The mainstream is mined

Author: Alexandr Ivanter

Why is the project financing mechanism stalling?

The current models of organizing budgetary investments, debt financing of major projects and money supply in the economy are not in line with the needs of the economy. The number of proposals and institutions are on the rise and they are eroding the liberal status quo.

The most important point of the federal budget crisis revamping became the audit of investment government expenditures - federal target programs (FTP) and the Federal Recipient-Oriented Investment Program (FROIP). The amount involved is significant: the volume of funding FTP was 937 billion rubles and FROIP without taking into account government defense procurements – about 1.6 trillion rubles. In the old good pre-crisis days a significant part of the federal budget expenditures were channeled through the FTP/FROIP mechanism ( at the peak of 20% in2008) and then the scale of using these instruments started to go down gradually and nevertheless we are now talking about each tenth ruble of government expenditures. Furthermore, this money is not for sandwiches – 54% of FTP spending is government capital investment and 19% is spending for R&D.

FTP under a microscope

In mid-March,the Government held a special meeting devoted to analyzingthe situation with government programs. In his keynote address, Economic Development Minister Alexei Ulyukaevspoke of homeopathic improvements in achieving target indicators of the programs as compared with 2013 and focused on the unresolved problems. According to the Ministry of Economic Development the performance of government customers, that is, line ministries and institutions can be rated as highly efficient or above an average level only with regardto 27 FTP (out of 45 open ones). The most problematic FTP is “Development of Russian Cosmodromes for 2006-2015. There is a lame duck inside it – a subprogram of constructing the VostochnyCosmodrome in the Amur region. Last year, cash expenditures under this program amounted to less than a third of those planned, namely, 8 billion rubles out of 25.3 billion. The Government believes that the main reason for the current situation is a low level of organizational management by general manager Spetsstroi and the absence of as-built documentation. The issues of funding the VostochnyComodrome have already formed the basis of several criminal cases. In the most high-profile case, former head of DalspetsstroiYuryKhrizmanwas arrested last autumn (he is charged with embezzlement).

Finance Minister Anton Siluanov’s stand is not to include non-important projects in this year’s FROIP. Projects without design specifications and estimates and with regard to which no tenders were held are not to be started at all and appropriate allocations are to be redistributed to the anti-crisis fund.

A new revised version of the federal budget for the current year provides for a ten-percent (up to 25.9 billion dollars) reduction in the program of constructing the VostochnyCosmosdrome.According to experts, a total reductioninprograms of budgetary funding of capital investments will exceed a 30-percent “record” of 2009.

But a proportional frontal crisis reduction is the worst thing you can come up with. “A logic of reductions must be not only arithmetic but also a managerial one insome other forms of development with due regard to changing conditions”, believes Director General of the Federal Project Finance CenterAlexandrBazhenov.

A radical idea

Management by objectives (MBO) is one of the most common and dynamically developing methods in managing budgetary expenditures in the world. The first MBO elements were developed in the US in 1949 in the system of budgetary planning. They made it possible to link government expenditures with their expected results. MBO is widely used in the budgetary process by Great Britain, Canada, France, New Zealand and a number of other OECD countries.

Since the early 2000s, attempts to link budgetary expenditures to their resultswere made repeatedly in Russia. In practice, they managed to do it partially with investment expenditures through federal target programs.

The introduction of FTP in the practice of the budgetary process was designed to spend budgetary funds to achieve concrete measurable results and ensure efficient interaction between various institutions and non-governmental players to accomplish these results. And a long-term nature of the programs was to guarantee required budgetary funding outside the budget cycle.

There is no doubt thatthe use of FTP yielded positive results. Budgetary funds were spent more efficiently. But the quality of implementing many programs varies significantly, a number of them suffer from serious problems:delays in schedules of stated goals, shortfalls in implementing policy measures, problems and delays in raising non-budgetary financing. Moreover, largelythere are no institutions and procedures for evaluating efficiency of FTP including an analysis of alternative options of achieving program goals.

An obvious development line of MBO principle of managing budgetary expenditures is to include expenditures onmaintaining property assets in federal ownership to be created in FTP. To this end, planning periods within long-term target programs should be expanded to a duration of a government property asset’slife cycle.

