Kremlin's Trillion-Dollar Headache

MTWorkers replacing electric cables in the Moscow region city of Noginsk in April. Lack of electricity capacity is so dire that LaFarge, the French cement giant, is considering running new factories on generators.
NARYAN-MAR, Nenets Autonomous District -- For nearly two decades, the regional government has been trying to build a road to connect this remote Arctic region to the rest of Russia.

Today, just half of a planned 180-kilometer road to the nearby city of Usinsk has been completed, and the residents of Nenets remain as isolated as ever, able to travel within the region and to cities beyond by airplane alone.

During the harsh winters the road ices over, and residents can make it all the way to Usinsk, a town of 45,000 in the neighboring Komi republic that boasts a railway station that connects it to the rest of Russia. In summer, the road is unusable.

"We call it the 'Road of Death,'" said Yana, a secretary at the regional administration building, likening the road to the path taken by those seeking to escape the siege of Leningrad during World War II.

Every winter dozens of people freeze to death after running out of gas along the road's icy path, she said. There are no gas stations, shops or services of any kind to be found.

Despite an oil-fueled boom that has filled Russia's coffers with unprecedented wealth, the infrastructure that provides the basis of social and economic life -- from roads to airports, electricity to phone lines -- remains woefully inadequate.

The Economic Development Ministry estimates that the poor state of Russia's roads alone leads to economic losses equivalent to 3 percent of GDP each year.

In one of his first moves as prime minister, Vladimir Putin on May 20 approved a massive spending package to revamp transportation infrastructure across the country.

"If we don't develop infrastructure, we won't have a future," Putin said after approving the $570 billion,

seven-year program -- the largest investment project since the Soviet collapse. The cost of the project, however, is expected to reach at least $1 trillion.

Yet experts warn that a host of problems remain, from labor shortages to a culture of corruption that breeds uncertainty as to where the funds will actually end up.

Eight years of stellar economic growth, fueled by oil revenues, have allowed Russia to pay off its foreign debt ahead of schedule, while amassing a stabilization fund worth $160 billion and $530 billion worth of gold and foreign currency reserves, the world's third-largest.

And yet, as Transportation Minister Igor Levitin told the Cabinet in April, just before Putin moved from the Kremlin to the White House, as much as 70 percent of all railroads, highways, ports and airports are "outdated," while 3 million people around the country, like the 44,000 who live in Nenets, lack year-round access to roads or rail.

Linking a country nearly twice the size of the United States with transport, energy and communications infrastructure could never be an easy task.

Rapid industrialization under the Soviets brought pockets of the country into the 20th century, leaving vast swaths of territory untouched by modern services or technology. Any investment programs started in the 1980s fell apart in the wake of the Soviet collapse and the 1998 financial crisis.

Since the country's resurgence at the turn of the decade, investment has continued to fall short of that of its neighbors. Russia spent just 1 percent of GDP on financing roads in 2006, according to research compiled by Renaissance Capital -- a far cry from the 4.8 percent spent by Italy, the 4 percent spent by Britain and even the 2.2 percent spent by neighboring Belarus.

"If you don't invest for 20 years there are two results -- first, the stock gets old, and second, you don't know how to run investment projects," said Yermolai Solzhenitsyn, a partner at the Russian office of consulting firm McKinsey.

"With the economy booming, you need to not just catch up, but provide enough for demand going forward," he said.

As any witness to Moscow's endless traffic jams can attest, the country's decaying Soviet-era infrastructure is already running at near capacity. Riding the oil boom and still swayed by a post-Soviet mindset that equates cars with prestige, Russians are adding an astronomical number of cars to the roads each year. Already, there are 185 cars for every 1,000 people in the country -- compared with 15 per 1,000 in China, according to Euromonitor.


Vladimir Filonov / MT
Soldiers repairing a street near the VDNKh metro station in north Moscow last year. Russia lacks the manpower to carry out the state's infrastructure plans.
Sea trade traffic surpassed its Soviet-era peak in 2006, with 421 million ton of cargo passing through the country's 44 seaports. The barrels of crude and oil products, which drive the country's economic growth, comprised nearly 60 percent of that amount.

As Russia's wealth trickles down to an ever-larger portion of the population, demand for imports is set to grow exponentially, and experts have begun to wonder how those goods will actually enter the country.

