RUSSIA: Russia bearish on infrastructure spending

Going up: a ski lift in operation at Sochi, site of the 2014 Winter Olympics – an infrastructure project that has thus far escaped government spending cuts

Published: June 7 2010 17:55 | Last updated: June 7 2010 17:55

By Charles Clover

The global economic crisis has hit ambitious goals Russia laid down in 2007 to rebuild its infrastructure, part of its plan to become the fifth-largest economy in the world by 2020.

Much of the country’s road, airport, railroad and power-generating capacity is decayed, left over from the Soviet era. Amid the post-communist economic chaos, investment spending collapsed in the 1990s, and only three years ago recovered to world averages.

In 2007, German Gref, the economics minister at the time, announced plans to spend up to $1,000bn (£695bn, €820bn) over the following decade on roads, airports, electricity generation, housing and other much-needed infrastructure.

The proposals – a potential bonanza for international banks and construction and engineering firms – are now likely to take longer to materialise than many optimistic forecasts had expected.

Just three years later, the plans are in tatters – the money spent on alleviating the financial crisis instead.
A total of $8bn earmarked for infrastructure investment from Vnesheconombank, the state development bank, went instead to bail out Rusal, the aluminium conglomerate, and other private companies. Budget money has also been moved from investment to social spending to soothe the impact of the crisis on the population.

The only projects that have been exempt from cuts are the $14bn Olympic site in Sochi for the 2014 Winter Olympics and a $10bn development plan in the far eastern region ahead of the 2012 Asia-Pacific Economic Cooperation (Apec) summit in Vladivostok.

“They can’t change the date of the Olympics, or they would,” says Andrei Kuznetsov, a strategist at Troika Dialog, the Moscow investment bank.

Sochi is one of the Kremlin’s flagship projects, meant to symbolise the rebirth of post-communist Russia in the same way that the 2008 summer Olympics showcased the new China. Up to $5bn of the costs will be financed from the federal budget, and much of the rest provided by investments from Russia’s large state- or quasi-state-owned industrial behemoths such as Gazprom, the natural-gas monopoly, and Rusal.

Gazprom is funding the construction of a resort for cross-country skiing; Interros, a big industrial group, is building a ski centre; and Sberbank, the largest retail bank in Russia, is constructing a ski jump. Tourism infrastructure plans include building a number of hotels, laying fibre-optic cables and installing a satellite navigation system in the city’s buses.

In Vladivostok, plans are afoot to build two massive bridges, a gleaming new airport and a university that will host the Apec conference.

In other areas, spending has been slashed, though official projections have yet to be revised. Finding figures is difficult, as the government does not disclose them, say analysts.

“The government doesn’t announce it is cutting spending on infrastructure. It just delays it, which is the same as cutting,” says Mr Kuznetsov.

The scale of the infrastructural task alone is daunting. Despite Russia’s size, its railway network is half the length of that in the US and freight trains crawl along at an average 25mph. The paved road network is less than one-10th the size of the US’s, and barely 5 per cent of its roads are considered “good quality” – which in Russia means having at least two lanes and a decent surface.

Improving this will mean radically changing the structure of the Russian economy away from consumption, to which it is currently geared, towards investment.

Investment, as measured against GDP, is 30 per cent for a typical emerging market, but in the middle of the past decade this fell to 15 per cent. It has only slowly been creeping back up, achieving the average overall world level of 23 per cent in 2007.

Russia invests far less in infrastructure than China or other Asian high-growth countries. Infrastructure investment is roughly 4-5 per cent of Russia’s GDP, while in China it is 8 per cent, according to Troika Dialog.

One constant obstacle to greater infrastructure spending is the cost of building in Russia, which seems to be astronomical compared with other countries. Moscow residents joke that the cost of a kilometre of the MKAD, or Moscow ring road, is equivalent to a kilometre of the Large Hadron Collider built by Cern on the Franco-Swiss border.

A planned 415-mile highway linking Moscow and St Petersburg will be expensive. Stage one, or 27 miles of the roadway, is projected to cost $1.2bn, and that is likely to rise.

Another costly road project is the western high-speed highway in St Petersburg, an eight-lane road designed to alleviate traffic congestion in the city. It is scheduled to be built, together with a ring road around the city, by 2015. Since spring 2006, the construction cost of the 29-mile road has risen by 370 per cent, from 57bn roubles (£1.3bn, €1.5bn) to 212.7bn roubles.

The problem, according to Mr Kuznetsov, is that

“when the government increases spending, it doesn’t increase volumes, it increases prices”.

Overall, 80 per cent of the $1,000bn announced in 2007 is expected to come from private sources, which in practice means mostly loyal oligarchs and state companies. But unlike China, which spends nearly $500bn every year on infrastructure, largely from its own resources, even Russia’s oil wealth will not be enough to finance the entirety of its ambitious plans. Foreign investors may be needed.

The European Bank for Reconstruction and Development has taken the lead in financing several projects, and will make its largest loan to date, of $245m, for the St Petersburg flood-protection barrier. It is also lending towards the reconstruction of the city’s Pulkovo airport.

Foreign investors will be wooed to participate in public/private partnerships to build projects such as toll roads and electricity generation, although Russia’s record with such investors leaves much to be desired. There are several damaging precedents such as the Sakhalin-2 oil and gas project, control over which Royal Dutch Shell lost to Gazprom in 2006.

This might make foreign investors think twice about getting into a long-term infrastructure project in Russia. However, for the time being, with oil and gas revenues buoying the economy, foreign appetite to invest in Russia never seems to wane.

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