#4 - JRL 7226
St. Petersburg Times
June 17, 2003
Yakovlev's New Job a Hard One
By Alla Startseva and Peter Morley
STAFF WRITERS

Vladimir Yakovlev may soon be thinking that his old job as governor of St. Petersburg was a walk in the park compared with being deputy prime minister in charge of communal-services reform.

Yakovlev's new brief will be to tackle issues that have been ignored for decades - such as maintaining and repairing buildings and supplying basic services such as water, electricity, gas and sewage and garbage disposal - in a sector of the economy that President Vladimir Putin this year labeled a "complete mess."

St. Petersburgers are left without hot water for large parts of the summer for maintenance work that rarely seems to make a difference to the quality or reliability of the water supply; power and gas stoppages are a regular occurrence in some areas of the city; and garbage often piles up for months on end in city courtyards. And this is in Russia's so-called "Window on Europe," a city that, traditionally, sees itself as modern and advanced, at least by Russian standards.

Multiply St. Petersburg's problems onto a Russia-wide scale, factor in the country's chronic infrastructure problems, especially outside the big cities, and add in traditional bureaucratic obstacles - as well as the fact that the sector employs just 3.6 million people nationwide, each earning an average of less than $90 per month - and the magnitude of the task facing Yakovlev becomes clear.

The additional involvement of Russian Communal Services, or RCS, a consortium of some of Russia's biggest businesses, is likely to tie Yakovlev's hands further.

Led by Anatoly Chubais, the loans-for-shares architect who now heads UES, RCS is confident it can succeed where the government has failed, making the venture profitable enough to encourage investment in the sector.

Putin in April scolded the government for what he called "social tensions" resulting from "the lack of elementary order" the sector, and called for urgent action.

OVERDUE REFORMS

Reforms are already past due: The utilities and housing infrastructure is about 60 percent obsolete and the number of breakdowns has increased geometrically, reaching one breakdown per kilometer of the central heating system, or 30 times higher than in the West.

According to different estimates, between $2 billion and $17 billion is needed to modernize the sector, a sum that far exceeds the federal budget's capacity.

RCS was officially registered earlier this month with a charter capital of 1 billion rubles, which is divided into 10 million common shares worth 100 rubles each. UES and Gazprombank each own a 25-percent stake, while the other five members of the consortium each have 10 percent.

The consortium will establish 100-percent-owned regional subsidiaries that will take over all local housing-service functions, ensuring supplies of water, power, heat and gas, television and radio access, garbage collection, sewage service and general building maintenance.

The idea is to convince local mayors to turn over, say, all the heating infrastructure of their towns for 10 years or so in exchange for a promise to provide stable heat supplies and maintain and modernize the infrastructure.

The catch is that municipal authorities do not have the power to set tariffs for non-city-owned companies, so for the project to be profitable for RCS the consortium must be able to convince regional energy commissions, which are controlled by regional governors, to set tariffs at a level to its liking.

UES and Gazprom, in particular, stand the most to gain, as they hope to recoup billions of dollars owed to the sector by current communal systems providers by streamlining the massive bureaucratic machine in which they operate. All that is needed, Chubais says, is to decrease theft, cut expenses and install better management.

"We will put everything in basic order. Our team is able to manage this task," Chubais told reporters when he unveiled his plan in March.

Chubais' confidence is reflected by the amount of money RCS says it will invest in the project - up to $500 million - but half a billion dollars is just a fraction of what will eventually be needed. Experts say the industry has been underfinanced by about $2 billion per year over the past decade, and even the government admits that modernization will cost more than $15 billion.

UES and Gazprom say streamlining the industry will allow them to recoup the billions of dollars owed to them by current communal services providers. They also expect it to turn into a moneymaker.

HISTORY REPEATING?

The scheme seems eerily similar to the scandalous loans-for-shares deals of the mid-1990s, which temporarily bailed the government out of a fiscal hole while simultaneously enriching a clutch of well-connected insiders.