At the end of the last year, Vnesheconombank Chairman Vladimir Dmitriev made a non-trivial proposal for changing FTP functioning model radically. In his opinion, funds of federal target programs could become a source of Vnesheconombank’s additional capitalization, with Vnesheconombank becoming an operator of some programs. Vnesheconombank’s Chairman stressed that such a measure would make it possible to reduce the cost of funding for projects in those sectors where investments are unprofitable at a current level of market interest rates. “Taking into account a complicated situation with government finances in the mid-term prospective, we offer a number of solutions to lessen the budgetary burdenand at the same time increase the efficiency of government investments Mr. Dmitriev said in his exclusive commentary to Expert magazine. VEB proposes itself to the state as an instrument for expert analysis and for implementing concrete projects on a reimbursable basis within FTP. We are ready to provethat some FTP projects could be funded by the state on a reimbursable basis, given purpose-oriented use of funds.Specifically, VEB offers a new model of working with FTP. Instead of spending 100 billion rubles in the form of non-reimbursable budgetary investments, the state could provide VEB with a loan worth 20 billion rubles in its capital for a period of 15 years at two percent per annum and using this 20 billion we’ll raise 100billion rubles of project financing and provide a project with funds in full at an acceptable interest rate. This is a classical operational model of Soviet Promstroibank. It operated successfully in the USSR and I see no obstacles to using it again. Today, under the conditions of sanctions,it’s difficult to raise funds on the market and this increases the value ofbudgetary resources. So, instead ofbudgetary money, VEB could become an operator of investing financial resources of the National Wealth Fund.

Certainly, not all programs and even not all expenditures inside programs are suited to be transferred to a reimbursable principle of funding. Nevertheless,this idea requires careful consideration.

Above barriers

In the last half a year an increasing number of unorthodox measures of monetary and fiscal policy have been under discussion in the expert community and some of them are already being implemented.

Above all, in March they started to use monetary resources of the National Wealth Fund to provide support for such strategic investment projects as projects on the reconstruction of BAM and Transsib, the construction of a Central Circular Automobile Road and a Nuclear Power Plant in Finland.

Two funds of government financing for long-term capital-intensive projects in the real economy at interest rates lower than market ones are at the launch stage now. Firstly, this is the Russian Fund for Technological Development designed to fund purpose-oriented expenditures on projects for an amount from 50 to 500 million rubles at a pre-investment stage at an interest rate of 5% per annum for a period of five-seven years. The Fund has already received more than 600 applications for funding, 27 of them were accepted for further consideration and submitted to comprehensive expert examination.

And secondly, a mechanism for project financing which focuses on projects in the amount ranging from 1 to 20 billion and the cost of financial resources for final borrowers is to be determined according to the following formula “a key interest rate of the Central Bank plus one percentage point”. Preferential final interest rates are guaranteed by a special procedure for refinancing projects at the Russian Central Bank (at a rate equal to a key rate minus one percentage point) and by raising a 25-percent budget guarantee.

And a proportionof borrowed funds should be in the range of 80% of a project’s value.

A main principle of project financing is sharing of risks between a project’s participants. As a result, it becomes possible to carry out a larger project than each of participants could afford separately.

An interdepartmental commission with the participation of representatives from the Economic Development Ministry, the Ministry of Industry and Trade, the Ministry of Agriculture, the Energy Ministry, the Transport Ministry and the RF Government Office was set up to implement a model of project financing. VEB’s subordinate role in the commission is rather discomforting (its representatives can attend the commission’s meetings in advisory capacity). From our point of view, VEB is competent enough to conduct comprehensive audit and expert examination of projects. The Bank performed these functions well as part of the Government Investment Fund in 2007-2008, so it’s difficult to understand why the Bank had been relieved from performing these functions. As of today, VEB managed to become one of authorized banks participating in implementing a program of project financing.

A program of supporting investment projects on the basis of project financing was approved last October. They have already selected seven projects to include into the program (most of them are in the agricultural sector) for a total amount of 73 billion, out of them borrowed funds account for about 50 billion rubles. But a launch of concessional lending mechanism is blocked because of the need to ensure guarantees. At a meeting of the Government last Monday, Prime Minister sharply criticized the situation with guarantees: “The situation with guarantees hasn’t been resolved so far and it’s bad.How long will this situation continue? Agencies blame each other and then they all put the blame on VEB, on commercial banks. What then?Where’s money? Where are guarantees?” Our informal survey of several authorized banks showed that bankers consider the need for guarantees in the mechanism under consideration tobe excessive and artificial. It’s enough to have a sieve of projects in the interdepartmental commission and banks’ own expert examination in order to launch concessional project financing.

We can hear even more radical proposals for making qualitative changes in the Bank of Russia’s monetary policy paradigm in order to expand channels of injecting money into the economy. This is what VEB Deputy Chairman Sergei Vasiliev proposes, “One of issue channels is for the Central Bank to buy VEB’s bonds issued to fund concrete projects.

An inflationary effect from this measure will be very insignificant and the most important thing is that this money won’t get into the foreign exchange market.

Under the current conditions of sharply limited access to foreign capital markets by Russian banks and companies, life itself prompts this decision. An alternative is to fall into a full-scale recession, that is, a self-sustaining contraction of economic activity.

A mechanism for moving to such a model of refinancing long-term investment creditsforVEB’s end borrowers by the Bank of Russia has been already launched today although it’s scaleis extremely small in the macroeconomic scale ( projects worth 20 billion rubles are being examined now).

A launch of concessional lending program is blocked because of the need for guarantees. Authorized banks consider these guarantees to be an excessive requirement.