Funding Freeze Weakens Infrastructure Sector

BMI View:   We have considerably downgraded our forecast for construction industry value real growth in Russia from -0.5% to -3.7% y-o-y. This is on the back of weaker than expected official growth reported for 2013 as well a deteriorating business environment. Russia's actions in Ukraine have prompted sanctions from the European Union (EU) which will constrain the country's access to capital for infrastructure projects. This bearish outlook is exacerbated by falling private investment, stubbornly high inflation, and slow economic growth.  

European Union (EU) sanctions on Russia over its actions in Ukraine target loans from the European Bank for Reconstruction and Development (EBRD) and the European Investment Bank (EIB), both of which have become an increasingly important source for the funding for Russian infrastructure projects. Apart from funding, the EBRD and the EIB provide considerable expertise to the Russian construction industry in the form of project management and the structuring of project finance. As such, the EU sanctions to be implemented by the EBRD and the EIB will have a detrimental impact on infrastructure industry growth in Russia. 

The EBRD has already announced that it will not make any new investments in Russia "for the time being", as the official statement said on 16th July 2014. In 2013, Russia borrowed USD2.4bn from the EBRD and USD1.3bn from the EIB.

Sanctions To Hit Infrastructure Growth
Russia Construction Industry Value LHS And Real Growth RHS (2012-2023)

Funding Freeze Weakens Infrastructure Sector

BMI View:   We have considerably downgraded our forecast for construction industry value real growth in Russia from -0.5% to -3.7% y-o-y. This is on the back of weaker than expected official growth reported for 2013 as well a deteriorating business environment. Russia's actions in Ukraine have prompted sanctions from the European Union (EU) which will constrain the country's access to capital for infrastructure projects. This bearish outlook is exacerbated by falling private investment, stubbornly high inflation, and slow economic growth.  

European Union (EU) sanctions on Russia over its actions in Ukraine target loans from the European Bank for Reconstruction and Development (EBRD) and the European Investment Bank (EIB), both of which have become an increasingly important source for the funding for Russian infrastructure projects. Apart from funding, the EBRD and the EIB provide considerable expertise to the Russian construction industry in the form of project management and the structuring of project finance. As such, the EU sanctions to be implemented by the EBRD and the EIB will have a detrimental impact on infrastructure industry growth in Russia. 

The EBRD has already announced that it will not make any new investments in Russia "for the time being", as the official statement said on 16th July 2014. In 2013, Russia borrowed USD2.4bn from the EBRD and USD1.3bn from the EIB.

From the various types of sanctions that target different sectors in the economy, we believe sanctions against the banking sector are most likely to affect the infrastructure industry - in addition to the already mentioned blockage on EBRD and EIB loans. State-owned banks in Russia account for a significant portion of infrastructure project financing and limiting their access to external capital is bound to have an effect on their capacity to fulfil this role. Furthermore, we believe that sanctions against the energy sector will also discourage capital investment from companies in the extractive industry. This is particularly significant as the energy and utilities sector accounts for over 45% of infrastructure industry value in Russia, according to our estimates.

Sanctions To Hit Infrastructure Growth
Russia Construction Industry Value LHS And Real Growth RHS (2012-2023)

Alternative Sources Of Funding

Given the squeeze in Russia's access to credit and capital flows, the country's alliances with non-European countries will gain significance. As such, an alternative source of funding for infrastructure comes from Russia's participation in the newly-established BRICS bank, which will initially invest in infrastructure projects among member states and subsequently expand its investment portfolio to other developing countries. The development bank is scheduled to start lending in 2016, but its structure still requires legislative approval from the countries involved ( see 'BRIC Bank: Long-Term Impact Positive, Near-Term Impact Immaterial', 17 July).

However, we believe that Russia's infrastructure development will only moderately benefit from the new BRICS bank as the majority of the authorised capital will be in the form of guarantees. As such, the bank's impact on infrastructure development will be dependent on private sector participation and given Russia's high risk business environment, the outlook is bleak.

Risks To The Downside
Russia Nominal GDP (RUBbn) And Real GDP Growth % chg y-o-y

BMI's Country Risk team has cut their forecasts for Russia's real GDP growth, from 1.9% to 1% in 2014 and to 1.5% in 2015 against 2.1% previously. This downward revision is partly premised on recent developments regarding the crisis with Ukraine and further revisions will follow to factor in the impact of US and EU sanctions. Perceived Russian belligerence towards Ukraine and the deteriorating relationship with the West have spurred rapid capital flight and shattered investor confidence in Russia. Investors are likely to remain wary of further escalation in the tensions over Ukraine and the impact of sanctions, including trade restrictions, capital controls and blocked access to loans.

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