PPPs poised to put regions on the map

  • 16 Apr 2008
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Foreign investment in Russia’s regions is still sporadic and tends to be driven by one-off events such as the 2014 Winter Olympic Games, which will be held in the resort city of Sochi. But there is hope that with the first public private partnerships finally under way, Russia’s huge infrastructure funding needs across the country are one step closer to being met.
Sarah White reports.

Known as the "pearl of Russia" to its residents, the southern federal district is one of the country’s regions which has had the most to celebrate recently. While the area is a popular holiday destination with Muscovites — the southern district sits between the Black Sea to the west and the Caspian Sea to the east and boasts a benign climate and attractive landscapes — it grabbed the world’s attention last year when the southern city of Sochi won the bid to host the 2014 Winter Olympic and Paralympic Games.

The region has been in the world’s spotlight before. Of the 13 federal subjects it is divided into — a subject is sub-division within a district — one is the Republic of Chechnya, which has been at war with Russia off and on since it unilaterally declared independence in 1991.

But while Chechnya is still a no-go for investors, the rest of the region presents a very different story.

The Russian government is planning to pour billions of dollars into developing Sochi, its surrounding area in the Krasnodar krai (territory) and beyond, in time for the Olympics. This is welcome news. Although the southern district as a whole is responsible for one fifth of Russia’s agricultural output, according to research from Bank Center-Invest, unemployment is higher here than in many regions and it has received little investment.

A key part of the plan is to attract as much foreign direct investment into the region as possible. Infrastructure development is top of the agenda, and the marketing drive designed to encourage foreign businesses to take advantage of the investment opportunities is in full swing.

In the promotional packages backing Sochi’s Olympic bid, local residents of Sochi, as well as international celebrities such as tennis star Maria Sharapova, were called upon to give their testimonials as to how life in the region would be improved if long term infrastructure investment is provided.

The Olympics organising committee has held a forum with the Swiss business community and events in association with the British Embassy and British suppliers, such as the "UK trade and investment major sporting events seminar" in February this year.

And Sochi has also come to international attention through president Vladimir Putin who has chosen it on several occasions as a centre for conferences and summits. Earlier this month, Putin met US president George W. Bush in Sochi for talks about missile defence systems.

Being thrust into the international spotlight has meant that Sochi and the surrounding region might benefit more readily from direct international investment, in marked contrast to many of Russia’s other, more anonymous regions that desperately need the investment that has so far been slow to come.

PPP possibilities

Like any one of Russia’s regions, including Moscow and Saint Petersburg, Sochi needs better transport links, better social infrastructure like hospitals and a more reliable and extended electricity distribution grid. This is apart from any additional needs for the Olympic games such as sporting and tourism facilities.

As Oleg Pankratov, head of infrastructure at VTB Europe in London, explains, the time pressure Sochi is under to make these improvements before the Olympics means the Russian government will have to fund the games directly instead of employing the types of infrastructure financing more commonly used elsewhere, such as public private partnerships.

"Why do you think PPP is not being used even for the [2012] Olympics in London?" says Pankratov. "Although PPP can deliver better value for money, the structuring and tendering process can take a long time. "

But in areas which have not been fortunate enough to benefit from the whirlwind of publicity surrounding Sochi, attracting investment for infrastructure projects has been much slower.

The realisation of PPP projects across the country is the biggest hope of bringing long term investment to Russia’s regions, but although big steps have been taken already towards making these projects happen, so far not a single one has actually been completed in Russia. This, says Pankratov, is because the concession legislation for any Russian PPP only dates back to 2005.

But the good news is that there are now five PPP tenders out this year, most of which are transport-related projects, such as the new light railway project in Saint Petersburg.

And despite the fact that Saint Petersburg and Moscow continue to be the focus of foreign investors’ attention, the potential for projects to proceed elsewhere is there. The Republic of Khakassia in south central Siberia, for example, is the only federal subject along with Saint Petersburg to have its own PPP concession legislation. And the redevelopment of the Don motorway linking Rostov-on-Don in the southern district to Moscow will be up for tender soon.

"Regions like Saint Petersburg are doing more, as they are the most experienced region in this case, and obviously Moscow as well," says Pankratov. "The financial expertise is centred around these regions, but others are developing too, like Khanty-Mansiysk [in the west Siberian plain]."

What Russia needs now is for Western investors to embrace lesser-known regions and take the necessary steps towards meeting some of these regions’ enormous funding requirements — and herein, according to some, lies the problem.

"Western investors would have greater opportunities if they tried to understand the realities of a particular region," Alexey Mordashov, CEO of Russian steel company Severstal said at a discussion on the future for Russia’s regions at the European Bank for Reconstruction and Development’s annual meeting in Kazan last year. "Sometimes Asian investors are more active, they spend their time focused on the realities and less time on stereotypes."