Likely not by air, they agree. Boasting more than 1,300 airports at the dawn of the post-Soviet era in 1992, that number has shrunk to 351 today.

Forty-one percent of the country's landing fields have no paved runways, and 52 percent lack landing lights, according to Renaissance Capital. Meanwhile, with salaries rising and domestic low-cost carriers like S7 popping up, passenger air traffic has been growing steadily since 2000, for both domestic and international travel.

Putin's recent approval of the $570 transportation investment program was seen as encouraging, a means of lifting, as Putin put it "the brake on the economy" caused by dilapidated infrastructure.

The plan would see 17,000 kilometers of new roads, 3,000 kilometers of railroad and more than 100 airport runways built by 2015, and annual port capacity nearly doubled.

Big Toys for Big Boys



Yet insiders and experts remain skeptical.

"It's important to decide which infrastructure projects are realistic and which ones are just big toys for big boys," Solzhenitsyn said.

As president, Putin oversaw massive government spending projects and the rise of dozens of state corporations. Coupled with a sprawling bureaucracy, these provide the perfect recipe for a culture of corruption, experts said.

The country consistently ranks among the world's most corrupt in surveys, and last year scored just 2.3 out of 10 in Transparency International's Corruption Perception Index, with zero being the most corrupt.

"What is always a problem more than anything else ... is the red tape and the quantity of administrative problems that you encounter all the time," said Alex de Volukhoff, head of the Russia office for LaFarge, the French cement giant.

The Problem: Infrastructure

What the government has done
  • Prime Minister Vladimir Putin on May 20 approved a $570 billion, seven-year transportation infrastructure program, the largest investment project since the Soviet collapse. It will cover 17,000 kilometers of new roads, 3,000 kilometers of railroad and more than 100 airport runways.
  • Utilities prices are being liberalized, freeing up existing supply
Solutions
  • Tackle corruption to make sure funds get spent on infrastructure
  • Boost the work force by easing immigration policy
  • Reform education to turn out qualified workers
  • Raise safety standards to protect workers
"It's clear corruption is not getting better," he said. "The only way at the end of the day is to have checks and controls on society. People who hold public office tend to think first about what they can trade their power for," he said.

"I'm sure that not all the money will be stolen," Eduard Faritov, a transportation analyst at Renaissance Capital, said, sarcastically. He quantified the figure expected to be squirreled away into bureaucrats' pockets at 20 percent, by making the following comparison: Russian Railways, in a plan to invest $550 billion to modernize and expand the country's massive railway network, put the average cost at $6 million per kilometer. A similar plan to lay rails through the deserts of Saudi Arabia saw Russian Railways put the cost at $1.2 million per kilometer. Private firms in Russia, such as coal and oil firms who build their own rail transport networks, put the figure at an average of just $1.5 million per kilometer.

"Even with inflation, Russian Railways will be over budget," Faritov said.

Global precedents indicate that Russia's ambitions -- which total some $1 trillion when the programs for roads, rail, electricity and beyond are counted together -- may already be undervalued. In early April, PriceWaterhouseCoopers told the European Union in a commissioned report that 30 transportation projects it had identified as priority projects would run $40 billion above initial projections, costing closer to $380 billion.

Further, most analysts believe that Russia's runaway inflation, which hit 15.1 percent in May, is being driven mainly by massive government spending, on everything from state corporations to populist pre-election projects like price controls.

Injecting $1 trillion into the economy promises to only fuel that inflation higher.

"The policy challenge for the government, on the one hand, is the big temptation to put a lot of money into all of this. But on the other hand, there are inflationary concerns," Solzhenitsyn said.

Where Are the Workers?




Vladimir Filonov / MT
Ports like Murmansk, pictured, are seen as attractive investment options because of high profit margins and returns.
Yet corruption and cost overruns do not rank first on investors' list of worries. Most problematic, they consistently say, is the lack of a labor force to carry out the enormous projects floated by the state.

Soviet infrastructure projects, from roads to rail to canals, were carried out by a labor force comprised of prisoners and troops who had no say in the matter. Today, the ranks of manual labor are filled mainly with migrants from Central Asia, a community targeted by widespread anti-immigrant sentiment, which is at times propagated by official nationalism.

