Putin's Wealth Shift Aims at Russian Economy's Idled Engine

(Bloomberg) -- As the U.S. tightens the noose of sanctions, Russia’s new plan to rewire its economy is counting on old-style state-led investment to drive growth rather than consumers.

President Vladimir Putin’s government wants to double the country’s total capital spending in ruble terms by 2024, under a blueprint published by the Economy Ministry. That would bring its share to a quarter of gross domestic output from 21 percent now, a pace of growth that’s more than twice the increase it envisions for retail sales.

Putin's Wealth Shift Aims at Russian Economy's Idled Engine

With the economy starved of foreign capital after years of Western sanctions and likely facing more, the pivot to state-led spending is putting the consumer in the cross-hairs. Taking a page from China’s playbook a decade ago, when it turned to investment to power economic growth, Putin is preparing for a dramatic shift after delivering the biggest consumer bonanza in his country’s modern history during the oil boom years.

Wielding such measures as a higher value-added tax, Russia’s new vision for the economy concentrates resources in the hands of the state -- channeling them toward costly projects such as railroads and bridges -- and all but gives up on privatization in the coming years. Investment as measured by gross fixed capital formation hasn’t reached 25 percent of GDP since the collapse of the Soviet Union in 1991, according to World Bank data.

“If we boost investment, then it will discourage growth in wages,” said Valery Mironov, deputy director of the Development Center at Moscow’s Higher School of Economics. “There’s no need to put the horse before the cart -- investment ahead of growth -- because it’s exports first of all that drive economic growth, and not investment.”

Putin's Wealth Shift Aims at Russian Economy's Idled Engine

Speaking late Sunday in a televised interview, First Deputy Prime Minister Anton Siluanov described state finances as a “bulwark of stability” that allow Russia to tone down its responses to existing or potential sanctions.

“We aren’t currently throwing resources around,” said Siluanov, who’s also Russia’s finance minister. “We understand the possible complexity of the whole situation and see clearly that we need to have a margin of safety.”

Once the lifeblood of Russia’s economy, domestic demand has limped along as incomes fail to recover after a bruising recession that followed the crash in oil prices. But with the central bank already looking to cool off credit to households with higher risk weights for loans, the government is counting on the VAT increase from next year to add 630 billion rubles ($9.3 billion) annually to its coffers.

Restricted from using its energy windfall on spending under a fiscal mechanism in effect since 2017, the government needs to mobilize capital by raising non-oil revenue from taxes and borrowing to fund spending on infrastructure. Putin’s top economic adviser has also proposed higher taxes on mining companies, saying in a letter that additional budget income is needed to help pay for the president’s promises after his re-election this spring.

“Net exports will decline, while final consumption will grow but at a slower pace,” Economy Minister Maxim Oreshkin told Bloomberg.

The authorities have made little headway in their previous efforts to unlock investment in a country hamstrung by weak institutions and a poor business climate. Even as fixed-capital spending has slowly picked up, it’s relied mostly on government efforts, with Alfa-Bank estimating that three major state projects accounted for 90 percent of all investment last year.

A new fund of about 3.5 trillion rubles will now be a key vehicle for the government’s program to cover its infrastructure spending. The Finance Ministry will mostly rely on domestic debt to raise capital, laying out its most ambitious borrowing plan yet of almost 5 trillion rubles for 2019-2021. State debt as a share of GDP will probably grow to 16.6 percent in 2021 from 14 percent this year, the ministry estimates.

Putin's Wealth Shift Aims at Russian Economy's Idled Engine

While China’s investment push led to a spiraling increase in debt, Russia is only likely to experience a boost in state borrowing without spillovers into private businesses as they steer clear of infrastructure projects, according to Denis Poryvay, an analyst at Raiffeisenbank in Moscow.

“It will hardly be possible to guarantee returns for private investors,” he said.

©2018 Bloomberg L.P.