Russian Railways Will Borrow NWF Funds For a Long Time

July 29, 2013
It is still unclear how to recover funds that were not originally intended for the railroad construction. Photo: AP Lisitsyn / RIA Novosti

Russian Railways is under considerable scrutiny of late. Its President, Vladimir Yakunin, has been accused of fraud by opposition leader Alexei Navalny. In a recent ruling, Russian Railways managers will have to report their income and expenditures to the government, which meets some demands of the opposition, but perhaps only in appearance.

Russian Railways is also receiving attention because, despite significant struggles and lagging incomes, it paid its board of directors 40% more in 2012 than in 2011. 

Now, Russian Railways will receive an infusion of funds from the National Wealth Fund. These funds will not be applied directly to a project, but will be invested in shares. – Ed.

Editor’s summary

  • Yakunin, President of Russian Railways, is asking for budgetary funds for BAM (Baikal-Amur Mainline) and Trans-Sib (Trans-Siberian Railway)
  • The state will pay for infrastructure.
  • By investing in stocks,  National Wealth Fund (NWF) is guaranteed ownership, but has no guarantee of return on investment.

The Government and Russian Railways have found a way to extend the life of investment into a sovereign wealth fund from 20 to 55 years. However, it is still unclear how Russian Railways will get the return on the investment.

All the 260 billion roubles, promised by the government to Russian Railways (RZD) for railway infrastructure development in the Far East (primarily the Baikal-Amur Mainline and the Trans-Siberian Railway), will be invested in its shares, according to Maxim Sokolov, the Minister of Transport. During the beginning of 2014, the National Wealth Fund (NWF) will invest 50 billion in preferred stock of Russian Railways (now RZD has only common shares), and another 110 billion roubles will be allocated from the budget.

Such an arrangement to finance the RZD projects should ensure a return on invested NWF funds, officials assure. The payback period for Baikal-Amur Mainline and  Trans-Siberian Railway is 55 years, the maximum payback period for the NWF projects is 20 years. According to Sokolov (reported by Interfax), the return on the NWF funds invested in RZD shares will be 2-3%, and after that an arrangement will be found to increase the yield adjusted for inflation.

So far, neither the government nor the RZD has a clear understanding of how RZD will return the money to the NWF, says a source close to RZD. The NWF can sell the resulting package when RZD is privatized, he suggests, since 24.9% of its shares are included in the privatization plan for 2014-2016. Sokolov believes that the NWF could sell the RZD shares to an outside investor over the next 30-50 years.

There is no payback mechanism to ensure that NWF gets its money back, said a Finance Ministry official. When money is invested in an asset, all the risks should be calculated in advance.

Three weeks ago, a senior Finance Ministry official said that the ministry strongly objects against investing the NWF money in RZD shares. Why the MoF position has changed its employees wouldn’t say, and the Ministry officials were not available for comment. “Most likely the MoF simply had no choice. The project has to be funded, and if you do not do it through the NWF, all expenses will be borne by the federal budget”, the government official lamented.

When decisions are not based on a market approach aimed at participating in the capital of a particular company, according to international standards it is to be considered budgetary spending, not investing in a marketable asset, according to Tatiana Nesterenko, the First Deputy Minister of Finance.

The NWF co-contributes to pension funds and covers the deficit of the pension fund. As of July 1, the NWF had 2.8 trillion roubles held in the Central Bank in different currencies. During the crisis, the NWF funds were deposited to a Vnesheconombank account to support the economy, banks and the stock market.

Late in 2009, Vnesheconombank returned 175 billion roubles, the NWF earned 13.3 billion (7.6%). The balances of the Vnesheconombank accounts (at various maturities, from 2014 to 2020) amount to 670 billion roubles. In 2012, the NWF earned 6.87 billion roubles on deposits at Vnesheconombank.

The NWF is authorized to invest in government bonds, securities issued by international financial institutions, bonds (up to 30% of the funds) and shares (up to 50%, listed only) of Russian and foreign companies. In May, the Budget Code was amended to authorize the invest also in Russian securities related to the implementation of self-financing infrastructure projects.

But in fact the NWF funds were placed only in the Central Bank and Vnesheconombank. Every year the Central Bank transfers its profits to the budget. In 2012 that amounted to 13.7 billion roubles, or less than 1%.

High yield is not a priority for the NWF. The Budget Code also allows short-term negative returns. The most important thing is to safeguard the assets and ensure income stability in the long run. They started using the NWF as a development institution, says Evsej Gurvich, the team leader of the Economic Expert Group. It’s unlikely that a yield-conscious investment company would invest in RZD.

Issue of preferred RZD shares for the benefit of the NWF will not dilute the government share, says Sokolov, warning that the financial and legal model for the transaction has yet to be developed, probably by the end of the year, so it’s too premature to talk about the NWF share in RZD.