The potential pitfalls are enormous - but so are the potential profits. Public and private expenditures on communal services last year totaled more than $17 billion. However, where huge chunks of that money end up is largely anyone's guess under the current system, as is where Yakovlev fits into the picture.

According to a recent study by the presidential administration's auditing directorate, 73 percent of boilers and 65 percent of all pipe networks in apartment blocks are "depleted," resulting in as much as 60 percent of all residential heat supplies being wasted.

The Kremlin's financial watchdog also found that:

the number of malfunctions has increased fivefold over the last decade; the national heating network suffered more than 1,500 failures last winter alone, a 20 percent increase on the year resulting in 75 "major" crises in 38 regions; for every 100 kilometers in the heating network there were on average 200 ruptures or other incidents requiring repairs last year; And that's just heat. Equally crucial - and decrepit - is the water system. For example, more than a third of all the water supplied to households is officially considered "unhealthy," according to government estimates, while water waste due to faulty pipes is about 40 percent, or nearly three times the average for developed countries.

"The ineffective management of housing and utilities services and a lack of coordinated measures at the regional and federal levels are the main reasons behind the crisis in the sector," the presidential auditors said on the Kremlin's official Web site, www.kremlin.ru. "Creating the legislative basis, ensuring financial stability, budget support, tariff policy and the formation of a services market in the sector remain uncoordinated."

What is needed, the Kremlin watchdog said, is a new law on housing reform to create the legal mechanisms for competition.

LESSONS LEARNED?

The government tried this approach in 1993, but made little progress, save for grouping municipal housing and utilities departments into regional units. The sector never became competitive because the newly created regional companies retained control at the municipal level while federal and regional budgets continued to subsidize them.

But in a classic series of hide-the-budget-money moves, nearly all of the regional companies' municipal departments have changed their names and locations numerous times over the last five years, making them virtually impossible to collect debts from, let alone control.

The total bill for consumer services last year came to 554 billion rubles ($17.7 billion), about 60 percent of which was paid by residential customers, while federal and regional budgets covered about 30 percent, leaving some 60 billion rubles in cross-debts between customers, suppliers and middlemen.

What's more, the federal government says a large portion of these budget funds are either stolen or misused by municipal authorities, meaning local communal service providers rarely see a kopek for their services. As a result, the government says, 70 percent of all communal services companies are bankrupt and collectively owe more than 3.5 billion rubles in back wages. (In some regions, like Kamchatka, communal service workers haven't been paid since last summer.)

The debt maze has resulted in consumers' owing communal services providers about $6 billion, while the providers owe about $9 billion to energy suppliers, mainly UES, Gazprom and coal companies.

With the system spinning out of control, housing specialists say it is clear that something must be done quickly, which is why the government, having failed in the task, is turning to Chubais, as it has in the past when faced with a seemingly impossible task, to begin cleaning house.

FUNDING PROBLEM

In another twist, the head of the State Construction Committee said earlier this month that the government will not allocate any federal funds for the maintenance of housing and communal systems in those towns and cities that have signed contracts with the newly created RCS.

"In towns that conclude a contract with RCS, let RCS work there," Interfax quoted Nikolai Koshman as saying. "We will see how these projects will be realized. The government will not allocate budget funds for maintenance in these places."

Koshman said the State Construction Committee is urging the government to allocate 13.47 billion rubles ($440 million) in additional support for the coming winter, but none of the regions where RCS is active will see any of that money.

Chubais said, however, that RCS is not counting on the government's help.

"We have our own resources. If we grab these meager state funds I don't think it will do good at all," Chubais said. "The volumes and tasks in the housing sector are so big that if the State Construction Committee manages to allocate some funds ... it will have plenty of things to spend them on."

By law, local authorities alone are responsible for communal services. The federal government can only pass vaguely worded laws that are little more than recommendations to municipalities.

