GLOBAL ECONOMIC DOWNTURN HITS ST. PETERSBURG

UNCLAS ST PETERSBURG 000002


EEB/IFP/OMA;EEB/EPPD

E.O. 12958: N/A
TAGS: RS ECON
SUBJECT: GLOBAL ECONOMIC DOWNTURN HITS ST. PETERSBURG


1. (SBU) Summary. The ongoing economic downturn is increasingly
being felt in St Petersburg and threatens to jeopardize many of
the achievements of St. Petersburg's economic development over
the last several years. The city government has been forced to
recalculate its budget, several ambitious infrastructure
projects have been downsized or postponed, various industrial
companies have suspended their production, and staff cuts are
beginning to be discussed more and more frequently. Although
some local analysts predict the crisis may stimulate healthier
economic growth in the long run, the current negative trends can
be expected to continue well into 2009.

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Public Mood Has Drastically Changed Since the Summer
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2. (SBU) The consequences of the global financial crisis have
become increasingly apparent in St. Petersburg recently, as a
quick glance at the headlines in any local newspaper reveals.
In August and September of this year, analysts and journalists
were still very upbeat - discussing ongoing infrastructure
development, new investment projects, outlooks for growth and
the challenges of a very tight labor situation. Today, however,
the most popular words in the printed media are "reduction",
"contraction", "suspension" and "staff separation."

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Government's Infrastructure Spending Plans Affected
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3. (SBU) The lack of investment capital and increased interest
rates has hit various multi-billion dollar development projects,
which the city administration had hoped to accomplish through
public/private partnerships with major Russian and foreign
investors. Foreseeing a significant decline in revenue, the
city administration has reviewed several programs, and cut the
overall city budget planned expenditures for 2009 by 10 percent.
According to public statements of St. Petersburg government
officials, several high-profile projects are likely to be
postponed, such as the as "Elevated Express" (construction of an
elevated tram line which would connect the southern outskirts of
the city with the main public transportation network, estimated
cost US$1.4 billion),the "Orlovskiy Tunnel" (a toll tunnel for
cars under the Neva river, $1.1 billion),the Western High Speed
Diameter road (a toll highway connecting the southern and the
northern parts of the city, $9.0 billion) and reconstruction of
Pulkovo airport ($1.0 billion). Independent market observers
have been speculating in the press that this list is not
exhaustive, arguing that many of the government's other
initiatives, such as "Morskoy Fasad" (construction of a sea
passenger terminal and an accompanying commercial/residential
complex, $1.4 billion) and various other real estate development
projects also seem to be in jeopardy.


4. (SBU) The city has already decided to cancel its
participation in the Okhta Center, one of the highest profile
and most controversial real estate projects in the city, which
entails the construction of a 1300 foot tall office building
jointly financed by Gazprom. The city government has officially
ended its participation in the project, to which it had
previously pledged around $330 million over next three years.
Gazprom's leadership, regardless, still claims it will continue
on with the project without government assistance if necessary.


5. (SBU) Another high-profile consequence of the downturn has
been the suspension of the South-West Heat Power Plant (HPP) in
St. Petersburg. This $500 million project was considered by
City Hall to be a key part to its overall city development plan.
However, Sintez Group, the project's main private investor, has
recently experienced serious difficulties in construction
financing and has suspended the project. This suspension has
ramifications for another of the city's strategic projects -
Baltic Pearl. This $3.0 billion construction project, financed
by Chinese investors, was one of the first large foreign
investments which Governor Valentina Matviyenko's administration
secured for the city. The project plans to create a large
commercial complex and accompanying residential districts which
would house thirty thousand residents in the southern outskirts
of the city. Local economic observers fear that the delay in
the construction of the South-West HPP, along with the
suspension of "Elevated Express" which would connect Baltic
Pearl with downtown, threatens the completion of Baltic Pearl as
well.


6. (SBU) The overall development plan for the city's overtaxed
electrical grid network is also being downsized. The plan was
initiated by both the city administration and the Russian
electrical power monopoly RAO UES in 2006 and called for a total
investment of about $11 billion into St. Petersburg's energy
complex. However, according to recent announced revisions, OAO
Lenenergo, the local distribution network operator, will only
invest $1.6 billion into the modernization of its facilities,
instead of the $2.8 billion as originally planned. Similarly,
TGK-1, the local electricity generating company, intends to
postpone the commissioning of various new power generating
facilities for up to four years.

