Igor FINOGENOV to ITAR-TASS: Regional Economic Integration is EDB’s Priority

Igor Finogenov, Chairman of Eurasian Development Bank’s (EDB) Management Board, told, in his exclusive interview with ITAR-TASS, how to stimulate long-term investments in the context of the current financial and economic instability.

EDB is taking part in preparing recommendations for the G20 leaders, which will pass the final communiqué – a “roadmap” for the global economy for the next year – at the summit in St. Petersburg in September. EDB is an outreach partner in the G20 Finance Track for the period of the Russian presidency of the G20 in 2013.

ITAR-TASS: How did the crisis of 2008 and the subsequent sluggish recovery of the global economy influence the financing of infrastructure projects?

Igor Finogenov: Private lenders and investors demonstrate a significantly lower risk appetite than they had before the crisis and public budgets in the current situation are less capable of undertaking the financial burden associated with large infrastructure projects. As a result, we see a reduction in the overall number of new infrastructure projects and projects that involve various forms of public-private partnerships (PPP).

Another instrument of infrastructure financing – loans in national currencies – has also shrunk.

There are certain geographical differences, however. While Europe, Central and East Asia have cut their new infrastructure projects by two or three times over the last three years, Latin America and South Asia increased their volumes by 25% and 75% respectively.

Here we come to a conclusion that the amount of financing for infrastructure projects, at least those involving various PPP tools, depends on the stage of the economic cycle to a significantly lesser degree than on the availability of sufficient quantities of well-developed projects.

Latin America was the first region to develop PPP tools and legislation to ensure their effective use by the economy. This is probably why the region managed to maintain infrastructure financing during the post-crisis period.

In contrast to this, European and Central Asian countries began to utilise new instruments to finance infrastructure and adapt their legislations to these instruments not so long ago – from the late 1990s and mid-2000s respectively.

ITAR-TASS: Russia has very few PPP projects. In your opinion, why does this form of infrastructure projects finance fail to “grow roots” in the CIS economies?

Igor Finogenov: In the beginning, when PPP instruments just appeared, many project participants considered them to be a “wand,” which would make it possible to finance any infrastructure projects with zero risks.

However, the crisis was a tough reminder that risks cannot be eliminated – they can only be redistributed. By simply assigning risks to partners (the state or a development bank) a doubtful project would not become a perfect one. A development bank also cannot cope with project risks alone: both national and interstate banks represent one or several states. Any risks assumed by the development bank are the transformed risks of the public budget.

In the post-crisis global economy, development banks are those that are capable of promoting investments in infrastructure. A development bank is the only party which can play three roles at a time in infrastructure projects: that of a source of long-term money, a consortium leader, which would unite different players in the private and public sectors, and a source of technical expertise to ensure high-quality performance.

In my opinion, the second function is the most important one, because the level of risks in large infrastructure projects makes it impossible even for major private investors to lead such consortia. Theoretically, this role can be played by public parties to a PPP project, however it is easier for development banks to found a consortium to finance a large infrastructure project. Interstate development banks, for example, by virtue of their status, can cover a number of specific (non-commercial) risks that cannot be assumed by other consortium members, both private and public.

Eurasian Development Bank enjoys this status, which includes international legal capacity, property and judicial immunities, tax and customs exemptions and other preferences, which make it possible to avoid risks associated with possible changes in legislations or banking regulations of its member states.

ITAR-TASS: And yet, how this “nominal leadership” of development banks can be transformed in real projects and investments in infrastructure?

Igor Finogenov: In practice, development banks differ in their capability to fulfil the above functions. The most recent review by the World Bank of about one hundred development banks stated that, to be successful, they needed to focus on a limited number of key tasks. Where a bank had an ambiguous objective of “the anti-crisis stimulation of the economy,” it produced disappointing results.

Eurasian Development Bank has, for example, a clear mission. Our priority is regional economic integration reflected in growing trade flows and mutual investments between the EDB member states. We fulfil our mission, in the first place, by making investments in large infrastructure projects, including interstate initiatives.

The lack of investments in infrastructure and, in particular, in  interstate projects, which connect different economies, is a particularly acute problem in the post-Soviet space. This results in the deficit of electric power needed for small and medium-sized businesses, carriers’ costs that exceed all economically reasonable thresholds, considerable losses among agricultural producers and their inability to deliver their products to neighbouring markets because of the lack of a state-of-the-art road network.

I would like to give an example of how EDB fills the gap in infrastructure financing in its member states.

Central Asian countries have a huge energy potential, which is needed to be distributed territorially in order to ensure a proactive trade in electricity and energy products between the countries of the region. In the Soviet times, these objectives were served by the “Central Asian Energy Ring.” Today, not all countries in the region operate their energy systems in a joint fashion. Economic losses caused by isolated operation of some national energy systems are significant. The region is already suffering from electricity shortages and these are predicted to grow.