"If you listen to what the politicians are saying, from the very top, they say Russia is for Russians. The country cannot afford that," Faritov said.

Alexei Bezborodov, an independent consultant to Russian Railways and private rail companies, agreed. "It's like a slave system," Bezborodov said.

"This slave system can only absorb Tajiks" and other immigrants, he said. "You are a slave to your boss here, he's a slave to someone else, and you're all slaves to the top managers."

The country's demographic crisis, which has just begun to reverse, means the manpower needed to carry out the state's ambitious infrastructure plans simply does not exist.

At the same time, anti-immigrant policy means the migrants willing to work for nearly nothing to rebuild Russia are either turned away at the border or sent home after reaching the country.

"The government should take a deeper look, from the entire system of education to making sure not just that babies are born, but that qualified babies are born. They must make sure that the curt system works so people do not take bribes. It's a much bigger task -- and that is what I call infrastructure," Faritov said.

"Even $1 trillion won't be enough."

Beyond the difficulty of finding labor, there is the question of keeping them safe, said Volukhoff of LaFarge.

"Russia is probably one of the most difficult environments from that point of view because there is no safety concern whatsoever," he said. LaFarge saw four fatalities in 2006 -- a rare occurrence in other global operations, he said.

Changing Russia's anti-immigrant sentiment, and its blasО attitude toward safety, will take time. "You don't obtain safety through new equipment, it's a mindset," Volukhoff said.

Despite the difficulties, investors are rushing in to get in on the game -- if for no reason than to keep up their own operations.

"After 20 years of not investing into anything, there is a need, so we have to be here, and we have to be strong," Volukhoff said. Lack of electricity capacity is so dire that LaFarge is considering the expensive option of running new factories on generators because the energy supply simply does not exist.

That should begin to change once Unified Energy System, the former electricity monopoly, wraps up its reform program this summer, launching into an investment cycle that it hopes will raise $120 billion for sorely needed funds.

If the political will to liberalize prices by 2011 remains, further supply will be freed up.

"You can actually reduce the physical demand of infrastructure if you use the stuff that's there better," Solzhenitsyn noted.

Free floating electricity prices should help regulate the market, Solzhenitsyn said, while calling for the introduction of flexible peak pricing models.

About 10 percent of private investment in Russia is already going toward infrastructure projects, he said.

Ports and rails are the most attractive investment options because of high profit margins and returns, Faritov said.

The new state investment model, as evidenced by Putin's plans to revamp Sochi for the 2014 Winter Olympics, gives wide range to public-private partnerships, in which government spending is matched by private investment.

Yet the focus on Sochi also illustrates another questionable aspect of the state's drive to modernize infrastructure -- the politicization of which regions benefit. Nearly all the main road projects disclosed so far focus solely on Moscow, St. Petersburg and, since the announcement of Sochi's Olympics win, the Krasnodar region.

Roads in the key transit city of Pskov, in northwestern Russia, for example, remain riddled with potholes so that drivers rarely push the speedometer above 50 kilometers an hour. The thoroughfares around Salym, in western Siberia, are at times unpaved. No plans have yet been announced to change that.

Perhaps, in part, that is the result of the fact that despite ambitious and widely publicized plans, it remains unclear where the responsibility lies.

The Transportation Ministry declined repeated requests for an interview for this article, referring all questions to the Economic Development Ministry. Officials at that ministry, in turn, said they had no one who deals with infrastructure, and referred all questions to the Transportation Ministry.

"We're back to the Soviet times where many leaders find it possible to publicly announce plans that are not achievable," Faritov said.

So, for now, the people of Nenets remain separated from the rest of the country. This year, regional transportation officials plan to build 15 kilometers of the Usinsk road, bringing the total built to 103 kilometers.

"We have grandiose plans," one regional transportation official said at an interview in his new office.

He declined to provide reasons for why the roadwork had been stalled so long. He also refused to detail what sort of budget funds had been allocated to the project, or the cost of building per kilometer.

"Why do you need to know how much it costs?" he said. "It's expensive, let's put it that way -- not cheap."

Editor's note: This is the second in a series of reports about the key challenges facing Russia today. Previous reports can be found at www.themoscowtimes.com.