Getting Out of the Swamp

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Russia today faces two great challenges: an aging and inadequate infrastructure and an acute economic crisis. Since the collapse of the Soviet Union, the country's infrastructure has been crumbling. The number of airports has fallen from 1,342 in 1991 to fewer than 350 today. The average Russian railcar was built in 1983, and many are much older. Today, Russia and the Congo are the only countries in the world where the number of kilometers of roads is actually decreasing. The infrastructure that does exist is inadequate: More than 15 million people have no access to the transport network at all.

Yet at the same time the global economic crisis is now hitting the country in full force. The stock market has collapsed, companies are cutting jobs and salaries, industrial output is declining, and the once-booming construction sector is starting to wobble.

Financing from the private sector for infrastructure projects is going to be hard to come by as long as the crisis continues. In 2009, I estimated that $27 billion of the $99 billion planned total infrastructure spending will be scrapped because of the lower availability of private sector finance.

This means that a massive government investment program into infrastructure is necessary. And unlike the United States and most other rich countries, Russia actually has the money to spend. Over the past decade, the state has done an excellent job building up its balance sheet by accumulating reserves from its oil windfall. At its peak this year, it had squirreled away nearly $600 billion.

Now is the time to spend part of these reserves to rebuild the country's infrastructure and stimulate the economy. With the price of cement down 40 percent since June, and steel down 20 percent, the government is in a position to invest without igniting inflation. Revamping public infrastructure is key to keeping economic growth going. In 2009, Russia's public sector must compensate for the nosedive in private sector investment.

The numbers involved are tremendous. My conservative estimate is that $875 billion needs to be invested in Russia's infrastructure through 2015, with $457 billion going into transportation. That is a huge increase over current levels. Investment in infrastructure is now about 2.5 percent of gross domestic product, compared with a global average of 4.2 percent, even though the country's economy is growing much faster than the rest of the world. I believe investment rates must rise to 6.9 percent of GDP over the next six years for Russia to build the infrastructure needed to support the expected rate of economic growth.

In the past, any public investment would simply have crowded out private investment. Very high growth rates and rising inflation indicated that the economy lacked the spare capacity to handle public sector infrastructure spending. As a result of freely available, cheap international funds, private sector investment has arguably been too high (there are a worrying number of unfinished real estate projects across Russia), while public sector investment has been too low.

Since June, the situation has clearly turned on its head. Funds for the private sector have entirely disappeared, resulting in a worryingly rapid increase in spare capacity. The public sector, on the other hand, can effectively fund itself at the 1 percent it is currently receiving on its net savings positions. Given the efficiency gains available from improving infrastructure, the returns from investing domestically should be easily profitable.

Top priorities in a big government infrastructure spend should include improving the links between Moscow and St. Petersburg, including the 659-kilometer rail line and the toll highway. The state should increase availability to its Asian regions, continue to develop rich mineral deposits in areas like Sakhalin and overhaul the country's 213 nonhub airports. The government should also modernize the railway link between the East and West to capture more of the trade from the world's biggest producing region -- China -- to the hungriest consumer bloc -- Europe. Finally, Russia needs to continue its massive investment in Sochi leading up to the Olympic Games in 2014.

The result of this large infrastructure spending will not just be millions of new jobs and growth in industrial output to the country's precrisis levels, but it will revitalized Russia and allow it to compete in the 21st century.

Paul Roger is head of infrastructure and transportation research at Renaissance Capital.