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Russia Markets: Without Finance Minister Kudrin, Budgets Go Wild

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The loss of Kudrin is important; he is often credited with forcing Russia's government to save money, in part by keeping billions safe from special interest groups and building up huge reserve funds.

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Vladimir Putin's announcement two weeks ago that he would reassume Russia's presidency for another six years was an unpleasant non-surprise. It was followed by a smaller but genuinely surprising unhappy footnote: the abrupt resignation of Alexei Kudrin, the country's veteran finance minister.

Kudrin was in Washington for the IMF/World Bank annual meeting when the news broke that Putin would return to the Kremlin and likely appoint current president Dmitry Medvedev as prime minister. The normally phlegmatic finance minister was apparently counting on becoming premier himself. He snapped and told reporters he would refuse to serve in a Medvedev cabinet. Medvedev, still president for the moment, had little choice but to fire Kudrin as soon as he flew back to Moscow.

These internal machinations are important because Kudrin, who held the finance post since Putin took power in 2000, is often single-handedly credited with forcing Russia's government to save money, somehow keeping hundreds of billions of dollars safe from a horde of underhanded special interests, and building up the huge reserve funds that cushioned the country's 8% GDP contraction after the 2008 world financial crash.

As an old Moscow joke has it: There are only two risks in this country, the oil price and Mr. Kudrin's health. Now that Kudrin has fallen politically ill, the Kremlin elite can only pray that oil stays high. Just how high was detailed the other day in parliamentary testimony by Kudrin's interim replacement, a previously obscure deputy named Anton Siluanov.

Russia needs an average price of $93 per barrel to balance its budget this year, Siluanov calculated. That sounds reasonable enough for the moment. The Urals crude that the country sells is fetching $107. But the budget gets hungrier at an alarming pace. Next year it will take $108 a barrel to avoid a deficit, and by 2013 $117.

Consider that Urals traded at around $75 a barrel for most of 2010 and below $50 for four months during the dark winter of 2008-09, and the expenditures begin to look scary. Kudrin's piggy bank for tough times only has half as much change in it now as before the 2008 calamity. Russia's Reserve Fund and National Welfare Fund, the finance ministry's two savings vehicles, hold a combined $115 billion at present, or 7.8% of gross domestic product. That's down from a peak of $236 billion three years ago.

Deficit spending might not be a bad option for Russia if it were spreading wealth to hard-put pensioners and teachers, or upgrading the country's woeful infrastructure. Some of that is going on. But the design and execution of upcoming budgets also guarantee that a lot of the Kremlin's money will be pilfered and wasted.

Russia is committed to hosting the Winter Olympics in 2014 and the soccer World Cup in 2018. Events like these are a signal for large, dubious expenditure in the best-managed economies. In systemically corrupt Russia, they are igniting a feeding frenzy. A new combined rail and passenger road near the Olympic site of Sochi, for instance, is budgeted at $8 billion for a 50-kilometer stretch, or $160,000 per meter.

Kudrin, before he left, also took public issue with a planned $65 billion ramp-up in military spending by 2014. Medvedev, who has championed the outlays, shot back that they must be "worthy of the Russian Federation, not some banana republic."

Siluanov's sobering budget projections were overshadowed internationally by a hint at financial largesse from another top Russian economic official. Medvedev's top economic advisor, Arkady Dvorkovich, told a Moscow conference his country could "help" the debt-tormented eurozone if its leaders produce a "concrete, clear strategy to exit the crisis." He added that Russian representatives have held bilateral talks with Spain about possibly shoring up its sovereign bonds with targeted purchases.

The approach to Spain amounts to shrewd diplomacy. Russia for the moment does have funds to invest with $517 billion piled up in central bank reserves. Moscow already has tight relations with Italy, the other troubled debtor that is too big to fail. (Putin's 59th birthday party last weekend was one of the few places in Europe where Prime Minister Silvio Berlusconi is still welcome). Helping Spain when it's down might cement another important friendship within the European Union, Russia's biggest customer for oil, gas and everything else.

But locking in spending "worthy of the Russian Federation" as if oil prices will never fall sets Putin and Medvedev up for a rapid reversal of fortune if and when they do. They had better enjoy playing the rich man while they can.

In Other News:

Adidas Plans Rapid Expansion in Russia

Oil Taxation Overhaul Aims to Keep Production From Declining

No positions in stocks mentioned.

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