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. Last Updated: 07/27/2016

Putin and Chubais Move to Clean House

MTThe government estimates that 40 percent of all household water is wasted due to faulty pipes and 35 percent is "unhealthy."
It is the last sector of the communist economy untouched by reform, and with each passing day it creaks closer to collapse. It is, in the words of President Vladimir Putin, "a complete mess."

But with parliamentary and presidential elections now just months away, the country's political and corporate elite are starting to take notice of what may be the most important and politically sensitive campaign issue of them all -- the national housing sector.

The issue of preserving, let alone improving, so-called communal systems -- the maintenance and repair of buildings and the supply of basic services such as water, electricity, heat, gas, sewage and garbage -- has been ignored for decades.

But not any more.

On Thursday, senior government officials, lawmakers, captains of industry and providers of communal services will convene for a two-day forum titled "Reforming the Housing Sector 2003 -- Time for Making Strategic Decisions."

Putin lit a fire under the government last month, calling for urgent action on housing reform and scolding officials for what he called the "social tensions" that are emerging from "the lack of elementary order" in the sector. The president said he was shocked when he discovered just how bad things really are: "I was stunned when I was told that electricity is being supplied by verbal agreement, absolutely on a whim."

Lawmakers were quick to sense the urgency and exploit the issue politically, calling Prime Minister Mikhail Kasyanov to the floor of the State Duma to explain what he planned to do about the crumbling, corrupt and debt-ridden industry, which directly affects nearly every person in the country and employs 3.6 million people who earn on average less than $90 per month.

The solution, Kasyanov said, is to introduce competition into the sector by taking it out of the government's hands in order to create a "real business project out of a black hole."

"The concentration of all the public's pains," Kasyanov told the Cabinet, "is connected to the housing sector. This is the most sensitive reform."

But while the government is not yet ready to turn the entire sector over to private firms, it is willing to let a consortium of powerful businesses -- led by the two most influential of them all, state-controlled monopolies Unified Energy Systems and Gazprom -- share the burden, and profit it from it if it can.

In what sounds eerily similar to the scandalous loans-for-shares deals of the mid-1990s, which temporarily bailed the government out of a fiscal hole while simultaneously enriching a clutch of well-connected insiders, UES, Gazprom and a handful of private companies, including Vladimir Potanin's giant Interros holding, have been given the green light to take control of vast swathes of housing infrastructure in exchange for assuming responsibility for communal services in regions where that infrastructure exists.

The potential pitfalls are enormous -- but so are the potential profits. Public and private expenditures on communal services last year totaled more than $17 billion. However, where huge chunks of that money end up is largely anyone's guess under the current system.

UES and Gazprom say streamlining the industry will allow it to recoup the billions of dollars owed to it by current communal services providers. They also expect it to turn into a moneymaker.


Anatoly Chubais

Enter Chubais

Led by Anatoly Chubais, the loans-for-shares architect who now heads UES, the consortium, called Russian Communal Systems, is confident it can succeed where the government has failed, making the venture profitable enough to encourage investment in the sector. UES and Gazprom, in particular, stand the most to gain, as they hope to recoup billions of dollars owed to the sector by current communal systems providers by streamlining the massive bureaucratic machine in which they operate.

All that is needed, Chubais says, is to decrease theft, cut expenses and install better management. "We will put everything in basic order. Our team is able to manage this task," Chubais told reporters when he unveiled his plan in March.

Chubais' confidence is reflected by the amount of money RCS says it will invest in the project -- up to $500 million -- but half a billion dollars is just a fraction of what will eventually be needed. Experts say the industry has been underfinanced by about $2 billion per year over the past decade, and even the government admits that modernization will cost more than $15 billion.

Take heating for example. According to a recent study by the presidential administration's auditing directorate, 73 percent of boilers and 65 percent of all pipe networks in apartment blocks are "depleted," resulting in as much as 60 percent of all residential heat supplies being wasted.

The Kremlin's financial watchdog also found that:

 the number of malfunctions has increased fivefold over the last decade.

 the national heating network suffered more than 1,500 failures last winter alone, a 20 percent increase on the year resulting in 75 "major" crises in 38 regions.

 for every 100 kilometers in the heating network there were on average 200 ruptures or other incidents requiring repairs last year.

And that's just heat. Equally crucial -- and decrepit -- is the water system. For example, more than a third of all the water supplied to households is officially considered "unhealthy," according to government estimates, while water waste due to faulty pipes is about 40 percent, or nearly three times the average for developed nations.

