Meeting Russia’s Infrastructure Gap

On behalf of the World Bank Group and President Robert B. Zoellick, let me congratulate the organizers of the VIth International Investment Forum in Sochi for this wonderful opportunity for open dialogue. I wish us all success and fruitful deliberations in the coming days. It is a great pleasure and privilege to be here today.

Why Infrastructure is Important

The case for infrastructure development is strong and easy to make. Indeed, it has been at the center of Russian politics ever since Peter the Great embarked on the process of Russia’s modernization. It drove Sergei Witte’s resolve to develop the railway system and construct the Trans-Siberian railway from Moscow to Vladivostok that was completed in 1896 and opened the gateway to the Pacific almost 200 years after St Petersburg had been founded as the country’s gateway to the west.  And it was the major force behind huge infrastructure developments of the Soviet era, such as major hydro-electric power systems.

Today the case for infrastructure is more valid than ever as Russia continues its quest to join the ranks of the most successful economies.

First and foremost, infrastructure development is key to economic growth.  Good roads and bridges expand market opportunities, lower the costs of goods and services, and enable countries to use their productive capacity better. China’s development would not have unfolded had the country not invested heavily in infrastructure. Singapore’s emergence as South East Asia’s economic hub is literally built on its excellence in building and maintaining world class infrastructure, in particular its much acclaimed ports and airports.

On the other hand, lack of infrastructure has often hampered economic growth.  For Latin America, it is estimated that the lack of infrastructure investment there in the 1990s has cut long term GDP growth rates by 1 to 3 percent.

Second, surveys all over the world have shown that well-developed infrastructure helps attract foreign investment and improves a country’s international competitiveness.  And where infrastructure is inadequate, businesses suffer and complain.

The globalization of production of goods and services presents enormous opportunities for all countries, provided they have in place the infrastructure to compete. 

First, the stakes are high.  World trade has grown exponentially since the 1960s with exports rocketing from under $1 trillion in the late 1960s to almost $10 trillion per year in 2006. 

Second, some countries have been better able to take advantage of this than others, which has helped them sustain high rates of growth.  Yet, in many countries, poor infrastructure is acting as a constraint to reaping the full advantages of globalization. 

Third, aside from spurring economic growth and improving competitiveness, infrastructure is critical to sharing growth more broadly, and reducing income inequality.  A few years ago, the World Bank published a study that involved interviewing thousands of poor people around the world.  It found that the poor themselves point to the dramatic impacts that access to potable water or to a road that enabled access to markets, schools and health facilities made to the quality of their lives.

Fourth, infrastructure holds countries and societies together.  Think of the First Transcontinental Railroad in the United States. Built in the 1860s, it linked the developing railway network of the Eastern coast with California. Completed on May 10, 1869, it gave the US a nation-wide transportation network, forever changing the American economy and emerging as the artery of the nation’s interstate commerce.

Lessons from Infrastructure Finance

 Against this background, Russia faces the obvious need to develop and upgrade her infrastructure, such as roads, bridges, airports, electricity, water supply and sanitation, to enable producers to get their goods to market,  to spur economic growth, and to provide education, health care and adequate living conditions for all, including the elderly.  One need only travel on the roads around Moscow or St. Petersburg to see how the numbers of motor vehicles have doubled, some even say quadrupled, since the transition and the strain that is putting on the road infrastructure that Russia inherited from Soviet times.

With its abundant oil and gas revenues, Russia has a single advantage today that other countries would envy.  But international experience with infrastructure finance suggests that this is no reason for complacency.  Challenges abound, even in cash rich countries.

First the amounts required to generate good quality infrastructure services are enormous, particularly in countries that are building up their infrastructure stocks. Rapidly growing East Asian economies, such as China and Viet-Nam, are investing upwards of 8% of GDP annually.  Korea did the same throughout the 1970s and 1980s. 

And resources are needed for more than investments.  In fact, a good rule of thumb is that any given project generates an annual need for maintenance expenditure equivalent to 2 or 3% of construction costs (8% in telecom).  Otherwise, the road, power plant or water infrastructure will start to quickly deteriorate. 

 Maintenance expenditures therefore represent a very large share of infrastructure expenditure needs, particularly in mature economies with larger stocks of valuable infrastructure. As you see from the next slide, the ratio of maintenance to investment needs shifts from 1: 1.5 in mid-income countries to 1:0.4 in high-income countries.  

