Russia's invisible infrastructure boom

By bne IntelliNews November 18, 2011

Ben Aris in Moscow -

An invisible infrastructure boom is underway in Russia as the state's trillion-dollar programme to remake or modernise the crumbling Soviet-era roads, railways, bridges and ports moves into full swing despite the crisis in Europe.

The Russian government is spending between $60bn and $65bn a year on a slew of major projects - not that you'd notice if you visit the country. Walking about Shanghai and the state spending is obvious; nearly every regional capital sports a forest of sparkling glass-clad skyscrapers and freshly minted shopping malls. By contrast, Russia's regional capitals are just as drab and rundown as ever, bar a few brightly coloured billboards. That's because the Russian money is going not into real estate, but predominantly on the transport and power systems that are the lifeblood of this vast and largely empty country.

Infrastructure investment in Russia in 2010 reached $111bn, according to a report by Morgan Stanley, a 10-fold increase from the pathetic $7bn spent in 1999. Moreover, after the government launched its trillion-dollar makeover for Russian roads and railways in 2008, it continued to spend over $100bn throughout the crisis, which has gone a long way to ameliorate the external shock that hit the economy when the global debt market froze in 2008.

Commentators regularly lambaste the Kremlin's spending frenzy that has driven up the level of the oil price required to balance the budget to over $125 today from just $21 in 2007, according to Citigroup. But what they fail to release is that a big chunk of this money is going into infrastructure projects rather than propping up struggling factories or paying public servants. And the splurge in spending is not that much when set against the rapidly expanding economy: the amount of cash being spent may have decupled in the last decade, but as a share of GDP it has only doubled from 3.5% of GDP in 1999 to 7.0% in 2010 - still behind China's 11%, but ahead of India's 6% in 2010.

However, the most telling change is that it isn't the federal government making the investments, but state-owned companies, many of which are now on the privatisation list. Over half of all infrastructure investment (3.7% of GDP) was made by just eight large state-owned companies, while federal budget spending accounted for only 1.8%, says Morgan Stanley.

Tip fo the iceberg

The real boom in infrastructure spending is only now getting underway. A host of mega-projects are currently being prepared that will come online over the next couple of years, which will push the spending even higher.

Amongst the biggest are: development of the Vancor oil and gas field, the biggest find made in Russia in the last 25 years; the development of the Ust-Luga port in the Gulf of Finland that will become the biggest warm water port in Russia; the reconstruction of the Black Sea resort town of Sochi ahead of the 2014 Winter Olympics; and the construction of the East Siberia Pacific Ocean (ESPO) oil pipeline from Siberia to Russia's Pacific coast.

Morgan Stanley estimates there is a total of $500bn worth of infrastructure projects already underway or about to start. "Based on our major projects database, we see a steady $60bn-65bn [per year] flow of infrastructure capex on major projects, and a new generation of mega-projects under development, including high speed rail, new federal highways, the Moscow transport hub and further development of the Yamal oil and gas province," says Jacob Nell, chief economist of Morgan Stanley and author of the report.

To sustain this high level of development, Nell estimates that the state-owned companies will have to raise another $28bn a year to finance the work - about as much as Russia currently attracts as foreign direct investment.

What is odd is that much of this work has gone unnoticed. Part of the reason is that the spending has failed to have much impact on either growth or overall investment - both are now actually lower than prior to the onslaught of the crisis. In addition, because the more opaque state-owned companies are in the frontline of this, their spending is less easy to see than federal budget spending or privately funded investment.

But perhaps the biggest factor is that unlike China and India, which were both largely agrarian economies, Russia inherited a lot of infrastructure from communism that is still serviceable; during the Soviet boom years in the 1970s when the workers' paradise looked like it might actually happen, Kremlin spending on infrastructure was averaging 40% of GDP per year. It was only in the 1990s that it dropped off to next to nothing after most of the heavy lifting was already finished. "Russia inherited significant elements of a modern industrial infrastructure from the Soviet Union, including an oil and gas industry, a mining industry, a railway network, a power network, and urban transport and municipal services. However, the infrastructure was often inefficient, and there were notable gaps, particularly in telecommunications and transport," says Nell.

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