"The ineffective management of housing and utilities services and a lack of coordinated measures at the regional and federal levels are the main reasons behind the crisis in the sector," the presidential auditors said on the Kremlin's official web site, "Creating the legislative basis, ensuring financial stability, budget support, tariff policy and the formation of a services market in the sector remain uncoordinated."

The Money Disappears

What is needed, the Kremlin watchdog said, is a new law on housing reform to create the legal mechanisms for competition.

The government tried this approach in 1993, but made little progress, save for grouping municipal housing and utilities departments into regional units. The sector never became competitive because the newly created regional companies retained control at the municipal level while federal and regional budgets continued to subsidize them.

But in a classic series of hide-the-budget-money moves, nearly all of the regional companies' municipal departments have changed their names and locations numerous times over the last five years, making them virtually impossible to collect debts from, let alone control.

The total bill for consumer services last year came to 554 billion rubles ($17.7 billion), about 60 percent of which was paid by residential customers, while federal and regional budgets covered about 30 percent, leaving some 60 billion rubles in cross-debts between customers, suppliers and middlemen.

What's more, the federal government says a large portion of these budget funds are either stolen or misused by municipal authorities, meaning local communal service providers rarely see a kopek for their services. As a result, the government says, 70 percent of all communal services companies are bankrupt and collectively owe more than 3.5 billion rubles in back wages. (In some regions, like Kamchatka, communal service workers haven't been paid since last summer.)

The debt maze has resulted in consumers' owing communal services providers about $6 billion, while the providers owe about $9 billion to energy suppliers, mainly UES, Gazprom and coal companies.

Cleaning House

With the system spinning out of control, housing specialists say it is clear that something must be done quickly, which is why the government, having failed in the task, is turning to Chubais, as it has in the past when faced with a seemingly impossible task, to begin cleaning house.

The UES CEO is starting at the regional level, where 11 administrations -- Chelyabinsk, Kirov, Murmansk, Nizhny Novgorod, Novgorod, Omsk, Orenburg, Perm, Rostov, Saratov and Volgograd -- have already agreed to turn over control of their housing service units to RCS.

Improvements, however, will likely neither be quick nor easy. Other regions, such as the vast northwestern republic of Komi, have tried to introduce competition into their communal services industry, but without success.

Komi's capital, Syktyvkar, organized a tender several years ago to manage one of the city's housing services companies, but the administration didn't like the winner, so the idea was simply abandoned, said Nadezhda Kulik, deputy head of the city's housing services who has worked in the sector for 18 years.

Kulik said that if the situation in Syktyvkar is anything to go by, Chubais and his RCS consortium will have their hands full. "The local administration doesn't allocate any repair equipment, transportation, uniforms or instruments. Workers have nothing with which to remove snow or fix anything," she said.

"Out infrastructure is ruined. Work is only done in an emergency, when a pipe finally bursts. It is becoming worse and worse every year," she said, adding that workers' morale couldn't be worse. Most of her employees, she said, applied for the job as a last resort: "The work is the least prestigious and the salaries, which are ridiculous, are not paid for months."

Nadezhda Kosareva, president of the Moscow-based Institute for Urban Economics, said the situation is the same throughout the nation.

The system is literally communist -- created by communists under communism -- and it hasn't changed a bit legally, she said.

"All the relationships within the sector were built on administrative principles, not economic principles. That is why it is impossible to describe the structure of the sector from an economic point of view."

A Soviet Maze

By law, local authorities alone are responsible for communal services. The federal government can only pass vaguely worded laws that are little more than recommendations to municipalities.

"Due to the differentiation of powers, municipal authorities are not obliged to obey federal laws concerning the housing sector," said Kosareva.

And those federal laws that directly affect the sector and that local governments must adhere to only make matters worse for the most part.

Last year, for example, parliament passed a law to increase salaries for teachers and state health care specialists without allocating additional funds for local administrations to pay them. As a result, local authorities either funded the wage hikes from the housing sector or simply chose not to increase salaries.

The whole system seems custom built for corruption.

Here's how it works: municipal authorities are not allowed by law to manage communal properties themselves, so they are obliged to create a management company to take over all rights and responsibilities for those properties. But once that happens it becomes virtually impossible to take back these properties, even if a management company runs afoul of the local administration, because it can hold on to that property as long as it wants.

The catch is that the head of the municipal government has the power to hire and fire the director of the local management company, thus controlling the company's money flows.

Now, just as communal services workers have no incentive to work, these management companies have no incentive to square their accounts. It makes no sense to initiate bankruptcy proceedings against them because legally their assets are considered "socially significant," meaning they cannot be sold in any liquidation proceeding.

