Infrastructure: Build Russia a boom before it breaks down

IN ECONOMIC TERMS Russia has charged ahead since the turn of the century, registering annual economic growth of more than 7% on the back of growing demand for commodities from abroad and rising consumption at home.

But as anyone who has used the country’s roads, railways, ports or airports can testify, the dilapidated Soviet-era infrastructure is clearly failing to keep pace with the increasing demands being placed upon it. The bill for fixing Russia’s infrastructure problems is forecast to run into trillions of dollars over the next couple of decades alone.

And while the government’s coffers are full to overflowing thanks to rising tax revenues, the authorities in the Kremlin recognize that only by harnessing private-sector capital and expertise can they ensure that their infrastructure development plans are turned into reality.

The good news for the government is that bankers and investors are increasingly excited about the prospect of a Russian infrastructure boom and are positioning themselves to take advantage.

"The numbers being talked about are enough to interest anyone," admits Trevor Sturmy, London-based director of project and export finance at HSBC. He adds: "If things develop to plan, Russia will be a very important infrastructure play."

Australia’s Macquarie Group, with close to $60 billion of infrastructure assets under management worldwide, has also hastened to answer the Russian government’s call. It has teamed up with leading Russian investment bank Renaissance Capital to form a 50/50 joint venture, Macquarie Renaissance, to develop infrastructure advisory and fund management services in Russia. "We see significant opportunities in this market that we believe are well suited to our long-term infrastructure approach," says Jim Craig, head of the Macquarie Group in Europe. Macquarie Renaissance is reported to be establishing a $1 billion investment fund so as to participate in the public-private partnership (PPP) projects that are set to be mandated in the course of the next few years.

Renaissance Capital is by no means the only Russian investment bank eying the infrastructure sector. Arch-rival Troika Dialog is said to be looking to raise a similarly sized fund, and the investment banking arms of leading Russian commercial banks VTB and Gazprombank have both been building infrastructure teams so as to be able to participate in the potential PPP bonanza.

Although there’s excitement about the prospective infrastructure boom in Russia, there is also scepticism about how it will play out in reality. "There’s been lots of talk about PPPs, but nothing really major has happened up until now," says Thies Ziemke, a director at Moscow-based hedge fund Parus Kreml Capital Management. He adds that sticky-fingered officials could easily help to upset the government’s carefully laid plans. "The potential for corruption is a major concern – there are so many opportunities for bureaucrats to solicit bribes."

Florian Fenner, managing partner at UFG Asset Management in Moscow, says that heavy-handed regulation and politically motivated interference by the Kremlin is another worry. "Our policy when playing the infrastructure theme in Russia is to keep as far away from the government as possible," he says.

Others take a more charitable view. "The government and government-owned companies will play a key role in infrastructure development in Russia," says Eduard Faritov, transport analyst at Renaissance Capital.

Right direction

Although the Russian government’s integration into the country’s economy might not find favour with free market purists, Faritov argues that it is not a unique situation. "It’s a similar model to the one that worked well in South Korea," he says. He adds that one of the key challenges for the government is to create an investor-friendly backdrop, which will help to attract foreign capital. "Russia’s moving in the right direction but it’s still behind India and China in terms of the legislative and regulatory environment related to infrastructure development."

Sturmy at HSBC says that although there are concerns about political risk in Russia the fact that international financial institutions such as the World Bank and the European Bank for Reconstruction and Development will play a big role as advisers and financial sponsors on many of the infrastructure projects in Russia should be a source of comfort to investors. "The IFIs are helping to drive the development of both public-private partnerships and pure private sector involvement in infrastructure and carry a lot of political clout with the Russian government," he says.

He adds that the Russian authorities need the financial, management and technical expertise of international contractors and financiers to ensure that their plans are translated into reality. "The underlying logic behind private sector involvement in infrastructure development is certainty of execution – the fact that there are lots of half-completed roads in Russia is one of the reasons that the government wants to get the private sector involved in the first place."

Upgrading and expanding Russia’s road network is arguably the key element of the country’s infrastructure plans, as it will ultimately connect the aviation, port and rail projects. The lack of roads and their poor quality is already a big drain on the Russian economy. For example, the ministry of economic development estimates that economic losses from the poor quality of roads are running at 3% of GDP – a substantial sum given that the Russian economy has now passed the $1.5 trillion mark. As well as the financial cost to the country, there is also a human price: the number of road accidents has increased by a compound annual growth rate of 6.4% since 2000. The number of accidents on Russian roads is 1,000 times higher than from other forms of transport in the country, and some 34,000 people a year die on the roads in Russia, 10 times more than in the UK. According to Russian road agency Rosavtodor and ministry of transport statistics, less than 40% of even the country’s main roads meet Russian regulatory standards. The poor quality of existing roads is one concern, but another worry is the total absence of roads in some parts of Russia. At present 85% of the country’s road network is concentrated in the western half of the country, with large parts of Siberia and the Russian Far East totally inaccessible by road. About 50,000 localities in Russia do not have year-round road access, and an estimated 15 million people – more than 10% of the population – have no access to the road network at all.