By Douglas Busvine
MOSCOW, Sept 29 (Reuters) - Vladimir Putin's desire for both guns and butter has just cost him his finance minister, and little can now prevent the future president from embarking on a $600-billion arms spree that Russia can ill afford.
Although Alexei Kudrin's political ambitions were thwarted, it was also his objection to huge increases in defence outlays -- he first offered to resign last February -- that this week brought the curtain down on the fiscal hawk's 11-year tenure.
"This does not allow us to reduce the budget deficit even when oil prices are high," Kudrin told reporters in Washington as he rebelled against the plan announced by Putin, now prime minister, to return to the presidency next March.
Former British premier Margaret Thatcher once said: "The Soviets put guns over butter, but we put almost everything over guns." Now, Putin's refusal to choose between them could endanger his goals of raising living standards and national security.
First, the butter.
Think-tank Capital Economics estimates that Russian public spending rose from 16 percent of gross domestic product in 2006 to a peak of 25 percent in 2009 as the state hiked pensions to soften the blow of the global financial crisis.
As a result of those increases in non-discretionary spending, the oil price at which the budget would balance rises next year to $116 per barrel, compared to as little as $40 as recently as 2007.
Now for the guns.
According to Kudrin's arithmetic, planned increases in the cost of equipping Russia's armed forces, military pay, pensions and investing in the military-industrial complex will add 3 percent of GDP to government spending over the next three years.
Putin, when he last December announced plans to spend 20 trillion roubles ($630 billion) over the next 10 years to upgrade Russia's ageing armed forces and missile capability, said he was "frightened" to name the number.
But President Dmitry Medvedev, poised under the job swap deal to assume the premiership -- a job coveted by Kudrin -- seems to have fewer concerns about rearming in what some analysts have described as an attempt to nip any Arab Spring-style unrest in the bud.
"We cannot do without defence spending, and I mean spending that is worthy of the Russian Federation -- not some banana republic," Medvedev told military top brass this week, sporting a jacket with 'Commander-in-Chief' sewn into the breast.
The good news for Russia is that its sovereign balance sheet, repaired by Kudrin after the traumatic domestic default of 1998, is strong, with debts equivalent to only about 10 percent of GDP.
The country holds half a trillion dollars in reserves, the world's third largest, of which around $120 billion are stashed in two rainy-day funds that have gathered windfall oil revenues.
The bad news is that, after stripping out energy revenues that cover half the federal budget, the world's largest oil producer is running a deficit of 11 percent of GDP.
Little change can be expected in the near future in Russia's spending plans with the three-year budget, which foresees annual spending growth of more than 20 percent despite Kudrin's restraining influence, due to go before parliament in days.
Chiefs of Russia's military-industrial complex are unlikely to have much of a chance to pick the pockets of acting Finance Minister Anton Siluanov, a little-known career bureaucrat, before he is replaced.
That, government sources told Reuters on Thursday, could happen right after the Dec. 4 parliamentary election when a government reshuffle is likely to be announced.
SOAK THE RICH
But once the transition is assured, Putin will have the chance to launch a new policy agenda that, as he outlined in his keynote speech to the United Russia party congress on Saturday, targets annual growth of 6-7 percent.
Putin said he would raise taxes on Russia's wealthy -- with increased levies on consumption, assets and property -- none of which have yet been factored in to the fiscal framework.
"If we want to talk about social justice, taxes on the rich ... should be higher than for the middle class, than for the mass of ordinary people," Putin told the congress.
Fears among affluent Russians that Putin would target their wealth to square the fiscal circle have driven capital flight in excess of $50 billion over the past 12 months.
The sound of money leaving the country grew louder at the start of this week, forcing the central bank to step up dollar-selling intervention and its chairman, Sergei Ignatyev, to call time on the rouble's 15 percent slide since early August.
There was less talk from Putin of Kudrin's priorities of pension reform and privatisation, both regarded as vital by independent economists and the International Monetary Fund to prevent Russia from becoming trapped in a low-growth scenario.
That all smacks of the pessimistic scenario of economic stagnation outlined by economists Sergei Guriev, of the New Economic School in Moscow, and Aleh Tsyvinski of Yale University in the United States.
In their view, an entrenched elite cannot risk the sort of economic reforms that would lead them to lose control over the commanding heights of the economy, condemning Russia to long-term stagnation and, ultimately, the risk of financial collapse.
"If oil prices remain high then Russia will probably repeat the experience of the Soviet Union in the '70s and '80s, when reforms were postponed and the economy sank into stagnation," they wrote in an opinion piece in the Vedomosti daily this week.
"This period ended in bankruptcy and the breakup of the Soviet Union." (Additional reporting by Lidia Kelly and Darya Korsunskaya; Editing by Janet Lawrence)