The bottom line is that nearly all of these companies are bankrupt even though they can never be declared so.

"In addition to corruption in the sector, there is complete muddle -- both financially and legally," Kosareva said.

Jolting the Status Quo

When Moscow allocates money to municipal administrations for their annual budget, that money is not earmarked, meaning local authorities can spend it on things it isn't intended for. (That is why it is not uncommon to see employees of the local water company decorating the streets with flags on national holidays instead of fixing broken pipes.)

For municipalities, which act as the supplier, middleman, customer and inspector all at once, the status quo is just fine.

"Tariffs [and thus revenues] grow every year, the Finance Ministry allocates funds, but it all disappears somewhere," said Kulik from Syktyvkar.

Another disincentive for communal services providers to streamline their operations is that tariffs are set based on how much it costs to provide a service.

Although housing and public utilities tariffs, which are controlled at the regional level by special commissions, rose 20.7 percent in the first quarter of the year, or 3 1/2 times faster than inflation, service companies generally make no effort to reduce expenses by modernizing because the regional energy commission would react by reducing tariffs and thus their revenues.

This is the main reason private companies have no interest in the sector -- there is no way to guarantee a return on their investment.

Another reason is the lack of property rights. Investors need guarantees that they can manage assets on a long-term basis to make any investment worthwhile, but the government has thus far refused to adopt a law on concessions that would strengthen renters' rights.

Most developed countries have some kind of concessions law, and the result is more efficiency, which usually results in a 30 percent drop in expenses, said Natalya Orlova, chief economist at Alfa Bank.

Orlova said that in Western countries, where tariff policies are predictable and property rights are strong, communal services is one of the least risky and most profitable areas of the economy. Energy giants E.ON and Ruhrgas, for example, have managed to successfully provide communal services in Germany.

Playing Monopoly

RCS will officially be registered this month with a charter capital of $40 million. UES and Gazprom, through its pocket bank Gazprombank, will each own a 25 percent stake while the rest will be evenly split among the other five members of the consortium -- Interros, Renova, Evrofinance bank, YevrazHolding and Kuzbassrazrezugol. RCS plans to establish regional subsidiaries in which it will hold stakes ranging from 100 percent to 25 percent.

The idea is to convince local mayors to turn over, say, all the heating infrastructure of his or her town for 10 years or so in exchange for a promise to provide stable heat supplies and maintain and modernize the infrastructure. The catch is that municipal authorities do not have the power to set tariffs for non-city-owned companies, so for the project to be profitable for RCS the consortium must be able to convince regional energy commissions, which are controlled by regional governors, to set tariffs at a level to its liking.

"UES and Gazprom have the political power to work around the system," Orlova said.

It's a simple formula for success: strong political ties, good crisis management and financial clout -- RCS has all of these and can quickly cut costs and turn a profit in the sector in a given region, Orlova said.

The Political Payoff

Energy analysts who track UES and Gazprom say the whole idea of creating RCS likely originated in the Kremlin, which wants to avoid recurring winter heating crises that have claimed hundreds of lives over the last few years -- especially with the presidential election just 10 months away.

It would also give Putin greater control of the regions, as any weakening of the power of municipal authorities gives the Kremlin a chance to strengthen its control of the regions, strengthening the so-called power vertical. It is easier for Putin to come to terms with Chubais than thousands of local chiefs.

But Putin isn't the only one who stands to gain.

"Improving the housing sector is in the interest of both Putin and Chubais," said Orlova.

Conquering the housing sector while overseeing the world's largest electricity company would give Chubais unprecedented political power.

In addition, rebuilding the national power sector offers Chubais, who has been dubbed the most-hated man in Russia for his past privatization shenanigans, something of a last chance to put a shine on his tarnished historical record, and the housing sector represents the last mile of that quest.

Kosareva of the Institute for Urban Economics said that if the RCS project can succeed in a few regions, Chubais could regain the people's trust and get them to believe in his pro-market reform mantra again.

Dmitry Orlov, deputy head of the Center for Political Technologies, called the housing sector "the last enclave where Chubais can improve his image as a reformer because no one has tried to reform the sector before."

"If Chubais can manage to turn the sector around, he will wash away his image of a poor privatization master forever," Orlov said, adding, however, that he doubts Chubais will succeed.

But if he does, it would be a fitting accomplishment for the man who essentially created the oligarchs as a class and drove perhaps the final nail in the coffin of communism in the process.

"The housing sector is the only untouched socialist industry left in the country, and all the political parties cherish and care for it because it gives them a wide area for populist activity," Kosareva said.