Entrepreneurial culture nurtured in the regions

  • 30 Apr 2007
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There are increasing signs that the Russian federal government wants to pursue a more market-orientated regional development policy, encouraging the creation of special economic zones, a Russian development bank and nine state-sponsored hedge funds to support start-up companies. Julian Evans reports.

There are 88 regions in Russia, of which 12 provide money to the federal centre. These ‘donor’ regions are, in the words of President Putin, "the hen that lays the golden eggs".

Their administrations give 60% or more of their tax revenues to the federal government. The other 76 regions receive federal handouts. About a quarter of this money goes to the Caucasus, where much of it is reputed to disappear into private pockets.

The donor regions are starting to complain about this process. Bulat Stolyarov is director of the Institute for Regional Policy, which advises the donor region of Krasnoyarsk Krai. He says: "The Soviet system of regional funding didn’t disappear. The ministry of finance takes from the rich and gives to the poor. It creates bad incentives. Only about 20 regions understand how to compete for investment. The rest think everything depends on the relationship with the federal government."

Marat Safyulin, economic adviser to the president of Tatarstan, another donor region, agrees. He says: "The present system rewards laziness. For example, our region has pursued an active housing policy, building new houses for our population. Now the federal government is pursuing a similar policy, and handing out money to regions to build housing. But we don’t get any money, because we’ve already done it ourselves. So we’re being punished for being active and forward-thinking."

There are signs, however, that the federal government, particularly the market-friendly ministry of economic trade and development, wants to try and pursue a less Soviet and more market-orientated regional development policy, using various market incentives to encourage regions to help themselves.

Minister German Gref, at a recent conference in Krasnodar, outlined the government’s strategy for regional development, saying at least 11 different methods would be used to encouraging regional growth, including: the establishment of ‘techno-parks’, the creation of special economic zones, the creation of a Russian development bank; the creation of nine state-sponsored hedge funds to support start-up companies; the increase of the federal investment fund to support regional infrastructure projects, and other tax incentives and concessions.

Scattergun approach?

This might seem like a bewildering array of different proposals, suggestive of a rather scattergun approach to promoting investment. But how exactly will these proposals work?

Analysts say they will help encourage regional administrations to become more market-orientated. Take the investment fund, which was created in 2005, and which has already committed around $4bn in capital to five regional infrastructure projects.

Stolyarov says: "If a region wants to attract money from the investment fund, it has to put together a project proposal, crunch the numbers to see what the IRR would be over several years, and work with a Western financial consultant to check the feasibility of the project. Then it proposes it to a commission at the ministry of economic trade and development, which also works with a Western financial consultant [UBS] to make their own analysis."

Stolyarov’s institute, together with ABN Amro, helped to put together one such proposal for Krasnoyarsk Krai, to build "a whole new industrial region" around the Angara river in Krasnoyarsk. The plan is to finish the construction of the Boguchanskaya hydroelectric dam, started in the 1980s but never finished because of the collapse of the USSR. The project will also include the construction of an aluminium smelter beside the dam, which will use most of its electricity. The project will be a joint venture between Russian Aluminium and HydroOGK, the hydroelectric power subsidiary of RAO UES.

The project was approved last year, and will attract $1.3bn from the investment fund, to be spent on infrastructure. It will also attract $2.5bn in financing from Western banks, with ABN Amro the main lender. The joint venture raised a $520m bridge facility in March. The three year loan had an interest rate of 82.5bp over Libor. ABN Amro, Barclays, Calyon, and Russia’s Sberbank acted as the deal’s arrangers and underwriters.

Another project to have won backing from the investment fund is a new petrochemical facility in Tatarstan, which will refine oil from Tatneft. The $5bn project was developed by Foster Wheeler, the Western engineering and construction firm. Umberto dela Salla, CEO of Foster Wheeler’s engineering and construction division, says: "It’s the largest petrochemical project of its kind happening anywhere in the world at the moment." BNP Paribas is the financial consultant for the project.

The investment fund is stumping up around $600m for infrastructure to support the project, while BNP Paribas is considering how to come up with around $3bn in project financing.

Pros and cons of regions policy

What are the advantages and disadvantages of this development policy? On the one hand, investing in infrastructure is a way for the Russian government to spend its petrodollars promoting long term growth rather than short term bubbles, thereby also easing the threat of inflation, which the government seems to have got under control.

Stolyarov argues that infrastructure is key to encouraging private investment in the regions. He says: "Our institute did research into 100 big investment projects that could take place throughout Russia, worth a total of $230bn in investment over the next 10 years. We found that the principle barrier to these projects taking place was poor infrastructure — roads, electricity, pipelines, railways. If the government invested say $80bn in infrastructure, it could attract a further $230bn in private capital."

At the same time, certain risks are obvious. First, as a source at the EBRD says: "PPPs [public-private partnerships] are fairly new and controversial mechanisms even in the UK, where they were invented. Even there, with all the institutional strength of the UK legal system, there is a danger of a confusion of public and private interests. There’s even more of a danger of that in Russia."

Thus we see in the petrochemical project in Tatarstan, for example, that the joint venture attracting $600m in Russian taxpayers’ money, called NNPZ, is 50% owned by two private funds, and that neither Tatneft nor the general director of NNPZ say they know who the main shareholders of these funds are.

The presence of either the EBRD or the IFC in these projects might help to guarantee that tender processes were transparent, but it is notable that both the EBRD and the IFC have both so far not played a role in the government’s PPP programme.

Nonetheless, the projects illustrate a central strand of the Russian government’s regional development philosophy — "if you regions show yourselves able to attract private capital, we will also donate federal capital to match it".

Eric Rasmussen, deputy head of the EBRD’s Moscow office, says: "It has become very fashionable to be known as a pro-investor regional administration. In fact, it has become a criterion for being on good terms with the Russian government."

Some regions have shown themselves particularly adept at attracting foreign investment. Tatarstan is an obvious example. In the last five months, delegations led by its president and prime minister have made investor presentations at Davos, at the Mipim real estate conference at Cannes, in Liepzig, in London and in Singapore. Umberto dela Salla of Foster Wheeler says: "They really understand the rules of the game, how to attract foreign capital."

Other regions which make similar efforts include Krasnodar, which holds a successful investment conference in Sochi every September; Samara, which has become one of the most prosperous regions in Russia over the last eight years; and Nizhny Novgorod.

Opportunities for the adventurous

Such regions offer great opportunities to the adventurous investor. One example is Kendrick White, an experienced US investor who has been living in Russia since 1982, working with the EBRD and PricewaterhouseCoopers. He has spent most of that time living in Nizhny Novgorod, and finding local entrepreneurs to back through his investment company, Marchmont Capital Partners.

He says: "Regions are a bit like a black box. They haven’t had the culture to do much self-presentation and to try and seek out investment. That’s changing as companies from Moscow and abroad reach out into the regions. Now regional firms have to adapt and modernise to survive. So where two years ago I was pleading with local firms to let me invest, now the local firms are much more hungry for capital."

White is particularly proud of his home town, Nizhny Novgorod, as a target for investment. He says: "We have one of the largest paper mills in the world here, one of the largest oil refineries of the former USSR, one of the biggest manufacturers of automobile glass in the world, one of the best mathematics schools in the world — according to Bill Gates — and much of the Soviet military industrial complex was based here, so there’s a lot of serious scientific talent here, and they’re now looking for venture capital."

He’s been putting local entrepreneurs in touch with high-net-worth investors in the West, but now he wants to take his business model to the next level, by raising a regional high-tech venture capital fund next year, and by publishing a monthly guide on investing in the Russian regions.

  • 30 Apr 2007

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