For this reason EDB participates proactively in the modernisation of generating facilities and electric power grids in Kazakhstan and Russia. In Kazakhstan the Bank finances the reconstruction of existing facilities at Ekibastuz GRES 2 and the construction of its third unit. This will help stabilise electric power supplies to Northern Kazakhstan and Southern Siberia. The Bank is also considering investments in the modernisation of the generating and grid infrastructure in Kyrgyzstan and Tajikistan.

ITAR-TASS: Does the Bank have PPP projects in its portfolio?

Igor Finogenov: EDB took part in two major PPP infrastructure projects in Russia and this was a positive experience. The projects were the modernisation of Pulkovo Airport and the construction of the Western High-Speed Diameter road.

The most important feature of these projects was that they had been prepared in a very cautious manner and the preparation period took significant time. This made it possible to correctly forecast demand and distribute projects risks. In both cases we have a stably growing demand, which is not affected significantly by the stage of the economic cycle.

Another important factor is that the St. Petersburg government is focused on making these projects successful. To this end, it adopted special concession regulations and the rights and obligations of all partners were set forth clearly in agreements with the municipality.

ITAR-TASS: These projects are often said to be unique...

Igor Finogenov: All such projects have some general, critically important characteristics. A project needs to be comprehensively analysed for feasibility and the financing scheme should be chosen at the stage of the business plan. At the same time, countries often lack specialists who can forecast the extent and structure of demand correctly. The solution is to rely on technical assistance from development banks, which have the necessary expertise and can arrange syndicated project finance taking into account risk capabilities of each of its partners.

ITAR-TASS: Back to Pulkovo and the Western High-Speed Diameter, why are the key infrastructure projects in Russia and other CIS countries financed in the dollars or euros?

Igor Finogenov: Although infrastructure financing in national currencies has decreased, this instrument has good prospects, especially in our region, for, at least, four reasons. The first is deepening integration processes in the region. The Eurasian Economic Union opens new prospects for all countries that will join it. Second, the member states of the Eurasian Economic Union undertook to pursue a coordinated and predictable macroeconomic policy and take measures to integrate their financial markets and harmonise the respective regulations. This will create new incentives to finance projects in national currencies. Third, the role of the Russian rouble and the Kazakh tenge as regional reserve and settlement currencies is strengthening. And, finally, the pension reforms that are ongoing in our region will result in the formation of an important source of “long-term money” accumulated in national currencies.

ITAR-TASS: Recently, there are many talks about project bonds which are deemed a panacea for recovering the infrastructure boom. Do you agree with this point?

Igor Finogenov: The enhancement of opportunities to finance infrastructure depends directly on whether and when new instruments form, which would suit the requirements of a wide range of investors. This is a critical function of development banks. Project bonds are one of these instruments. They help to channel private non-banking capital into large infrastructure projects. Development banks’ task is to assume risks, which are unacceptable to the market. The key mechanisms of this redistribution are subordinated loans for the issuer and guarantees for bonded loans.

The European Union chose this path when it launched in 2012 the pilot phase of its initiative to set up a market in project bonds in order to finance transnational infrastructure projects, supported by the European Investment Bank. Latin America also has a positive practice of using project bonds.

A number of obstacles exist in the EurAsEC to using this instrument. First, the quality of infrastructure projects in the EurAsEC countries is for the time being poorer than in the EU and Latin American countries. Second, the mechanisms to reduce investors’ risks such as sovereign guarantees and the involvement of insurers, or guarantees and subordinated finance from development banks, are not widespread yet. The system of tax preferences for investors with respect to revenues they derive from project bonds is still being discussed and potential investors, in particular pension funds and insurers, are burdened with regulatory restrictions and have practically no opportunity to invest in project bonds.

However, despite these limitations, Russia had several successful bond issues in recent years. These included the issue of bonds for the reconstruction of the M1 highway in Belarus and the construction of the M10 Moscow-St. Petersburg high-speed highway. The fact that these transactions took place in the absence of the relevant regulatory framework and measures to stimulate the use of this instrument means that project bonds are in high demand with both sponsors of infrastructure projects and investors.

EDB is considering possibilities to use bond instruments in the financing of infrastructure projects and is studying potential mechanisms to stimulate this market in the EurAsEC. As a development bank, we see our role in, on the one hand, providing technical and financial expertise in preparing infrastructure projects and, on the other, in reducing risks for private investors by creating and introducing guarantee mechanisms and subordinated finance. EDB experts are working proactively in the task forces of the EurAsEC governments that develop mechanisms to advance the market in project bonds.

Interview by Valery Zhukov