"Due to the differentiation of powers, municipal authorities are not obliged to obey federal laws concerning the housing sector," said Nadezhda Kosareva, president of the Moscow-based Institute for Urban Economics.

And those federal laws that directly affect the sector and that local governments must adhere to only make matters worse for the most part.

CORRUPT AND FALL

The whole system seems custom built for corruption.

Here's how it works: municipal authorities are not allowed by law to manage communal properties themselves, so they are obliged to create a management company to take over all rights and responsibilities for those properties. But once that happens it becomes virtually impossible to take back these properties, even if a management company runs afoul of the local administration, because it can hold on to that property as long as it wants.

The catch is that the head of the municipal government has the power to hire and fire the director of the local management company, thus controlling the company's money flows.

Now, just as communal services workers have no incentive to work, these management companies have no incentive to square their accounts. It makes no sense to initiate bankruptcy proceedings against them because legally their assets are considered "socially significant," meaning they cannot be sold in any liquidation proceeding.

The bottom line is that nearly all of these companies are bankrupt even though they can never be declared so.

"In addition to corruption in the sector, there is complete muddle - both financially and legally," said Kosareva.

The system is literally communist - created by communists under communism - and it hasn't changed a bit legally, she said.

"All the relationships within the sector were built on administrative principles, not economic principles. That is why it is impossible to describe the structure of the sector from an economic point of view."

When Moscow allocates money to municipal administrations for their annual budget, that money is not earmarked, meaning local authorities can spend it on things it isn't intended for. (That is why it is not uncommon to see employees of the local water company decorating the streets with flags on national holidays instead of fixing broken pipes.)

For municipalities, which act as the supplier, middleman, customer and inspector all at once, the status quo is just fine.

Another disincentive for communal services providers to streamline their operations is that tariffs are set based on how much it costs to provide a service.

Although housing and public utilities tariffs, which are controlled at the regional level by special commissions, rose 20.7 percent in the first quarter of the year, or 3 1/2 times faster than inflation, service companies generally make no effort to reduce expenses by modernizing because the regional energy commission would react by reducing tariffs and thus their revenues.

This is the main reason private companies have no interest in the sector - there is no way to guarantee a return on their investment.

CHUBAIS TRIUMPHANT?

Conquering the housing sector while overseeing the world's largest electricity company would give Chubais unprecedented political power.

In addition, rebuilding the national power sector offers Chubais, who has been dubbed the most-hated man in Russia for his past privatization shenanigans, something of a last chance to put a shine on his tarnished historical record, and the housing sector represents the last mile of that quest.

Kosareva of the Institute for Urban Economics said that if the RCS project can succeed in a few regions, Chubais could regain the people's trust and get them to believe in his pro-market reform mantra again.

Dmitry Orlov, deputy head of the Center for Political Technologies, called the housing sector "the last enclave where Chubais can improve his image as a reformer because no one has tried to reform the sector before."

"If Chubais can manage to turn the sector around, he will wash away his image of a poor privatization master forever," Orlov said, adding, however, that he doubts Chubais will succeed.

But if he does, it would be a fitting accomplishment for the man who essentially created the oligarchs as a class and drove perhaps the final nail in the coffin of communism in the process.

"The housing sector is the only untouched socialist industry left in the country," Kosareva said. "All the political parties cherish and care for it because it gives them a wide area for populist activity."

Yakovlev's role in sorting out the current mess was unclear on Monday. However, the head of local power utility Lenenergo, Andrei Likhachyov - who originally declared he would run for governor, but subsequently withdrew his bid, saying he would back Valentina Matviyenko, presidential representative the Northwest Region - said that the future of communal-services reform is unlikely to depend on Yakovlev alone.

"A whole set of measures and efforts is imperative," Likhachyov said in an interview with the Vedomosti business daily, although he refused to comment on the specifics of Yakovlev's appointment.