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Manufacturers Also Being Hit
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7. (SBU) Private businesses are being affected by the global
downturn as well as government promoted infrastructure projects.
One of the most prominently affected industries has been the
automotive industry. In response to a sharp decline in demand,
the Ford Motor plant in Vsevolozhsk, Leningrad oblast, has
announced plans to halt production for about one month, resuming
production in late January, 2009. Similarly, the new GM plant
which opened in St. Petersburg in early November announced that
it would not reach its design production capacity in the near
future. The plant will not operate through mid-February 2009,
after which production will commence only three days per week
for an unspecified period of time. Also, both Hyundai and
Suzuki, who recently signed agreements to construct plants in
St. Petersburg, are both considering postponing their projects
until the economic climate improves.


8. (SBU) Other industries also provide a growing number of
similar examples of business retrenchment. Flextronics, a
Singapore-based producer of high-end electronics for major U.S.
computer manufacturers, which had planned to start production at
its assembly plant in St. Petersburg in 2008, has decided to
suspend production for an undetermined period. Fosforit
company, a large producer of mineral fertilizers based in
Leningrad oblast, has suspended production following a sharp
decline in the demand for its products. Another Leningrad
oblast-based company, Pobeda Knauf, a Russian-German joint
venture which manufactures construction materials, has also
announced a two-month production freeze. Many construction
companies have frozen their current projects and are reviewing
or even cancelling their investment plans for the future. City
government officials have noted that in November and December
almost no new construction projects have been started throughout
the city.

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Banking Sector: Next-in-Line?
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9. (SBU) Against the deteriorating manufacturing background, the
banking sector of St. Petersburg appears to be in relatively
good shape. The only significant problem in this sector thus
far has been the St. Petersburg-based VEFK Bank bankruptcy
threat. This bankruptcy could have potentially had serious
repercussions on the economic and social situation in the
region, because VEFK has the fifth largest retail network in
northwest Russia, and works with many thousands of individual
clients, including pensioners who receive their pensions through
the bank. Heading off bankruptcy, federal authorities replaced
the bank's administration and provided the bank with a $290
million cash infusion - measures which prevented financial
losses for VEFK clients and generally reassured the small
depositors of other banks as well. Overall, although there are
still concerns about the stability of the banking system, St.
Petersburg banks have been operating without major failures so
far.

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Average Ivan Starting to Feel the Pinch
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10. (SBU) More and more ordinary people seem to have begun
feeling the impact of the crisis in their everyday life.
According to the St. Petersburg administration's Vice-Governor
for Economic Development Mikhail Oseyevskiy, 1000 people are
losing their jobs in the city every week, with many more
companies reducing their employees' compensation packages and/or
considering staff cuts as a real possibility. Also, in
expectation of a decline in consumer purchasing power, some
shops are beginning to shift to cheaper and lower-quality goods.
Several popular retail food chains have announced a 50%
reduction in the variety of articles they keep in stock on their
shelves. But there seemed to be little slowdown in spending in
the run-up to New Year's, the biggest holiday of the year for
most Russian families. Some observers commented that Russians
would not stint in their New Year's purchases, but would start
to feel the financial pinch in January and February.

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Yet, Crisis May Provide Opportunity for Future Growth
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11. (SBU) Optimistic business analysts, however, expect that the
crisis will be instrumental in bringing eventual improvements to
the city's business environment. They argue that the crisis
will open more space in the marketplace for the development of
stronger companies, as their less efficient competitors will be
forced out. The cooling labor market should also relieve the
staffing shortages and turnover problems for businesses. The
head of a major U.S. company told us that staff turnover has
decreased from the pre-crisis figure of 40 or so people each
month to only one per month in December. Lower economic growth
rates should make the infrastructure development concerns
somewhat less pressing. Analysts also point out that St.
Petersburg has one of the most diversified economies in Russia
-- a key policy objective of Governor Matviyenko -- and hope
that the slowdown in some branches of its economy would be
compensated by the growth in others.


12. (SBU) Comment. The spreading economic downturn is becoming
a serious test for St. Petersburg's economy, as it threatens
many of the economic achievements which have occurred over the
past five years. Although some of the optimistic expectations
are not unrealistic in the long run, in the shorter term, St.
Petersburg's economy will likely experience significant
dislocations which will negatively impact both businesses and
people alike.


GWALTNEY