The government will have to combat the disastrous condition of Russian roads alone. Private investors are only interested in certain stretches of highway close to major cities.

Ekaterina Shokhina

During a May 6th cabinet meeting, officials discussed plans for a national road modernization and development program ending in 2025. The meeting began with heartrending tales of the pitiful condition of Russia’s roads. According to Prime Minister Mikhail Fradkov, half of Russia’s roads are currently in an unacceptable state. In the Far East and Siberia, there are practically no roads at all, “which makes it difficult to incorporate these large territories with great natural resources into our economy.” Almost 50,000 settlements in Russia have practically no roads connecting them to neighboring regions.
According to Igor Levitin, Minister of Transportation and Communications, road construction is not receiving adequate funding. In 2003 it fell to 1.5% of the GDP from 2.9% of the GDP only three years ago. If this negative trend continues, by 2010 the number of road accidents could increase by as much as 40-45%, while the length of Russia’s roads will fall by four times. This will further complicate traffic problems in big cities and the regions surrounding them. The average speed on Russia’s roads will fall by an average of 20%. Construction at many important sites has ground to a halt. Private investors do not see Russian roads as an attractive area for investment. According to Levitin, private investors are not investing in roads due to a lack of a proper legal basis for private road construction. There are no laws governing concessions, toll roads, or land deals related to road construction.
The final version of a national program to modernize and develop Russian roads should be complete by October 1st, 2004. For the time being, there are two main proposals for dealing with Russia’s roads. The first comes from Minister of Finance Alexei Kudrin. With uncommon generosity, he proposed to increase the budget for roadwork by 15-20 billion rubles a year. The second proposal was put forth by Levitin: create turnpikes to attract private investment. According to the transportation minister, Russia needs to pass a law on concession contracts to encourage private roads. Then, roads and the areas immediately adjacent to them could be handed over to private investors for an extended period of time. This would in turn reduce the amount of time required for investors to see a return on their money and would encourage the development of road-related infrastructure. Specialists, however, are extremely skeptical about the minister’s proposal.

Business hits the roads

Why aren’t private investors interested in road construction? Because the majority of road projects take a long time to see little, if any, return, and also because there are very high risks associated with long-term investment in Russia. When you compare Russian turnpike projects with those in other countries, it becomes clear that the investment costs for building roads in the West and in Russia are approximately the same, while the number of cars on Russian roads is less than half that of the West. The actual tolls on Russian turnpikes would also be 2-2.5 times lower than in Western Europe, from 20 to 100 rubles. For this reason, it would only be possible to create a profitable turnpike within the city limits of Moscow or St. Petersburg or along certain stretches of major highways.
Investors are also scared away from Russian road construction by legal and sovereign risks. “According to the world average, it takes from ten to thirty years to turn a profit on roads,” notes Pavel Gurin, Director of Corporate Finance and Investment Bank Operations Management at Raiffaisenbank. “At the same time, the main problem for any investor is whether he is willing to take on the sovereign risks for that period of time. At present, only a handful of international financial institutions have invested in Russia for ten years or longer. Even ten years is a very long time and investors have to be absolutely confident that there are no legal risks and that their interests will be protected by the government.”
At a time when state officials are constantly hinting that the decisions the authorities made ten years ago (regarding privatization, tax breaks, agreements to divide production, etc.) could be revisited, investors can have little hope that their interests will be protected.

Disheartening practice

“Any investor first and foremost evaluates the legal risks, and in this sense the road construction industry offers more questions than answers,” says Gurin. “We still have no legal definition of concessions and it is still not clear how it will be formulated in the legislation. Western concession agreements of a similar sort stipulate not only the period and amount of work, but also give government guarantees of road usage so that investors can see a return on their money before the contract runs out.” We should note that guarantees of road usage imply a long-term plan for economic development and production in a particular region. Most long-term planning in Russia as a rule consists of a collection of general statements and well-meaning words.
All concrete decisions, experience has shown, only serve to hurt investor interests. “For the time being, federal law is creating various types of obstacles for private investors,” notes Director of the State Budget Division at the Center for Fiscal Policy, Leonid Bogdanov. “The law’s application in practice does more than not allow potential investors to gain profits; it does not allow them to recover construction costs.”

Mixing it up

Experts maintain that a milder and perhaps more feasible alternative for investors is the mixed model, which involves partnership between the government and private business. Here, it is useful to look at practices in Eastern European and Latin American countries, where roads are not as developed as in America or Western Europe. The low level of highway usage in these countries also does not allow them to turn highways into toll roads because there is no consistent demand for such services. “In our opinion, projects to build toll roads should begin by creating state toll roads, which after a certain period of time when the basic parameters of the project (road usage, tolls, etc.) are confirmed in practice, could be handed over to private investors, thereby compensating for the investments made,” argues Vyacheslav Agapkin. “The funds received from concessions could be used to build new state toll roads.”
There are a whole variety of possibilities for state and private collaboration on road construction. “For example, the area adjacent to a road could be handed over in the form of a concession to investors who invest in road construction along with the government. Then the road could be toll-free. However, we need to remember that this would not be possible everywhere, but only near big cities where there is a significant demand for gas, food, accommodations, entertainment, and shopping. In remote areas, you won’t be able to make any money next to the highway,” argues Viktor Ivanter, Director of the Russian Academy of Sciences’ Institute for Economic Forecasting.

In the slow lane

According to experts, only 2-3% of Russia’s roads might be of potential interest to private investors. That means 98% of the country’s roads fall to the government, which is, after all, completely logical. “There is a general rule that the infrastructure is the authorities’ problem because it is a necessary condition for business to function,” says Ivanter. “If the government wants to have economic growth and attract direct investment into the economy, it has to provide businesses with an infrastructure.”
State officials reply by complaining that there is not enough money in the budget for roads, especially since the turnover tax and the federal highway fund were eliminated. However, experts propose that the main problem has nothing to do with a lack of financing for road construction. “All of Russia’s industries are complaining about a lack of financing,” argues Bogdanov. “But I believe that the main problem with road construction lies in the inefficient use of funds. For this reason, giving an extra 15-20 billion rubles a year to the industry, as the finance minister proposed, is not well founded. The main problem is that budget legislation does not stipulate any way to realize targeted spending. As a result, almost 50% of the funds designated for roads and given to regional governments are used for other purposes. The common practice over the last few years is to move road money into constructing housing and utilities, providing regions with natural gas, repairing sports facilities, holding sporting events, renovating airports, building runways, etc. There are no penalties for using designated subsidies and transfers improperly.”
Funds are also used inefficiently in road construction because the industry is not transparent. “A lot of money is simply stolen during road construction and maintenance,” notes Bogdanov. “Estimates for construction work in neighboring regions swell by several times. To get decent roads in Russia, we need competition. For competition, we need bidding to be conducted properly. Then private companies will also be able to build roads and road construction estimates will fall.”

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