Russian crisis creates opportunity for private infrastructure investors

Vladislav Zabrodin
02 February 2015

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Russia needs investment of $30bn a year to upgrade its infrastructure and new rules make PPP schemes faster and cheaper to negotiate, says Vladislav Zabrodin. 

In 2014, Russia held 74th place among 144 countries in the Global Competitiveness Report 2014-2015 infrastructure rating, which is 19 slots up from the previous year. In 2013 the country held 93rd place and in 2012 it was in the 101st.

One should note, however, that this position is not due to a growth in investments, but rather due to the basic infrastructure created during the Soviet era and the restrained financing (mainly from the state budget).

"Since the rouble value dropped by 85% in 2014, in order to retain the forecast infrastructure development, dollar investments will be needed in a much lesser amount (even considering the 12-15% inflation). That is why the Russian infrastructure market, irrespective of all the crisis events, is of great interest, since it allows for acquisition with at least a 40-50% discount of something that will be needed in Russia in any case, is underdeveloped and will continue to grow due to consumer demand."

On average Russia spends 3.4% of the GDP on infrastructure projects, which is below the general global level of 3.8%. At the same time, Russia’s infrastructure needs renovation and development due to ongoing deterioration. Therefore, bringing infrastructure investments to a level of 5.5% of GDP (the average for developing countries) is a vital but difficult issue. It should be noted that the current crisis places restrictions on achieving even the planned conservative scope of infrastructure financing.

The scope of infrastructure financing that was planned for the period from 2014 to 2020 in state programs and strategies comprised on average $90-100bn  per year, which was practically in line with the plans for a gradual (but not explosive) infrastructure expansion in response to the needs of business and the public.

However, the crisis of 2008-2009 showed that a substantial drop in oil prices leads to a 25-30% reduction in state infrastructure investments. Therefore, in the next few years infrastructure financing can be expected to fall short by $30bn per year or by a total of $180bn by the year 2020, which creates opportunities for private investors.

The need for investments by type of infrastructure is as follows:

transport infrastructure 55%;

pipeline transport 25%;

power grid infrastructure 7.5%;

telecommunications 10.5%;

public utilities 2%.

Therefore, the main area for private investments is transportation (the same as most countries), although transportation projects are more expensive and subject to substantial exposure to administrative and political risks. It should be noted separately that private investments into pipeline transport will be made by state companies (Gazprom, Transneft, Rosneft, Gazpromneft), and PPP in Russia is generally not used in practice for this type of infrastructure, although such an opportunity is indeed available under the law.

In 2014, Russian law regulating infrastructure investments underwent revolutionary changes, which led to substantial adjustments in the federal law “On concession agreements.” In 2015, new regulations will take effect, which will allow private investors to independently prepare an infrastructure project and approach the state authorities with an initiative to enter into a concession agreement. And if the state does not find other interested parties for the infrastructure facility proposed by the investor, the concession agreement will be signed without a tender.

This substantially cuts the project timeframes from idea to commercial and financial close, and allows private companies competent in PPP to ensure that a project is well structured, rather than to wait as usual for offers and tenders from the state officials (who aren’t always competent in structuring transactions especially in the Russian regions).

The English PFI model served as the basis for such legislative changes, and that is why foreign investors, particularly those that have experience in implementing projects in the UK, will have an even easier time, as compared to Russian infrastructure players, when it comes to adapting to the new opportunities in Russia.

At the same time, the economic situation in Russia along with geopolitical risks are likely to hold back investors from developed and developing countries. The financial market situation is complicated. The recent significant drop in the rouble exchange rate caused the Russian Central Bank to raise the key interest rate to 17% (this is the indicator of the cost of loans). This in fact leads to Russian commercial banks lending out funds at an average rate of 23-25%. Such a high interest rate makes for rather complicated financing of long-term infrastructure projects.

The Russian Central Bank, realising the obstructive nature of the high interest rate, is taking quantitative easing measures by implementing a number of special refinancing tools available to the country’s main bank:

i) loans at an annual rate of 9% to commercial banks against pledge of receivables under loans granted by commercial banks to investors for implementing investment projects under project financing schemes, which allows commercial banks to grant loans to SPVs at a rate of 13-14%;

ii) loans at a rate of 9% against pledge of bonds issued to finance investment projects and included in the Bank of Russia’s Lombard List; as of now, the Lombard List contains all the infrastructure bonds issued by private investors that have entered into concession agreements with the state for creation of transport infrastructure facilities.

Considering all the difficulties of the Russian economy, it is hard to forecast the prospects for infrastructure project implementation in 2015. Since the rouble value dropped by 85% in 2014, in order to retain the forecast infrastructure development, dollar investments will be needed in a much lesser amount (even considering the 12-15% inflation). That is why the Russian infrastructure market, irrespective of all the crisis events, is of great interest, since it allows for acquisition with at least a 40-50% discount of something that will be needed in Russia in any case, is underdeveloped and will continue to grow due to consumer demand.

At the same time, considering the geopolitical risks, the opportunity for UK companies to work on the Russian infrastructure market will depend on how ready the Russian authorities are to take on additional administrative and political risks, which can be implemented only through concession agreements.

Vladislav Zabrodin is managing partner, Capital Legal Services