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Despite crisis, positive outlook for PPPs in Russia

Editor's Note: The following is a joint submission by Filip Drapak and Natalia Reznichenko.

Many countries are experiencing a big infrastructure gap, and Russia is no exception. The Russian government is well aware of the problem, and it has announced that it will invest about US$1 trillion over the next 10 years in improving infrastructure. But how can the government raise that kind of capital? The expectation is that the private sector will contribute most of the financing though a Public Private Partnership (PPP).

While Russia does have some experience with PPPs, the track record so far has been spotty. We might mention in this regard one project that is sometimes considered to be the first PPP in Russia—the South-West Wastewater Treatment plant of St. Petersburg. The project was agreed upon by the Russian, Finnish and Swedish governments all the way back in 1986, but due to a lack of public financing the project was stopped. It was resurrected as a PPP in 2002 and formally procured as a 12-year BLT (Build-Lease-Transfer) contract.

The financial crisis has also thrown a wrench in the works. St. Petersburg has taken a lead in developing PPPs in Russia, but shaky credit markets have meant many projects have been put on hold.

The first PPP project launched by the government of St. Petersburg was a toll road called the Western High Speed Diameter (WHSD). The WHSD was enacted under the Federal Law on Concession agreements, which has been in force since 2005. Since the city government didn’t have the experience and proper skills to procure PPP projects, the WHSD met a lot of difficulties, including legal problems and issues with a feasibility study. In 2006 new regional legislation on PPPs was introduced in St. Petersburg that allowed the government to attract private sector interest and prompt PPP development. The value of the WHSD project is estimated at US$5-6 billion, which makes it difficult to procure in the current circumstances due to the high costs of capital and limited available funding. (Not to mention that the overall downturn of the economy has affected traffic forecasts.) Although a tender has passed and a bidder was chosen, the instability in financial markets has meant that the project had to be rescheduled. Investors need more time to redesign their financial models to meet the challenges of the financial crisis.

Two other projects sponsored by the government of St. Petersburg have also been postponed: Nadzemny Express and the Orlovsky Tunnel. Both were announced around the same time as the WHSD project. Unfortunately, due to their size it is difficult for potential investors to find lending now and at the same time demonstrate the ability of these projects to generate sufficient revenues. Both projects have been rescheduled for 2011.

There is one bright spot, however. A PPP agreement for Pulkovo airport is scheduled to be signed on the 2nd of November. The winner of the tender is Fraport (along with VTB bank), and they will have a 30-year BOOT (Build-Own-Operate-Transfer) contract on the redevelopment of Pulkovo airport. Pulkovo appears to be the one and only PPP project that seems to be able to generate revenues and ensure its economic viability under the present circumstances.

The problems generated by the financial crisis are further compounded by the legal environment for PPPs. Unfortunately, the current federal concession law limits the types of PPPs that can be applied in the Russian market. For instance, it is impossible to use the BOOT (Build-Own-Operate-Transfer) or DBOO (Design-Build-Own-Operate) models. Among the limitations of the current legislation, there is a necessity to use standard PPP agreements affirmed by the Federal government. It confines investors and the government in designing the concession agreement. Federal law also doesn’t provide flexibility in the design of the bidding process, potentially leading to an inefficient choice of the winning bidder. (One exception is St. Petersburg—the regional law on PPPs passed in 2006 also extended the PPP models that can be implemented in the region. This creates favorable conditions for PPP project realization in St. Petersburg.)
 
Despite the difficulties seen with PPPs in Russia so far, we still have a positive outlook for their future. Why? We see two reasons to be optimistic: (1) The Russian PPP market is potentially enormous, and (2) The government understands the benefits PPPs can bring. The government is seeking new spheres in which to implement PPPs, moving away from huge PPP projects in the transport sector to more feasible projects in the healthcare and waste treatment subsectors. There are several PPP hospital projects that are currently in the preparation stage now and one waste treatment plant project (Yanino), which has a tender scheduled for autumn 2009.

In short: expect a lot more activity in the PPP space in Russia over the next few years.

Comments

Submitted by Bernardo Weaver on
Very good article. I also believe that hospital PPPs and other social sector PPPs will increase in the coming years. In Brazil the trend is the same, with some states in the Northeast of the country getting on board now.

It seems that PPPs get more popular in developing nations - Russia, Chile. Bernando Weaver blogged about Chilean PPPs and their efficiency. However, in the case of Russia, my concern is that PPPs will crowd out the conventional private firms. PPPs are more likely to be more efficient in providing public goods such roads, bridges etc. But once we are out of the scope of public goods, I really doubt that PPPs are more effective than their conventional counterparts.

Submitted by Filip Drapak on
Dear Leo, Thanks a lot for the comment. I am not very worried that PPPs would crowd out private business. PPPs are more about private companies crowding into the traditionally public service and infrastructure delivery. And of course you are right - outside of the public sector domain there is no reason for PPPs.