Educating the West

Russian institutions with which Western banks and investors are already familiar are doing their bit to promote investment in Russia’s regions, as well as the use of PPPs. Gazprombank has, according to market participants, played an important part in advising parties interested in doing PPPs. And the government has delivered on its promise of creating a Russian development bank as part of its multi-step strategy towards regional development — Vneshtorgbank has now taken on that role.

There is also a government-backed infrastructure fund which gives out grants to projects, to fund project design as well as construction.

But proponents of Russia’s plans for infrastructure development in the regions hope that the involvement of international organisations such as the World Bank, the European Investment Bank and the EBRD in projects can help attract and reassure foreign investors.

Certainly, institutions such as the EBRD are doing plenty to persuade potential backers of infrastructure projects, such as Western investment and commercial banks, that PPPs across Russia and its regions are the next big thing — and that they will be safe to invest in them.

The development banks have also advised investors on how best to position themselves to make the most of new funding opportunities that will arise over the next few years, such as making provisions for funding in roubles.

"There will be a lot more demand for syndicated loans in roubles," Lorenz Jorgensen, head of loan syndications at the EBRD told bankers at the Euromoney Syndicated Loans Seminar in London in March.

"If you want to be one of the top banks in Russia in 10 years' time, you have to do roubles. The electricity sector wants roubles. Factories selling stuff in roubles, such as Volkswagen in Russia, want to borrow in roubles."

Last year, the EBRD says it did more than 90% of its business in Russia’s regions. It led a housing refurbishment project in Surgut, Khanty-Mansiysk, and water projects in Ufa, in the western Ural region, and Kazan in the Republic of Tatarstan. It also supported construction of the Russian Superjet — the first civil regional plane since the fall of communism — which was developed in the Far East region.

The EBRD also says it is planning to open offices in Samara, Rostov-on-Don and Krasnoyarsk. It held its last annual meeting in Kazan, attracting hundreds of foreign investors to the region — many of whom had never been outside Moscow.

"I’ve been doing business in Russia for years and go there all the time," says one London-based banker, who preferred not to be named. "In all that time I’d never been further than Moscow airport, let alone been as far as Tatarstan."

But one of the obstacles to investors taking a step closer to the regions is the reluctance to fund projects in places where they do not understand the local legal system. This also applies to the workability of the PPP concession law — with no precedent for potential lending banks and investors to take some comfort from, many are hesitant.

"It is partly a question of educating people, and showing them that the law is workable," says Pankratov. "People are worried by the transparency of processes, but in many cases, the authorities are supported by respectable international advisors such as the World Bank, so there is no reason people shouldn’t feel comfortable."

Vast funding needs, investors poised

Without mentioning precise projects which are still in the bank’s deal pipeline, Pankratov says that VTB Europe is looking to work with local municipalities across the regions in Russia.

Many of them are seeking funding and have so far not had any contact with international investors — a gap which VTB Europe hopes to bridge by bringing western Europe-based banks into their deals.

But for now, the only contact foreign investors have had with the regions has largely been through funding companies that operate in the regions, but which are headquartered in Moscow.

"We would fund someone like Russian Railways, or a borrower like [steel company] Mechel on the balance sheet for example," says one official whose bank took part in the $2.35bn loan raised last year to fund Mechel’s acquisition of stakes in coal producers in Yakutsk, a city in the Far East region. "They will then invest it into developing its iron ore complex in Irkutsk, but that is not something we are directly involved in at all."

What is clear to many foreign investors, however, is that the funding and infrastructure needs across Russia are huge, and that the opportunities to become more involved are about to increase.

The government has valued investment needs in Russia over the next ten years to $1tr — and that’s only the latest figure. Given that some regions have received a fraction of that sum in foreign investment in recent years, it is a big ask.

The southern federal district is in fact one of the regions which has lagged behind the most, and which will need to maximise the opportunity that the games in Sochi presents. In 2005, it reaped $987.3m in foreign investment, compared to the more than $5bn that the Far East received for the same year, according to VTB Bank.

But the Far East is where the island of Sakhalin is located, and where international oil and gas companies are busy with both exploration and extraction.

For now, the disparities between Russia’s regions remain as varied as the geographical and climatic differences that characterise them.

"The development of worthwhile, proper infrastructure in the regions, such as social infrastructure, is second to the exploitation of Russia’s resources by Russian and foreign companies," says one London-based banker. "Finally though, there seems to be something of an awakening in terms of making it possible for people to invest in something else. When PPP projects start actually happening, it will help enormously."
  • 16 Apr 2008

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5 Deutsche Bank 21.89 32 4.14%