Feb. 28 (Bloomberg) -- The shadow of inflation is threatening Russian President Vladimir Putin's economic legacy and complicating the decisions facing chosen successor Dmitry Medvedev.

Russia's prosperity is built on nine successive years of expansion, a sixfold increase in average incomes and almost $500 billion of currency reserves. They contribute to Putin's inability to contain consumer-price growth, which overshot its target in every one of his eight years as president except 2003.

Medvedev, 42, the likely winner of the March 2 election, must find ways of containing inflation that accelerated to 11.9 percent in 2007. Failure to do so may trigger unsustainable wage demands, squeeze consumer spending and dent company profits.

``It's the biggest macroeconomic problem Russia faces right now,'' said Roland Nash, chief strategist at Renaissance Capital in Moscow. ``If you look at any public survey, they all say the same thing. It's absolutely a political issue, but it has an economic solution. It will be a test for Medvedev.''

At the same time, Medvedev will have ``no real tools'' for meeting an annual inflation target of 8.5 percent, said Anton Struchenevsky, an economist at Moscow's Troika Dialog brokerage.

Monetary policy isn't effective because, 17 years after the collapse of the Soviet Union, Russia hasn't developed a fully fledged consumer-credit market. Mortgages are few and credit-card use is in its infancy outside the biggest cities.

Cash Is King

Cash dominates transactions, with almost 90 percent of cards used only to withdraw rubles from bank accounts, according to Anatoly Aksakov, a member of the lower house of parliament.

``Inflation is undoubtedly the most serious problem the government will face after the election,'' said former acting Prime Minister Yegor Gaidar, who abolished Soviet-era price controls that pushed inflation over 2,000 percent in 1992. It will be ``a serious blow to the long-term potential of the economy,'' said Gaidar, now director of The Institute for the Economy in Transition in Moscow.

The soaring amount of money entering the economy from energy revenue, share sales and foreign investment isn't helping. M1 money supply rose by 28 billion rubles to 4.05 trillion rubles in the week ended Feb. 18, up from 700 billion rubles in April 2002.

Greenspan's Analysis

``Growth in money supply in Russia has been very large, well in excess of nominal gross domestic product, and this is a major factor, I think, in the upward pressure'' on prices, former Federal Reserve Chairman Alan Greenspan told a conference in Moscow on Jan. 30.

The Central Bank of Russia's dilemma is a policy that targets both the exchange rate and inflation. It uses the reserves to manage the ruble, pumping money into the economy to weaken the currency and stoking inflation. Finance Minister Alexei Kudrin said last month that Russia will move to a floating exchange rate by 2011.

``I don't think Russia is going to make it three years without allowing much faster exchange-rate appreciation,'' said Kenneth Rogoff, a professor at Harvard University and former chief economist at the International Monetary Fund. ``The current macropolicy is unsustainable.''

A 40 percent jump in government spending and record net capital inflow of $82.3 billion in 2007 also spurred price growth.

Wages and Pensions

The average monthly wage reached 18,467 rubles in December; the average monthly pension was 3,309 rubles. Food comprises 40 percent of Russia's average consumer basket, the statistics office says. Forty-one percent of Russians spend more than half their income on food, according to a January poll by the All-Russia Center for the Study of Public Opinion. Sixty-eight percent have no savings, the poll found.

Public transport, funerals and housing maintenance have become more expensive. Utilities prices jumped an annualized 16 percent in January, when the government traditionally imposes the largest increases on water, gas, heat and electricity.

``For many, the situation is much worse than what the official figures show,'' said Natalya Tikhonova, chief of social policy research at the Moscow-based Institute of Sociology of the Russian Academy of Sciences. ``The poor are hardest hit.''

To rein in prices, the government cut dairy and vegetable-oil import duties and persuaded companies including OAO Wimm-Bill-Dann and X5 Retail Group NV to freeze prices on some milk, egg and bread products until May 1.

A Rebuilt Economy

Russia, the world's biggest energy exporter, has rebuilt its economy since 1998, when inflation was 84.4 percent and the government defaulted on $40 billion of debt. It has accumulated $483.9 billion in reserves while wages grew an average 14.4 percent a year since 2000.

At the same time, ``accelerating inflation has a direct impact on growth,'' said Vladimir Tikhomirov, chief economist at Moscow-based UralSib Financial Corp. It makes borrowing more expensive, enticing companies and individuals to reduce the spending that helped the economy expand 8.1 percent in 2007, he said.

The result is acutely felt among families like Sergei Polyakov's. The worker at the Balt Keramika brick-making factory in the western region of Kaliningrad said his 74-year-old mother, who worked as a teacher for 35 years and receives a state pension, can't afford both food and utilities payments.

``Everything is just getting more expensive, from food to everything else,'' Polyakov said. ``I have to help her live.''

To contact the reporter on this story: Maria Levitov in Moscow at mlevitov@bloomberg.net

Last Updated: February 28, 2008 06:32 EST