* Hits out over capital flight
* Says Russia must close productivity gap
* Public sector pay hikes should improve services
By Douglas Busvine
MOSCOW, Dec 12 (Reuters) - President Vladimir Putin conceded for the first time on Thursday that Russia's economic problems were home-grown and vowed not to abandon the spending promises he made on returning to the Kremlin last year.
Facing an audience of lawmakers, officials and business leaders, Putin also said "nothing has been done" to implement an initiative he launched a year ago to stem capital flight that has sapped both investment and the Kremlin's coffers.
The 61-year-old leader's grim diagnosis marked a shift away from blaming the woes besetting Russia's $2 trillion economy on trouble abroad, especially the sovereign debt crisis in Europe - its biggest export market.
"We have to be clear: the main reasons for the economic slowdown are not external but internal," Putin said in his annual address in the Kremlin.
During Putin's first two terms as president, the economy clocked up annual growth rates of about 7 percent thanks to a boom in oil prices, while easy monetary conditions flooded emerging markets with cheap investment dollars.
That ended abruptly with the global financial crash of 2008 and, with the government now relying on oil prices of over $100 per barrel to balance its books, consumer spending is all that is keeping the economy ticking over.
The downturn, along with vast illegal outflows of cash estimated by a former central bank chief at $50 billion a year, has caused the fragile recovery to stall. The government now expects the economy to grow by just 1.4 percent this year.
Long-term growth is likely to average 2.5 percent, lagging the world economy and other emerging markets. The government meanwhile risks exhausting its rainy-day savings in three years, officials warn.
Putin called for action to improve the business climate and said that low labour productivity was a major drag on Russia's economy, ranked by the World Bank as the fifth biggest in the world by purchasing power parity.
"Russia is among the top-five global economies," Putin said. "However, we lag developed countries by two-thirds to three-quarters on such a key indicator as labour productivity. We must act resolutely to overcome this gap."
Former Finance Minister Alexei Kudrin, still widely viewed as Russia's most competent economic policy maker, faulted Putin for failing to act sooner.
"It's a shame that so little has been done," Kudrin said on Twitter after the speech. "The president's proposals for reactivating the economy are a tactical response to the problem. We need a strategic plan to get out of stagnation."
Speaking earlier, Europe's development bank said that Russia needed to restructure and sell the large state companies and banks that play a dominant role in business and finance.
"For Russia, without reforms, we are very pessimistic about growth," said Erik Berglof, chief economist of the European Bank for Reconstruction and Development.
BRING BACK THE MONEY
Putin's landmark initiative to "de-offshore" Russian finance, announced in the same Kremlin hall a year ago, has had little impact beyond forcing some lawmakers to resign after they were found to have owned property secretly abroad.
He said that companies whose ultimate owners were Russian would be barred from state contracts and refused credit by state development bank VEB if they failed to pay taxes in Russia.
"If you want to enjoy benefits, state support and earn a profit working in Russia, then register in a Russian jurisdiction," said Putin.
"Since nothing has been done in this area over the past year, I have a proposal," he said. "If you want to go offshore, you are welcome. But send your money here."
Despite the weaker economy, Putin also said he would follow through on the so-called 'May decrees' he promulgated on returning to office that include doubling pay for teachers and doctors by the end of his six-year term.
"The economic cycle can and is changing, but this is no reason to talk about revising our goals," Putin said.
He said, however, that pay rises must be tied to improved public services.
"This means increasing the personal responsibility of every manager for achieving results," he said.