Inflationary bust stalks oil-fuelled expansion

MOSCOW - The party had to come to an end sooner or later.

But, after six years of growth averaging 6.7 per cent, Russia seems to be doing its best to turn its oil boom into an inflationary bust.

Companies are refusing to invest, spooked by the Kremlin's attack on the big oil company Yukos. Pensioners are protesting over the axeing of benefits. And the Government is wobbling and may resort to a short-term fix to buy its way out of trouble.

Russia managed to squeeze down consumer price inflation last year to 11.7 per cent, the lowest since the Soviet Union collapsed in 1991.

But prices are heading up again, at least if steep New Year mark-ups by Moscow's supermarkets and a 40 per cent hike in the price of a metro pass are anything to go by.

And the 8.5 per cent inflation target in this year's Budget already looks a lost cause - Natalya Orlova, chief economist at Alfa Bank, forecasts 13 per cent.

Add to that factory gate inflation running at close to 30 per cent and the gains in the rouble driven by Russia's oil export bonanza, and the non-oil economy faces a serious loss of competitiveness.

"High oil prices may well allow the subsidisation of poor policy for some time, but unless there is a change in direction, it is a matter of when, not if, growth turns to stagnation," warned Roland Nash, strategist at Renaissance Capital.

That is bad news for President Vladimir Putin, who has promised to boost the living standards of ordinary Russians by doubling the economy in a decade - a feat that would require annual growth of 7.3 per cent.

On top of hefty payroll tax cuts that kicked in at New Year, the so-called "monetisation" of benefits will pump cash worth about 2 per cent of gross domestic product into the economy.

That money supply boost may lift inflation by 0.5 to 1.5 percentage points this year, although economists say that would be a small price to pay for improving the funding of Russia's stretched health and social services.

But with Premier Mikhail Fradkov pushing a proposal to jack up pensions by 15 per cent from February 1 to soften the impact of the reforms, three times the planned 5 per cent, economists say higher inflation could become entrenched.

Another proposal from the Fradkov camp is to cut value-added tax by five points to 13 per cent, paid for by drawing on a Budget stabilisation fund set up by Finance Minister Alexei Kudrin.

Kudrin wants to spend the stabilisation fund surplus on paying down foreign debt. But talks with the Paris Club on a US$46 billion ($64 billion) debt repayment deal are dragging, and Kudrin is in the firing line for his department's handling of the welfare reform.

If, as newspapers speculate, Kudrin becomes a casualty of the benefits row, his Cabinet rivals may be tempted to splurge the US$18 billion stabilisation fund on pet projects.

"Raiding the stabilisation fund to pay for state investments - that would be a disaster," said Christopher Granville, chief economist at Moscow investment house UFG.

The stabilisation fund ring-fences Russia's economy from its bulging Budget surplus - which reached 4.1 per cent of GDP last year. That sterilisation effect limits inflation and appreciation pressures on the rouble.

Letting spending rip would push Russia into a spiral of rouble appreciation and inflation which, economists warn, could deal a hammer blow to growth.

- REUTERS