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. Last Updated: 07/27/2016

The Devilish Triangle of Budget Policy

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The climbing value of the ruble is generally explained of late as a result of deliberate policies. Inflation jumped over the winter, so the responsible officials were ordered to bring it under control. Since the tried and true method of lowering government spending was politically unappealing, they decided to let the ruble appreciate.

But then President Vladimir Putin reshuffled the cards. Apparently talks with businessmen convinced him that a stronger ruble could harm the economy. So now the government and Central Bank have three assignments: keep inflation down, halt real ruble appreciation and, foremost, increase government spending. In short: Do the impossible.

The source of the problem is the influx of petrodollars. Government spending will rise by more than 26 percent in 2007. Inflation is projected at 8 percent, meaning the real increase in spending will be 16 or 17 percent, which is much higher than the projected growth of 6 percent in gross domestic product. So spending will grow 10 to 11 percent faster than the economy.

But if the Central Bank continues to print rubles to buy up petrodollars to prevent the ruble from strengthening, it will just feed the very inflation it is supposed to be fighting.

And this inflation could lower the real increase in government spending not to 16 or 17 percent, but to zero. If this happens, the national projects and other social spending initiatives will end up existing only on paper and on television.

Clearly at least one of these objectives has to be abandoned. The simplest and most politically attractive path is to let the ruble appreciate. This will make life harder for exporters but will not hit the economy that hard. In 2005 a Higher School of Economics and World Bank survey revealed that only 30 percent of Russian firms export their products.

The head of the Russian Union of Industrialists and Entrepreneurs, Oleg Vyugin, offered a simple solution -- make a realistic projection for the price of oil over the next 10 years, and then calculate the real exchange rate necessary to cover the balance of payments. He also suggested that all budget revenues from oil exports should be channeled into the stabilization fund, and not just the Natural Resources Extraction Tax and export duties, as is presently the case. This would mean foregoing spending increases but would make it possible to lower both inflation and the value of the ruble.

The one goal that can't be abandoned is reducing inflation, which depletes the value of increased expenditures and deters investment. In the long term, further GDP growth may allow for more spending without ruble appreciation and galloping inflation. But achieving this result tomorrow means surrendering at least one of these goals today.

This comment was published as an editorial in Vedomosti.