24 January 2019
Trade & Export Finance
Oleg Pankratov, global head of infrastructure capital and project finance at VTB Capital, discusses Russia's private infrastructure funding plans with TXF. While attracting foreign investment may be expensive, the government cannot afford to put the country's $100 billion infra plan on balance sheet.
Russia's need to improve its infrastructure has led to some major project financings in recent years. The government has an ambitious plan to spend around RUB 7 trillion ($100 billion) on developments over the next five years. Public-Private-Partnerships (PPPs) will account for a significant portion of those deal structures, with around RUB 3 trillion expected to come from private funding. However, PPPs are often rouble-linked and tend to have a limited appetite from international investors, contractors and operators, especially given the current volatility of Russia's domestic currency.
Russian state-owned bank VTB has recently closed some of the more notable large-scale project financings. For example, the $7 billion 47km PPP Western High Speed Diameter toll road project in St. Petersburg is the largest regional infrastructure development in Russia to date. The project, which saw VTB partner up with French concession company Vinci, is expected to need around €3 billion in funding. Likewise, the Pulkovo Airport project includes investment from the Qatari Investment Authority and Mubadala (Abu-Dhabi). And given the government's steep infrastructure development plan, foreign investment in Russian infra projects is only going to grow over the coming years. But regional banks still have a major role to play in getting these projects across the financial line, especially given their surplus in dollar and euro denominated liquidity as an indirect side-effect of the sanctions.
TXF spoke with Oleg Pankratov, global head of Infrastructure Capital & Project Finance at VTB, to find out more about the bank's pipeline of rail and road projects and how it plans to attract foreign investment in Russian infra projects.
TXF: Which sectors do you focus on?
Oleg Pankratov (OP): Our most noteworthy deals recently have been in the airport and road sub-sectors, where we see great opportunity. In the Russian airport sector, nine out of the ten top airports are already entirely or partially privatised. Undoubtedly, the aviation market in Russia still has room for growth. There is potential for significant expansion, with the tenth largest airport currently servicing only 2 to 2.5 million passengers per year, in a market of approximately 100 million passengers annually.
In recent years, there has been many PPPs and concession projects in the Russian road sector, with both federal and regional projects entering the market. At a federal level, the most high-profile projects include the new M11 toll road between Moscow and St. Petersburg (sections 7-8) and the Central Ring Road in the Moscow Region (sections 3-4). The other sections of these roads are being procured either outside of the concession framework or with the support of direct state guarantees
At a regional level, projects in the road sector have been more moderate as the PPP framework is still quite a new procurement mechanism for local governments. However, VTB was involved in the largest regional project to date – the Western High-Speed Diameter – a new 47km toll road in St. Petersburg, with a total funding amount of more than $7 billion at the time of construction. The open international tender was run by the City of St. Petersburg in 2011, under the local PPP law. The winning consortium (VTB Bank and Gazprombank) successfully completed the construction phase in 2016.
TXF: When you compare Russia to Western Europe would you say it's lagging behind in infrastructure?
(OP): If you measure it by the density of railroads, Russia arguably has less than Western Europe. However, if you measure by length, Russia has more tracks that exist at a greater scale – for example, the Trans-Siberian Railway is the longest domestic railway in the world. The challenge Russia faces is the sheer scale of the country and that Siberia is scarcely populated compared to Western and Eastern Europe.
If we were to look at infrastructure development as a percentage of GDP, Russia has caught up and is no longer lagging behind our counterparts in Western Europe. This breakthrough coincided with the West reducing their investment. However, to achieve the same quality of infrastructure in Russia, we must continue to invest in order to overcome the unique challenges we face such as a severe climate and a vast territory.
TXF: Is there growing confidence from abroad to invest in Russian infrastructure projects?
OP: We definitely see interest from foreign investors. For example, since securing the position of lead investor for the Pulkovo airport, we have successfully sold two significant stakes in it, worth 25% each to international investors. In October 2016, the Qatari Investment Authority bought a stake in the Pulkovo Airport for €240 million and in April 2017, a new deal was announced for VTB Group to sell a 25% stake to a consortium made up of the Russian Direct Investment Fund (RDIF), Mubadala (Abu-Dhabi) and Baring Vostok, an international private equity.
The Pulkovo Airport PPP project has been a great success story, with the airport expansion completed on time and within budget in 2014, transforming Pulkovo into a world-class air transportation hub. Although the Russian economy is largely self-sufficient in terms of the available capital for projects, foreign investment has not dried up. Recently, we have partnered with French concessions and construction company Vinci on the Moscow-St. Petersburg toll road.
TXF: Do you see a lot of competition with other banks for these sorts of infrastructure projects?
OP: Most domestic infrastructure deals in the Russian market are denominated in roubles. This means that only lenders with substantial access to rouble liquidity can be meaningful players. On the other hand, it is true that the Russian infrastructure market is still highly competitive. We are currently investors in eight different projects won in competitive bids.
TXF: Are Russian banks charging high interest rates for projects?
OP: In today’s market, it is common to pay a rate of 10-11% for infrastructure project loans. To put this in context, the central bank’s rate is 7.75% and Russia sovereign debt trades at around 8-9% so private infrastructure is funded at a premium to the government debt. However, I do not think a premium rate of 1.5-2% is excessive and is in fact expected in the market. When you consider the levels of risk lenders and investors are taking, the volatility, and the complexities of long-term hedging for deals that are done at a fixed rate, I think Russian banks are potentially undercharging for infrastructure projects, particularly when managing deals in roubles.
TXF: How have sanctions affected the way you operate?
OP: Despite all the issues related to the geopolitical environment, we still see interest from high-profile international investors in well-structured transportation projects at the early post-development stages. Such projects offer a high degree of inflation protection to the shareholders, which, coupled with the limited traffic risk, enable potential investors to take a longer-term view on their exposure to the Russian economy. Also, the vast majority of PPP/concession projects in Russia have always been essentially rouble-linked, thereby limiting the appetite from international investors, contractors and operators. However, we expect that, as more projects (both federal and regional) complete construction phases, we will see more appetite from international players, both financial and strategic.
TXF: What future infrastructure projects do you have lined up?
OP: The Russian government has announced their plans to invest RUB 7 trillion in the Russian infrastructure over the next five to six years, of which RUB 3 trillion will be private money. As a result, infrastructure will be a major sector focus for us in the next few years. One of our recent deals is a joint venture with the Russian Post, to develop the postal logistics across Russia. Another project we are interested in is the toll road in to the City of St. Petersburg, sometimes called the Eastern High Speed Diameter. We estimate that this new road could require €3 billion in funding. It is still early days, but we believe that what we have done previously with the Western High-Speed Diameter puts us in a good position to take part in the transaction. Another project we expect to work on soon is the railroad transaction, the North Latitude Railroad, spearheaded by Russian Railways. This project is expected to be funded by a bank syndicate. With regards to non-transportation deals we're looking at, we could mention a hospital project in Kamchatka that is due to be tendered next year.