RUSSIA’s suburban rail operations are key components of public transport infrastructure serving the country’s largest and most important cities. While well used, investment in the networks has been restricted by government policies which fail to encourage prospective investors to support improvement plans.

The absence of any long-term infrastructure fee subsidy policy, a long-term value-added tax (VAT) collection policy, and the rapid ageing of rolling stock used on these services are the three main issues which have held suburban services back in recent years.

Traditionally the Russian government has subsidised 99% of the infrastructure fee paid by every suburban railway operator to the infrastructure manager, Russian Railways (RZD). However, a long-term government decision on how to allocate these subsidies was not forthcoming, with a decision made annually and repeated year-on-year.

RZDJune18This scenario would leave transport operating companies (TOCs) vulnerable if the government decided to stop subsidising infrastructure. Indeed, TOCs faced the risk of a 100-fold increase in their infrastructure fees, which may account for up to 30% of their total costs, should the government pull or cut back support. The TOCs had a taste of what this could mean in 2015 when for two months infrastructure subsidies were cut from 99% to 75%. With many TOCs suffering from cashflow problems, some services were suspended until the subsidies were restored.

A similar annual approach was taken to the VAT strategy. Russia’s suburban railway services are exempt from VAT on ticket sales. However, TOCs have to pay VAT when paying their suppliers. At the end of the fiscal year, the government would grant the right to retrieve the VAT paid by TOCs to their suppliers, back to TOCs from the federal budget. But again, there was no long-term strategy for this policy.

This uncertainty also prevents the TOCs from establishing long-term rolling stock investment plans. Following the restructuring of the suburban sector, RZD effectively became the infrastructure manager, with operations provided by the TOCs, many of which are RZD subsidiaries. As a result, RZD no longer included investment in suburban rolling stock in its annual budget, with renewal now an obligation of the TOCs. Yet with the planning horizon defined by annual government decisions, the TOCs were prevented from developing any long-term strategies, calculating potential return on investment, and starting any negotiations with financial institutions to secure sufficient resources to support procurement.

With the procurement issues directly related to the problems with VAT and subsidies, the government focused on developing a long-term policy in these areas. In 2016 two federal laws supporting development of the suburban railway sector were passed, which included a commitment to spend $US 800m annually, an unprecedented level of government financial support.

The first law reaffirms the government’s 99% infrastructure fee subsidy for a period of 15 years, with the government allocating around
$US 620m annually until the end of 2030. The second law affirms the VAT refund right for TOCs for 15 years, equivalent to around $US 180m annually until the end of 2029.

Break even

Such long-term financial obligations are unique for Russia. Since they were introduced, the suburban railway sector has been able to break even, which has led to an increase in the attractiveness of prospective investments and greater investor interest in suburban railway TOCs, reflecting the perception that investment carries less risk.

For example, in November 2017 a strategic investor acquired a 25% equity stake from RZD in the leading suburban TOC in Russia, Central PPK, which operates nine out of the 10 major lines serving the Moscow region and has a 65% share of Russia’s total suburban passenger market. In January 2018, another strategic investor bought almost 13% of Central PPK from the Moscow regional government.

The Russian government has also encouraged regional authorities, which are responsible for providing people with transport services, to sign long-term contracts with TOCs to guarantee TOC revenue streams and rolling stock investment. Moscow, Moscow region, Ryazan region, St Petersburg and others have already signed 15-year agreements. In addition, in 2018, some regional transport entities, which are TOC shareholders, began the acquisition of rolling stock for TOCs by themselves by allocating funds from regional budgets.

Buoyed by the government’s policy changes, TOCs now are able to accurately forecast potential costs, incorporate these costs into financial and investment models, develop long-term business plans as well as start negotiations with financial institutions and leasing companies on obtaining financial recourses and rolling stock procurement. For instance, Central PPK has already bought 86 11-car EMUs and is developing extensive plans to spend $US 3bn on renewing 50-60% of its fleet, or more than 2000 cars, by 2025. Others are following this lead. In 2016, Severo Zapadnaya PPK, which serves the St Petersburg region, and Saratovskaya PPK started buying new rolling stock.

The new environment is also improving the prospects of suburban railway rolling stock manufacturers and spare parts suppliers. In addition to Central PPK’s vast rolling stock renewal programme, more than 1100 suburban railway vehicles used by other TOCs, are due for replacement or renewal up to 2025, which could potentially add another $US 1bn to manufacturers’ order books.

The long-distance sector suffers from similar issues with ageing rolling stock and a shortage of investment resources. According to recent estimates, around 5900 or 30% of long-distance passenger railway vehicles should be replaced or renewed by 2025, which may require an investment of up to $US 4.5bn.

Regulation changes

Two special government documents intended to change the regulation environment for long-distance passenger services, are expected to be issued in the near future. Ticket prices for some long-distance services are currently limited by the federal government, with the difference between a profitable price level and the limit set by the government compensated from the federal budget.

The first document is expected to propose that in the future TOCs will bid to operate long-distance services and the level of compensation they will receive from the government. The second document will look at reducing market entry barriers for new TOCs and will set the stage for the development of a competitive long-distance market.

The combined purpose of both documents is to challenge the domination of Federal Passenger Company, which has a market share of more than 90%. Regulatory environment change is expected to stimulate market entry by new players, trigger competition development, increase efficiency and improve the quality of services.

The hope is that a renewed regulatory environment and the development of competition in the sector will prompt private investment in the long-distance sector, which will help to solve the problem of ageing rolling stock. Furthermore, potential market structure changes together with high rolling stock renewal demand is expected to make an impact on long-distance rolling stock manufacturing, inducing very high production volumes and the development of new technologies.

The draft documents have been forwarded by the Ministry of Transport to the Russian government and are currently undergoing an approvals process by other relevant state authorities.