To give an example: the Canadian government spent $8.5 billion (0.6% GDP) on road investments in 2006 but $9.8 billion on road maintenance (0.7% GDP).  But Canada is one of the few countries that structured its finances in such as way as to ensure reliable flows of funds to maintenance.  Instead, the US has not and analysts have blamed insufficient maintenance for the recent tragic incident when a bridge collapsed in St Paul, Minnesota.  Today, the US Department of Transportation estimates that the country must invest some $1.6 trillion during the next five years in transportation systems to make up for aging and insufficiently maintained roads, bridges and tunnels.
 
Infrastructure projects are long lived, and as such require long-term finance.  Construction often takes 3-5 years, which is ill-suited to the vagaries of public finance.  And when financed through borrowing, the needed terms are often 10 to 20 years, which becomes costly unless measures are taken to offset some of the risk.

This brings me to my second point: because the amounts are so large, and the investments long lived, some creative financing is needed.   Special purpose vehicles, such as the one recently created in Russia, can be very helpful in leveraging additional investments – if they are well designed.  Reliable and predictable sources of funds can reduce the overall risk in a project, hence reduce its cost and attract reputable investors.  But not all investment funds are created equal: the Swiss Infrastructure Fund for example is a model of good practice; the Argentina Transport Fund is not.  The latter is established and frequently modified by decree (rather than law), has never been audited, and its resources allocation is under constant modification. 

Institutional investors, such as pension funds, can be tapped.   Chile, for one, has relaxed the constraints on pension funds, allowing them to invest in the 20 year AAA infrastructure bonds it issues that are sold exclusively to domestic investors.  These bonds have allowed Chile to raise US$ 1 billion between 1995 and 2003.  

And most countries need to make greater use of user charges for funding infrastructure.  These should be designed to signal price, reflect real costs and contribute to demand management.  But cost recovery is an issue everywhere.  In half of water utilities in rich countries, tariffs barely cover operation and maintenance expenditures, and can’t even begin to fund capital costs.

Finally, public-private partnerships (PPPs) are a way of raising additional financing and diversifying the business model.  They do not reduce the demand on public financing however (except in the case of telecom).  The countries that have successfully used PPPs such as Chile or the UK have actually increased public investment in infrastructure.  More generally, despite the availability of private finance, public finance will continue to dominate.  Today worldwide, public funding from governments and public utilities still accounts for 70 percent of investment in infrastructure while the private sector accounts for 22 percent and official development assistance makes up 8 percent.

 And this brings me to my third point: Neither private nor public finance is the panacea for infrastructure projects.  The choice between public and private provision should be driven by local conditions, not ideology.   Spain has financed one third of its transport system from private sources, yet Germany has almost entirely used public financing. China is relying on public financing yet is increasingly seeking private financing for the expansion of its expressway system.  The UK government perhaps says it best: the guiding principle of its PPP program is “value for money.”  The choice between public or private provision is guided by cost effectiveness principles.  

 Aside from the question of how to finance infrastructure, there are several other lessons to keep in mind based on international experience in developing infrastructure.

On the environmental front, Russia has the chance to learn from the experience of other countries and to develop infrastructure in a way that is sustainable and that leads to the maximum gains for the Russian people.  In this respect, it may be instructive to learn from the European Union’s “Cardiff Process,” which is mainstreaming environmental considerations in nine key sectors such as transport, agriculture, and energy.  Energy production, transformation and use is a major contributor to rising greenhouse gas emissions and mitigation strategies would ideally include changes in energy systems such as greater end-use efficiency, switching to cleaner fuels and adoption of new technologies. Moreover, in a situation where domestic and international demand for Russia’s oil and gas is likely to surpass present supply levels, energy efficiency and energy savings is emerging as a promising strategy to close the supply gap.

 Further, our experience shows that if designed well, infrastructure can provide greater access to goods and services and that it meets the needs of the people and the economy, and contributes to productivity.  Vietnam, for example, has developed a power network within 10 years that now gives access to electricity to more than 95% of the population.  In Bangladesh, an innovative rural electrification project achieved low system losses and high collection rates by working closely with consumers and hiring meter readers on annual contracts to prevent corruption.
 
 Lastly, it is important not to forget the basics. Sustainable infrastructure projects need to be designed in a way that they safeguard people and nature.  Careful planning and consultation can make a positive difference. Confronting corruption is also important because it can run up costs, keep honest investors away, and undermine public trust.  Lack of transparency in Latin America’s infrastructure reforms is directly to blame for the huge popular backlash against these reforms.  

Finally, to be successful, it is also important to invest in the people that manage the assets. In Romania, a project aimed at increasing the capacity and reliability of the Romanian railways system ensured that railway management and staff were trained in new techniques.  This resulted in big gains in efficiency and productivity while the railways system’s deficit fell from $214 million in 1995 to $44 million in 2002.

Infrastructure Needs in Russia

 So how does all of this apply to Russia? 

