’s data.
Since Putin is unlikely to change his fiscal strategy, he should at least consider implementing reforms that offer a longer term payoffs to work alongside the short-term benefits of the infrastructure projects. Perhaps by next year he could launch investments in energy technology or free market reforms that would increase privatization of state-owned enterprises.
Tiffany Shorter is a foreign and economic policy analyst.
Follow Tiffany on Twitter at @TiffanyShorter or via Google+
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