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Putting Long-term Capital to Work for Infrastructure Development

May 26, 17:53 UTC+3
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The weak infrastructure in Russia and its continued wear and tear hold back the country's economic growth, increase production costs, and bring down the standards of living. Experts estimate that investments in transportation, industrial, utilities and other types of infrastructure need to go up by at least 1.5 times just to halt its ageing. Given the long payback period of infrastructure projects, the search for investment in this area is becoming a crucial task against the backdrop of the budget deficit and Western sanctions.

A high rate of fixed assets depreciation is one of the key challenges the Russian economy is facing. According to the Federal State Statistics Service, in 2008–2015, it increased from 45.3% to 47.7%, including 50.4% in construction, 55.8% in transportation, and 44.5% in natural gas and water production and distribution. All these figures primarily refer to the infrastructure.

  • In the ranking of road quality prepared by the World Economic Forum for the purpose of the Global Competitiveness Report 2016–2017, Russia only took 123d place. The government data show that only 40% of the regional roads meet the operating requirements.
  • According to the Russian Ministry of Construction, Housing and Utilities, the rate of depreciation for the infrastructure of public utility systems averages over 60% for the entire country and exceeds 75% in a number of select regions.
  • The Russian Ministry of Energy estimates that approximately 50% of its facilities and engineering networks require replacement, while at least 15% of them are in a critical condition.

In its Russia Economic Report, the World Bank notes that Russia needs major infrastructure investments in order to speed up its economic growth: "Russia’s public expenditure on infrastructure amounted to less than 1.0% of its GDP a year in 2012–2014, while the investment needs are estimated to be at about USD 1 trillion or 75% of Russia’s 2015 GDP."

The New Economic Growth Business Partnership has calculated that infrastructure investments need an annual growth of about 1.7% of the GDP (by ca. RUB 1.5 trillion a year), which is 1.5 times as much as the current level of expenditure (about 3.5% of the GDP). By contrast, McKinsey Global Institute estimates that China spends 8.6% of its GDP on infrastructure, India – 4.9%, Oceania and the developed nations of Asia – 4.6%, and Eastern Europe – 4.1%.

A key challenge with regard to Russian infrastructure projects is the crisis-induced capital shortages.

  • In nominal terms, the 2017–2019 budget allocations for infrastructure are lower than those in 2016. According to experts from the Russian Presidential Academy of National Economy and Public Administration and the Gaidar Institute for Economic Policy, the share of such expenditures in the GDP is to drop by more than a quarter by 2019, while their share in the overall budget spending is to go down by 9%.
  • The role of the Russian National Wealth Fund as a provider of long-term funding for infrastructure projects is being revised now, as the Fund is going to be used to close the budget deficit as of the end of 2017.
  • Bank loans are hardly an option for infrastructure projects due to a long payback period, the Central Bank's high interest rate, and restrictions on foreign funding.

Government officials and experts are trying to address this issue by harnessing public–private partnerships and concessions and raising capital from non-state pension funds (NPFs), insurance companies, and investment funds.

  • According to the Bank of Russia, in 2016 the NPF pension savings and reserves increased by 19% to exceed RUB 3.2 trillion. The concept of the Individual Pension Capital enabling people to save money for their pensions in the NPFs on their own, developed by the Ministry of Finance and the Bank of Russia, is meant to bolster up this potential source of funding.
  • The Ministry of Economic Development proposes to put in place a new project financing system that would rely on the monies of NPFs and insurance companies rather than those of the Bank of Russia.
  • Speaking at the investment forum in Sochi in February 2017, Prime Minister Dmitry Medvedev stressed the need to create a "project financing factory" based on the Vnesheconombank state corporation, which will look for projects (including infrastructure ones) that could appeal to investors, and acquire a share in their capital to attract third-party resources. In 2017–2021, the total value of projects in Vnesheconombank's portfolio can amount to RUB 1.4 trillion, including the co-financed portion.
  • Russia has had some experience engaging NPFs to finance infrastructure projects through issuance of concession bonds. According to the Concessionaires and Long-Term Infrastructure Investors National Association (CoLTI), ca. RUB 70 billion has been invested in infrastructure projects since 2010 leveraging the mechanism. In order to enhance the concessionary toolkit, the Bank of Russia intends to set up a Long-Term Investment Council.
  • Yet another strategy is to finance projects through the Tax Increment Finance (TIF) scheme relying on future tax revenue increases stemming from infrastructure projects. This approach has been adopted by the Far East Development Fund to support regional investments by providing tax exemptions to the companies that invest in infrastructure required for the completion of their projects.

Engagement of foreign partners in infrastructure development projects is also an option:

  • As part of the Silk Road Economic Belt, in 2015 Russia and China signed a memorandum to finance a high-speed rail link between Moscow and Kazan, with China set to invest about RUB 300 billion (USD 5.9 billion) in this project.
  • The Ministry for the Development of the Russian Far East came up with an initiative to develop, jointly with China, cross-border transportation corridors. A preliminary agreement with the Export-Import Bank of China has been reached to that end.
  • The Far East Investment and Export Agency of Russia and the Japan Bank for International Cooperation (JBIC) are setting up a project promotion vehicle to attract Japanese investments to the Russian Far East.
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