LITTLE HOPE FOR RUSSIA'S ATROPHIED INFRASTRUCTURE

C O N F I D E N T I A L MOSCOW 000430

SIPDIS

STATE FOR EUR/RUS, EEB/IFD
TREASURY FOR TORGERSON AND WRIGHT
DOC FOR 4231/MAC/EUR/JBROUGHER
NSC FOR ELLISON

E.O. 12958: DECL: 02/13/2019
TAGS: ECON EIND EFIN RS
SUBJECT: LITTLE HOPE FOR RUSSIA'S ATROPHIED INFRASTRUCTURE

REF: 08 MOSCOW 431

Classified By: ECON Minister-Counselor Eric T. Schultz, Reasons 1.4 (b/
d).

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Summary
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1. (C) The GOR's stated commitments to modernizing and
developing Russia's transportation infrastructure are
unlikely to materialize soon. With a looming budget deficit,
the government has cut infrastructure financing repeatedly.
Some investment bankers argue that investing in
infrastructure projects during the present crisis would take
advantage of low input costs and employ laid-off workers, but
it appears that only some high-profile projects, such as
those connected with the Sochi Winter Olympic Games, are
likely to receive government financing. Russia's inability
to implement a coherent infrastructure strategy will hamper
its chances of coming out of the crisis more economically
competitive.

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The Mirage of Infrastructure Improvement
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2. (U) Since 2000, Vladimir Putin has regularly called for
the modernization and development of Russia's neglected and
dilapidated infrastructure. In November 2007, Putin stated
that USD 1 trillion (80 percent of it to be supplied by
private investors) was needed over the course of the next
decade to achieve the goal. A year later, in October 2008,
Putin vowed that infrastructure improvement would not be
de-railed by the economic crisis. President Medvedev
included infrastructure as one of his four "I"s
(infrastructure, investment, innovation, institutions) in his
Krasnoyarsk speech last February (reftel). Most recently,
Presidential Aide Arkadiy Dvorkovich promised that
infrastructure projects would be a key component of the GOR's
anti-crisis measures. Most of the GOR's concrete efforts to
date have been focused on road infrastructure, which is the
prism we have used in our discussions with contacts. Rhetoric
notwithstanding,few projects have gone beyond the planning
stage.


3. (C) Contacts attribute the problem to the staggering
infrastructure needs of Russia's vast territory combined with
pervasive corruption at all levels of government and the
elite. Paul Roger, Head of Infrastructure and Transport
Research at RenCap noted that corruption in Russian
construction was significantly higher than elsewhere. He
estimated that in the U.S. about 5 percent of a project's
cost was eaten up by corruption, whereas the figure in Russia
was about 10 percent. Moreover, in Russia, an additional 10
percent "gets lost", owing to inefficient project
implementation and management -- for a total of about 20
percent.


4. (C) According to Alexander Shitov, Assistant Chair of the
Industrial Policy Committee of the RF Chamber of Industry and
Trade, the GOR's rhetoric has been intended to reassure
Russians that infrastructure would be improved and that
"tomorrow would be better". Shitov himself, however, doubted
that any infrastructure improvements to Russia's industrial
base would be undertaken in the foreseeable future. Sergei
Drobyshevskiy of the Institute for the Economy in Transition
also dismissed the GOR's stated infrastructure commitments.
Citibank Public Sector Banking Head Andrei Mineev was equally
pessimistic. Reviewing the GOR's current, and likely future,
budget situation, he told us that more pressing needs such as
supporting social expenditures would have to be met first.

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The Realities of the Budget
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5. (C) The GOR has been contradictory about its budgetary
allocations for infrastructure. In January, the GOR almost
halved the allocations of the Investment Fund for approved
infrastructure projects from approximately USD 3.2 billion to
USD 1.8 billion. (Note: The Investment Fund is the main
vehicle that provides GOR contributions to infrastructure,
among other things. Investment Fund contributions, however,
are intended to be paired with private sector investment,
which has dried up because of tight capital markets and
Russia risk. End note.) On 4 February, First Deputy Prime
Minister Igor Shuvalov announced further unspecified cuts to
infrastructure programs in order to support the banking
sector. The next day, Dvorkovich announced that government
support for infrastructure projects would come second only to
support for the labor market.


6. (C) Natasha Khanjenkova, Director of the Infrastructure
and Energy Russia Business Group at EBRD, told us recently
that although the GOR remains committed to infrastructure
development, given budget constraints, it is now "looking
much more carefully at which projects it will move forward
with at this time". Out of the list of EBRD-related projects
that Khanjenkova discussed, it appears now only two are still
being actively considered: the expansion and modernization of
St. Petersburg's Pulkovo Airport, which has a hard currency
component and, as a public private partnership, continues to
be viable, and the first part of the Moscow-St. Petersburg
toll road, which would effectively provide Moscow with a toll
road to Sheremyetovo Airport -- Aeroflot's hub.

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Poor Infrastructure Costs Russia
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7. (C) The costs of the crumbling roads are not
insignificant. RenCap analysts have calculated that Russia's
poor infrastructure costs its economy approximately six
percent of its GDP per annum. This accounts for lost
efficiency using decrepit assets and the lack of "connective
infrastructure" that leaves over 40,000 towns and villages,
housing about 12 million people, cut off from the rest of the
country. Russia has only about one million kilometers of
highways, of which about 5 percent are federal roads. Of
those 50,000 kilometers, only 40 percent are considered
"normal". Experts estimate that it needs about 2 million
kilometers, all of which should be "normal". RenCap's Paul
Roger also noted that Russia's roads were approximately 48
percent depreciated.


8. (C) There are regional disparities as well. Our
interlocutors in the retail, auto, and warehousing sectors
have all told us that since Russia is essentially cleaved in
two at the Urals and the majority of the population lies west
of them, marketing and expansion strategies focus on European
Russia, thereby excluding Siberia and the Far East. As
Avtomir's Vladimir Petrov told us, it is pointless to even
consider a true car dealership network in Asian Russia since
there are fewer roads and fewer people every year.

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"Silver Lining" of Crisis?
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9. (C) Despite the government's lack of initiaitve, there are
some analysts who hold hope that the GOR will take advantage
of the crisis to address Russia's pressing infrastructure
needs. RenCap's Paul Roger, for instance, argued that the
crisis would encourage the government to channel more
resources into large public works projects such as road
construction as a means to provide jobs, and he predicted
that a condition of government-financed infrastructure
projects would be that construction firms use Russian labor
instead of (cheaper) migrant labor, which has comprised road
construction crews to date. Moreover, Roger emphasized that
the Sochi Olympics and the Vladivostok 2012 APEC Conference
would be finished because it was a "matter of pride" --
Russia would want to show its best face to the world at these
events. Indeed, the government has been at pains to reassure
IOC officials that Sochi-related infrastructure projects will
be unaffected by Russia's budget woes.

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Comment
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10. (C) The few infrastructure projects that are likely to be
undertaken will probably not do much to boost Russia's
economic growth. Moreover, addressing Russia's growing
unemployment problem with a New Deal-type infrastructure
initiative seems unlikely. The continued inability of the GOR
to implement a coherent strategy for infrastructure
development and modernization will be another important
obstacle to Russia's coming out of the crisis stronger and
more competitive economically. End Comment.
BEYRLE