Submitted by Gerald S. on
I am keen on and concerned at the same with the developments taking place in Russia with the PPP program. Since the PPP model is adopted from the UK model, it is interesting if the legal framework (which is very much needed to support the PPP initiative) will exist to ensure free mobility among the players as well as to attract foreign investment and sponsors into the market. Another concern is the readiness of the public sector to handle the huge responsibility when a PPP project running in the billions are initiated, is in question. At this stage there is a clear indication of outsourcing the task to consultants rather then building capacity internally unlike the Partnership UK set up. I am also keen to know if there is a governing agency in Russia looking after the PPP program?

Dear Gerald, Thank you for the comment. The legal framework was introduced in Russia in 2005, when the law on Concession Agreements was introduced by the Russian federal government. In the same period the Investment Fund of the Russian Federation was created to support financially the implementation of PPP projects. Then the St. Petersburg government introduced its own regional law on PPPs, which helps to attract foreign investors into the market, since it creates more favourable conditions for private sector participation. Later the Russian Development Bank - Vnesheconombank (VEB) was founded to support PPP development and provide lending to those projects. Thus, the government is showing its willingness to do PPPs in Russia and makes some steps to speed up its usage. Still, it is rather difficult to procure PPPs in Moscow due to inflexibility of legislation, and the non-existence of a PPP unit. VEB is supposed to perform some functions as federal PPP unit, but they are not succeeding at it. St. Petersburg, on the contrary, was following the advice of the World Bank when they launched a PPP unit and designed a government PPP policy. PPP unit in St. Petersburg is organised under the Committee for Investments and Strategic Projects.

Submitted by Vickram Cuttaree on
To complement the discussion on legal framework, it is true that the law on concessions is seen as rigid. This is certainly what drove the city of St Petersburg to have its own PPP legislation. So a project like WHSD or Orlovski are implemented under the concession law (as they benefit from federal funds) and Nadex was prepared under the City's PPP law. One concern is that there has been no value-for-money (or at least efficiency) discussion behind the drive for PPPs in Russia. It's pretty much about investment and I've seen at least one region w/o the budget to properly manage its road network for example, started preparing a very expensive PPP project counting on tolls and Investment Funds to make it "cost-free" for the region. This obviously did not work but they spent quite some effort before realizing it. The result is that a PPP is equivalent to a concession in Russia and the value of more limited private participation to increase efficiency is not seriously considered. PPP projects in Russia have mostly been huge ones not integrated in a sector strategy. The role of VEB as an investor can help close transactions being stuck right now. In practice this is equivalent to more public support to a PPP project. The positive aspect is that Russia's fiscal situation seems better than in other countries of the region. This gives more scope for additional Government support to PPP projects.

Submitted by Rasika Gokhale Athawale on
PPPs in India have also come a long way - from just highways & bridges - to now even hospitals being developed under this route. A recent interesting work is on setting-up a railway coach factory through PPP mode and for a fixed concession period.

Yes, you’re absolutely right Vickram on Public Sector Comparator (PSC). There was no proper assessment of a PPP route. Russia is not exception on making decision on PPP implementation based on political will. Still, PSC is a mechanism of ensuring VFM under PPP route, which St. Petersburg government understands its importance to design, but still we’re under way to implement it. Incorporating PSC in the PPP policy framework in Russia requires government to have a proper skills, experience and expertise to do so, and Russia is still on its way of capacity-building in PPPs. This gap can be closed by international consults that have experience in PPP implementation and PSC, but still it requires government to have spare financial resources to be able to use this alternative. There are a lot of activities devoted to PPPs which are happening in Russia. Vladimir Putin, the prime minister of Russian Federation was talking about PPP as a way to deal with the financial crisis, and he is promoting idea of developing cooperation between government and private sector. There are more and more regions in Russia that are doing their first steps on PPP development (now we could name around 15 regions of RF). A new legislation on infrastructure obligation is almost ready now, which will force PPP implementation, and should be a source of capital attraction. St. Petersburg government has designed a feasibility study 30 year PPP project to develop and operate a 350,000-450,000 tonne per year waste processing plant in St. Petersburg, and will hold a roadshow in London on 26th October 2009 for interested parties in the tender process. I hope we will be able to estimate first results soon.

Submitted by scott James on
It is apparent from the recent legislative changes and the growing infrastructure demands across Russia that PPP will play a significant role in shaping the future needs. PPPExpert.com is running a series of PPP training programmes in collaboration with a number of Government and Private sector organisations. If you are interested in attending the 'PPP Financial Modelling' and 'PPP Project Management' training in Moscow during September 2012, Please visit our website www.pppexpert.com The training is being delivered by PPP experts and promises to deliver an interactive and practical learning experience based on case studies and thought provoking content.

Submitted by Shaq on
I can see an increase in the Russian PPP sector by the number of projects that are in the pipeline and the international companies now tendering for those projects. I am also attending a series of trainig courses in Moscow scheduled for September 2012. They are being run by PPP Experts limited and include PPP Financial Modelling and PPP Project Management. My understanding is that they are being delivered by experts from UNECE. for more information, i would suggest you visit www.pppexpert.com Hope this helps.

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