The Kremlin is looking for a way to stimulate its economy. Russian President Vladimir Putin cannot risk the kind of poor economic growth that Russia is currently facing or the associate risk of social unrest at a time when his approval rating is on the decline. His government needs to find some kind of way to kickstart the economic growth it has promised, and though that has failed to materialize, it seems to have settled on an unconventional target: Russia’s National Wealth Fund.

In 2018, the growth of Russia’s real gross domestic product exceeded expectations – it hit 2.7 in the fourth quarter, with annual growth rate of 2.3 percent, driven mainly by the short-term effects of energy sector construction projects. But the Russian economy is flagging this year. In the first quarter of 2019, real GDP slowed 0.5 percent compared with the same period the previous year. This is worse than the most pessimistic forecasts. And since the beginning of June, the World Bank revised its 2019 forecast for Russian GDP growth to 1.2 percent from 1.4 percent, and the Russian Central Bank (which is a relatively independent entity) to 1 percent-1.5 percent growth from 1.2 percent-1.7 percent growth.

The Kremlin knows that the substantial economic growth Putin has been promising is only possible through a significant stimulus driven by domestic infrastructure projects. To this end, it’s now planning to deploy money from the NWF, Russia’s sovereign wealth fund. The Ministry of Finance had previously dismissed the possibility of using the country’s sovereign wealth fund; the government did not want to expend the domestic reserves it has accumulated from high oil prices. The reversal carries with it risk for both the NWF and the economy as a whole.

The NWF enables Russia to store up funds during years of high oil prices, which would be used to help stabilize the economy in the face of an economic shock or downturn. The country’s budget rule, enacted in 2017, sets parameters for its maintenance and use. It requires the government to put into the NWF profits from oil if the price per barrel or Urals oil exceeds $41.60. It allows the government to use the NWF for the kinds of projects it’s currently considering if its liquidity equals 7 percent of GDP. According to the Ministry of Finance, it will hit that mark by the end of 2019, when it’s expected to reach 7.9 trillion rubles ($126 billion). At that point, the government would be allowed to spend the portion of the fund that exceeds the 7 percent threshold. The Ministry of Finance expects it would be able to invest 1.8 trillion rubles in 2020 and about 4.2 trillion rubles in 2021.

(click to enlarge)

A Risky Proposition

But observers have warned that while investing money from the National Wealth Fund may provide an economic bump in the short term, the long-term risks aren’t worth it. There are two in particular that the government will need to consider. First, if Putin hopes to see his approval ratings turn around, Russia will need to see sustainable economic growth as soon as possible. That will hinge on the government’s budget, which is dependent on oil prices. Urals is currently priced at $60.75 per barrel. But that still doesn’t seem to be generating enough savings for the NWF. At present, there’s 3.8 trillion rubles in the NWF, which comes to only 3.6 percent of GDP. Any fluctuation in the price of oil could put further pressure on the fund and therefore the budget and jeopardize the implementation of domestic projects. An NWF-driven fix, therefore, likely won’t be quick.

(click to enlarge)

Second, even though Putin has helped the Russian economy overcome the challenges posed by sanctions and falling hydrocarbon prices, Russia is losing foreign investment. Preliminary data from the Central Bank of Russia showed that capital outflows for January-May 2019 amounted to $35.2 billion – almost doubling compared to the $18.9 billion in outflows from same period last year. Capital outflows include the physical export of money as well as the acquisition of foreign assets, and the Central Bank attributed this increase in large part to Russian investment in overseas assets. Meanwhile, foreign investment in Russian businesses decreased by more than $6 billion in 2018 to $15.9 billion, with no signs of improvement in 2019. Where foreign investors may have once used the opportunities of a weak exchange rate and crises in the Russian economy to boost their market presence and competitiveness, they’ve now been scared off by new sanctions. Furthermore, Russian businesses are now in a rush to pay off foreign debts before new sanctions take effect; the Central Bank says Russians have paid $5.5 billion more in foreign debt than they received since the beginning of the year.

There are no signs that oil prices will increase significantly in the near future – the tensions in the Middle East notwithstanding – and the European Union recently extended sanctions on Russia. The state, then, sees no other option to stimulate the economy than to use NWF resources.

A Difficult Decision

Still, the government hasn’t made a final decision on if and how it might use the fund, and it’s not expected to do so any time soon. The decision, when it comes, will be the result of a long and intensive discussion; whichever way the government decides, it will not mean an entirely positive result for the economy or the Russian population, and the government is particularly sensitive to how its measures will impact the public – especially if the results aren’t favorable.

There’s one faction of the government that sees the Russian economy as healthy enough to withstand a potential crisis: It has little public debt, a budget surplus and high foreign currency reserves. In the economy’s current position, they say, it’s possible to consider the kind of domestic investments the NWF would be used for. However, if the government starts investing in national infrastructure projects, it will drive up demand, and possibly cause inflation. After battling high inflation for years, that’s not an appealing prospect for Russia.

There’s another faction that instead is advocating the use of NWF funds to invest abroad in hopes of creating a demand for non-oil Russian products from foreign countries. First Deputy Prime Minister Anton Siluanov suggested, for example, using the NWF to invest in the construction of nuclear power plants in Egypt. As part of the project, Russia plans to extend a $25 billion loan to Egypt. This could very well work. But it would be difficult to explain to Russians why, in a time of stalled growth, the government isn’t investing at home.

If by the end of 2019 the NWF exceeds 7 percent of GDP, the government will be hard pressed to deliver on the economic growth that Putin has promised without tapping into the fund. What the government will have to decide is how much of the fund to spend and on which projects. If the Kremlin makes the wrong choice, inefficient investments could negate the positive results of the budget rule, which allowed the government to somewhat lessen its reliance on high energy prices. Add in the prospect of domestic unrest, and the government finds itself under significant pressure in this decision-making process.

Ekaterina Zolotova
Ekaterina Zolotova is an analyst for Geopolitical Futures. Prior to Geopolitical Futures, Ms. Zolotova participated in several research projects devoted to problems and prospects of Russia’s integration into the world economy. Ms. Zolotova has a specialist degree in international economic relations from Plekhanov Russian University of Economics. In addition, Ms. Zolotova studied international trade and international integration processes. Her thesis was on features of economic development of Venezuela. She speaks native Russian and is fluent in English.