Campaign promises and the inflation outlook for 2008

A bill that raises pensions for military pensioners is the latest item of “social” legislation passed this autumn, during preparations for the parliamentary election. The economic consequences of the election campaign will be felt by all, since the sums being spent are substantial.

A bill that raises pensions for military pensioners was passed by the Duma yesterday. It’s the latest link in the chain of “social” legislation passed this autumn, during preparations for the parliamentary election. Independent analysts say that the outcome of December’s election is largely predictable already.

Therefore, the election won’t have any noticeable political consequences; but the economic consequences of the election campaign will be felt by all, since the sums being spent are substantial.

Against this backdrop, campaign spending by political parties seems relatively small. As at November 7, total deposits in the campaign funds of the 11 parties competing in the Duma election amounted to about 1.27 billion rubles. That is the official figure, although there is bound to be some unofficial spending as well. However, all this is still small change on the national scale. The real election campaign is happening at an entirely different level.

Right from the outset, the budget passed last year was described as a socially-oriented election year budget. Spending was increased by 1 trillion rubles: that is, by almost 25%. Subsequently, the federal leadership decided that even this wasn’t enough – and approved more spending increases. The amendments added another trillion rubles to the federal budget for 2007. As a result, basic pension payments have been raised by over a third, the wages of state-sector employees have been indexed, more funding has been provided for subsidized medications and federal targeted programs.

In early November, however, the priorities started changing again. October’s inflation surge shocked citizens and the authorities alike. It became clear that the government won’t be able to hold year-end inflation to the target figures initially specified in the budget. The government won’t even be able to keep inflation down to 10% for 2007.

As recently as October, Finance Minister Alexei Kudrin was saying confidently that increased social spending wouldn’t have any impact on prices. Now the mood has changed. A week ago, Kudrin announced that this year’s additional spending will be confined to 47 billion rubles. The remaining trillion rubles will be postponed until next year. The Investment Fund will have to wait for its 150 billion rubles, said Kudrin. A further 320 billion rubles in postponed spending is earmarked for subsidized medications, federal targeted programs, higher pensions for military pensioners, and other purposes.

But election fever can make corrections of its own. The Duma seems to have misheard the Finance Ministry, or ignored it. The Duma voted yesterday to pass a bill raising military pensions as of December 1 (the day before the Duma election). The intrigue gets even more complicated when it comes to subsidized medications for benefit recipients. The Health and Social Development Ministry has solemnly sworn that distribution problems will be solved and medications will be available nationwide by December 25. Earlier, the Ministry calculated that the federal budget’s debts to medication suppliers amount to 75 billion rubles for 2006 alone. If these debts aren’t paid, it’s very likely that benefit recipients in many regions won’t be able to obtain their medications at all. But if we’re to believe Finance Minister Kudrin, the funding has been postponed until 2008. Benefit recipents tend to be active voters – so they must not be disappointed. And this means that extra spending in 2007 won’t be restricted to 47 billion rubles after all.

Practically all experts agree that the abrupt increase in state spending will push inflation even higher – and inflation has already gone out of control this year. However, assessments of the likely economic impact vary.

Yevgeny Yasin, research director at the Higher School of Economics: “If you have a lot of money, you’re entitled to spend it as you see fit. It’s all right for individuals to think this way, but state officials must not do so. Before taking any action, they should calculate its likely consequences. In this case, the question is whether Russian business can digest this money and create new revenue sources. But this question isn’t being asked. Clearly, this trillion rubles is directly linked to the election campaign: in effect, it’s an investment in the cause of remaining in power. In any event, business can’t compensate for all of it. That means prices will rise. And spending is being increased in such a way that consumers won’t feel the first inflation surges until the second half of March 2008, or slightly later – that is, after the presidential election. It’s hard to predict how many percentage points will be added to inflation by that trillion-ruble spending increase, but it’s certain that inflation will rise.”

Vladislav Inozemtsev, director of the Post-Industrial Studies Center: “The major problem is that our budget spending is going into pockets where it clearly isn’t supposed to go, thus increasing price pressure. But we need to understand that spending money on state-sector employees and pensioners is the lesser evil. Doing this is much better than increasing defense and security spending, for example. Our government cut back spending on vulnerable social groups in the 1990s, and we shouldn’t do it again. Besides, inflation is not an absolute evil – it’s common to all countries with fast-growing economies, and it’s largely due to significant growth in consumer demand. The damage is done not by inflation as such, but by its unpredictability. When the authorities feed us unrealistic fairy-tales about keeping inflation down to 8% a year, this is what generates the most unpleasant consequences of the process.”

Mikhail Delyagin, research director at the Globalization Studies Institute: “The most curious aspect is that the authorities aren’t really bribing voters – they’re bribing numerous financial-industrial groups linked to Kremlin factions. The apparent assumption is that these industrial groups will affect the election outcome. Judge for yourself: the greater part of the postponed additional spending, 640 billion rubles, is intended for supporting corporate projects – 240 billion for the Housing and Communal Services Reform Assistance Fund, 180 billion for the Development Bank, 130 billion for Russian Nanotechnologies, and 90 billion for the Investment Fund. Thus, less than half will be social spending as such.” According to Delyagin, the results of all these funding injections are obvious: an inflation shock in early 2008. He explains that aside from budget amendments, other factors will come into play: the moratorium on raising food prices will be lifted, and regular state spending – not campaign-related spending – tends to peak at the end of the calendar year.

By the way, the practice of increasing state spending immediately before elections is confined to developing nations. Inozemtsev says: “It’s hard to imagine such things happening in France or the United States. Socially-oriented parties over there are prevented from doing this by the legislative system itself, while right-wing parties are unlikely to take such steps anyway. But in countries where elections essentially take the form of plebiscites – as they do in Russia – this happens all the time.”