 As we gather here in Sochi, the economic prospects for Russia look good.  In 2007, Russia is set to enjoy another year of rapid economic growth on the back of strong energy prices and investment, rapid expansion of domestic demand, and unusual weather conditions. 

These gains follow the strong performance of the Russian economy ever since the crisis of 1998 was overcome. Since Economic Crisis of 1998, Russian Economy grew by almost 70%, while real incomes of the population grew by 84%, and poverty was cut by half.  Russian investment mushroomed in early 2007.  Both domestic and foreign investors have been vying to invest in Russia, where they find solid macroeconomic conditions and an attractive business environment with profit margins to sustain business growth.

 Today we are all agreed that for Russia to maintain that growth and to remain competitive, substantial  investment in infrastructure will be critical. The needs are vast, they range from investment in oil and gas to energy generation and transmission. They cover urban infrastructure from transport to water and sanitation, housing and heating. They relate to the ports and inter modal transport facilities. They continue into the areas of aviation and railways. The development of the rural areas and their centers is on the agenda as is the development of a rural roads network.

As I said earlier China and other East Asian countries are investing 9% of GDP.  In Europe, Spain is spending 4.5% of GDP on transport alone in its effort to catch up with the rest of Europe. For its part, Russia is investing close to 5 percent of GDP or $47 billion in infrastructure.  But the needs are enormous if Russia wants to compete in the globalized economy and more make the most of its vast territory and abundant resources. 

 Russia is currently in the enviable position of having substantial domestic savings to leverage for the infrastructure it needs.  However, challenges remain.  These resources must be well targeted and strategically used.  The new (and existing) infrastructure stock must be maintained and this does not come cheap.  Annual investments of US$ 47 billion increase the need for maintenance expenditure by about US$1 billion per year.  Finally, Russia may want to diversify sources of financing by broadening the contribution of private finance to Russian infrastructure into new areas such as communal services and transport.  While the Europe and Central Asia region has become the leading destination for private participation in infrastructure (PPI), Russia has only made limited use of PPIs.

Also PPI in Russia has been mostly limited to green-field investments and telecom. 

 As to the need for creative financing, the creation of the infrastructure fund is a good start.  However, further reforms to make the fund a more secure source of co-financing, and allowing the country to tap institutional investors could help leverage even more resources.  The challenge is to resolve a number of critical constraints linked to tariff levels, regulatory frameworks, and legal instruments. Many of the key reforms needed are already underway, though many of them are politically challenging and depend on political will and budgetary resources at the sub-national level.

Building on 15 Years of Partnership

 
 For its part, the World Bank Group has been privileged to assist Russia in its continued economic development.  Since 1992, cooperation between the Bank and the country has resulted in 62 approved projects aimed at achieving sustained economic growth, creating the environment for private sector development, improving social services, and protecting the environment.

Most recently, as Ms. Matvienko will recall, we worked with the St. Petersburg authorities on a request to help structure the concession of a $3 billion Western High Speed Diameter project in your city.  It is a project of critical importance to expanding port capacity, but also to relieve the city of all the traffic congestion from the port and transit traffic.  Last December, we had a highly successful road show in London, with over 100 participants and biggest firms in the world on infrastructure PPPs actively participating. 

St. Petersburg has become a model of innovative approach in developing PPPs.  Our interest here is to help the City of Saint Petersburg and subsequently other Russian regions learn how to structure and manage these PPPs, and to give the market the confidence that the deals being put on the table will be carried out fairly and transparently.  Our hope is that Russia develops a strong reputation for fair and transparent process.  While forging ahead with this mega-transaction, we are also working with the City of Saint Petersburg on developing a number of other PPP projects including Orlovski tunnel, Nadzemni Express Light Rail, and Pulkovo Airport, worth in total of nearly $3 billion.

As Russia develops and changes, the World Bank Group’s cooperation with Russia changes as well. Our new Partnership Strategy for 2007-2009 puts strong emphasis on knowledge sharing and policy advice. At the suggestion of the Federation, we will increasingly work directly with Russia’s regions and oblasts.  Most Russian regions continue to exhibit significant rates of growth and poverty reduction.  The challenge now is to maintain equitable growth and nationwide social cohesion as different regions embark on different growth paths and we are pleased to see that regions are interested to work with us to overcome those obstacles.  

 Looking ahead, the World Bank Group stands ready to build on its 15 years of partnership with the Russian Federation and to assist it in achieving widespread growth and development.  And what better way to look ahead than to meet here in Sochi, the site of the 2014 Winter Olympic Games, and the place where Russia will put its best foot forward for the world to see.  I look forward to a stimulating few days of dialogue and discussion here in these beautiful surroundings at the Black Sea.

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