By Lidia Kelly
MOSCOW (Reuters) - Russia's recent decision to spend more of its fiscal reserves on infrastructure to keep the sanctions-hit economy turning marks an about-turn for President Vladimir Putin that leaves a question mark over the future funding of pensions.
Hit by plummeting investment and capital flight after Putin's decision in March to annex Crimea from Ukraine, the $2 trillion (1.17 trillion) economy is on the brink of recession. U.S. and EU sanctions have been limited in scope, but there are signs foreign investors are holding off for fear of worse to come.
To revive the economic growth that was the main driver of Putin's popularity in the previous decade, the government has resorted to something that Putin only last year vowed not to do: tap the $87 billion National Welfare Fund.
The fund has been built up from windfall oil revenues and is intended to help finance a growing state pension deficit; but a government decree last week raised the share of the fund that could be used for direct investment such as infrastructure projects to 60 percent from 40 percent.
The move deals a blow to the Finance Ministry, which manages the extra energy revenues and had previously insisted on a 40-percent cap with the rest invested conservatively, mostly in foreign currency and foreign sovereign debt.
But the real victims could be ordinary Russians whose pensions the fund is intended to cover in the future as the population ages and the state budget can no longer keep up.
Pensioners remember how Putin restored order to the pension system after its near collapse in the 1990s, and they make up his strongest voter base.
But in a country where every fifth dollar of spending on state procurements is officially acknowledged to end up stolen, and state companies come up with elaborate schemes not to return federal funds, the promised return on those investments may never materialise.
"We should not be taking money away from the future generations for which the Fund was, strictly speaking, created," said former central banker and Finance Ministry official Sergei Aleksashenko, a critic of Putin.
"We are on track to leave them an economy that is not powerful and thriving, but rather rotten through and through with theft and kickbacks."
ABOUT-FACE
The National Welfare Fund and its sister, the $87 billion Reserve Fund, were created by former finance minister Alexei Kudrin, who is credited with restoring public finances to health after the chaotic 1990s.
The funds helped Russia to survive the 2008-2009 global financial crisis relatively unscathed, by providing about $100 billion of support to state companies.
Last November, when risk aversion towards emerging markets began threatening the economy and some officials called for more of the reserves to be mobilised, Putin said the National Wealth Fund was a security cushion not to be toyed with.
"Those who supposed that we should allow ourselves to spend the entirety of this fund are deeply mistaken," he said then.
But the economic fallout of the Ukraine crisis appears to have prompted a government change of heart.
Net capital flight is $80 billion in the year so far, compared to $64 billion in the whole of 2013.
Capital investment in tangible goods, which grew in double digits in most of the first decade of the millennium, was down 2.6 pct in May, year-on-year - the latest in a series of monthly falls that have extended the 0.2 percent decline seen in the whole of 2013.
Last month, Putin surprised markets by suggesting that the state-run gas producer Gazprom could boost its capital with billions of dollars from the fiscal reserves - a notion the Finance Ministry has ruled out for now.
Then came last week's decree to tap the National Wealth Fund by giving roughly $9 billion each to two state institutions, the Russian Direct Investment Fund and the state nuclear corporation Rosatom, to spend on projects ranging from roads to railways and nuclear power stations, both inside and outside Russia.
In the first days after the announcement, the Finance Ministry made no comment.
Asked this week by Reuters why he had agreed to raise the fund's cap on direct investment, Finance Minister Anton Siluanov said the new projects were "reliable and profitable" and could bring returns of up to 18 percent.
"(These projects) will create new jobs and spur demand for our suppliers of fuel for nuclear power stations, of equipment and so on," Siluanov said, adding that the money had been earmarked exclusively for projects that also involved foreign investment.
NO SPECIFICS
Last year, the Fund's investments in all foreign currencies brought a 9.9 percent return in rouble terms and 3.35 percent from dollar deposits in the U.S.
Kudrin said late last month that he did not oppose increasing spending from the Fund slightly, but that he could see hardly any projects that met the required standards of quality and profitability.
He warned that the government should not invest "when the economics of the projects are still unknown, no trust has been established, and private investors are still not present".
So far, there are no specifics on foreign investment in the projects, but few doubt that Russia needs a growth stimulus, and the move represents a victory for Economy Minister Alexei Ulyukayev's advocacy of bigger spending.
Analysts at the state-owned VTB Bank said the move was likely to "support a recovery in investment and, more broadly, economic growth, starting in 2015 (maybe late 2014)".
At the same time, economists warn that there is a risk of money being lost along the way.
"Infrastructure spend is about all that is left â but is incredibly inefficient in Russia, as evidenced by the Sochi Olympics. The $50 billion spend was three to four times more than the London Olympics, and I would hazard a guess that a lot of this leaked out via graft," said Timothy Ash, head of emerging market research at Standard Bank in London.
In a report last month on Russia's fiscal policy, the International Monetary Fund criticised the Finance Ministry for not providing "any risk analysis around (the wealth funds') investment strategy".
The main risk, analysts say, is that Russia, which has a generous retirement age by global standards - 55 for women and 60 for men - may not have the money to pay pensions to a population where the share of retirees is 28 percent and rising.
PENSION SHORTFALL
Last year's pension deficit was $27.4 billion and the government has so far managed to cover the shortfalls from its budget. But it expects that it will be unable to do so beyond the end of the decade, as the population continues to age.
In the meantime, growth has stalled.
The government expects the economy to expand by at most 0.4-0.5 percent this year, and the World Bank and the IMF say a recession is likely if Russia is subjected to the deeper sanctions that the EU and United States have threatened over its role in the crisis in Ukraine.
Russia, which expects a small budget surplus this year, could potentially increase federal spending. But that is limited by a budget formula, while the National Wealth Fund is administered outside the annual budget.
Aleksashenko says increasing the budget deficit would be the most logical substitute at a time when private investment is largely absent.
"(It is) also more transparent as you include those expenditures into the budget," he said.
That, however, is unlikely to happen. The Finance Ministry only recently won a heated battle to defend the limiting spending budget rule, leaving the Wealth Fund as the only readily accessible source of funds.
"A little more, a little bit more and we can forget about the National Wealth Fund," Aleksashenko said.
Ash at Standard Bank echoed the view of many Western analysts that Russia above all needs "meaningful economic reforms" to make it more attractive for both domestic and foreign investment.
"But this means changing the whole model of development, from the power vertical to something else, and that is a risk to Putin's grip on power; he is above all a conservative with a small 'c', and does not like radical change," Ash said.
"So raiding the National Wealth Fund is a sign of desperation in my mind, and suggests little prospect for meaningful reform. The Finance Ministry knows this very well."
(Reporting by Lidia Kelly; Editing by Kevin Liffey and Ralph Boulton)