Despite crisis, positive outlook for PPPs in Russia

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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.

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