Mark Magaletsky: We Are Introducing Road Maintenance Contracts Based On Final Result

Mark Magaletsky Senior Banker, EBRD 30 July 2013 10:48

The European Bank for Reconstruction and Development is one of the longest-standing creditors of the state automobile road agency (Ukravtodor). The EBRD likes to stress that its mission is not limited to financial assistance: as a condition for provision of loans, the bank usually demands improvement of the structures of the agencies to which it is providing loans. The aim of this is to increase their transparency and bring their management system as close to international standards as possible. Obviously, the movement toward these standards in Ukraine is very slow - Ukraine is only now talking the first serious steps towards reforming its road sector. Mark Magaletsky, the head of infrastructure and energy at the Ukrainian office of the European Bank of Reconstruction and Development (EBRD), explains why Ukraine cannot avoid further increase of the excise taxes on fuel and expresses his views on what is currently happening at Ukravtodor.

One of the areas of road reform involves transfer of local roads to local self-government agencies. Why is the industry taking this very logical step only now?

It is difficult for me to say why. In general, the reform involves many things that could have been done before or a very long time ago, and the transfer of management of local roads to local authorities is one of those things. It is obvious that it is better to monitor local roads at the local level rather than to manage them from Kiev. This is the practice in most countries.

When will the transfer take place; will it not result in a further deterioration of the situation involving the financing of local roads?

As far as I know, a transfer plan under which the transfer will take place within one year or two has been approved. As for funds, there is a specific formula for distribution of funds among regions. This procedure, which was approved by a joint order of the Ministry of Finance and the Ministry of Infrastructure, will be implemented. It outlines the principles for distribution of funds for financing national and local roads, as well as the principles for their distribution at the local level – among regions. The calculation formula takes into account a number of indicators of the road sector, such as the state of roads, the length of the road network, the intensity of traffic, operating conditions (including natural conditions), and others, which means that it is relatively objective.

What is the point of the pilot project that Ukravtodor is currently implementing in conjunction with the EBRD?

It is about an attempt to introduce long-term contracts for maintenance of roads based on results in Ukraine. The implementation of a pilot project based on such a contract is now beginning in the Stryi-Lvov-Brody segment of the Kyiv-Chop highway. The difference between this and the traditional contracts is that contractors are paid for the condition of the road and not for the volume of the work they perform.

For Ukraine, a decision to improve the quality of its road network is essentially a decision to further increase the excise duties on fuel

In other words, there is guarantee of the quality of the work performed?

Here, the issue is not so much about guarantee as it is about motivation. Under such conditions, the contractor is not tempted to inflate the volume of work. Rather, there is an incentive to maintain the road in the specified condition through the most efficient method because failure to maintain the road in this condition will entail certain financial sanctions.

Payment for results and not the volume of work is so logical. Why is this practice not applied universally during construction of roads?

It is a completely new experience for Ukraine. It is necessary to create the appropriate regulatory and methodological framework and develop this approach through a pilot project. The practice is expected to be widely applied if it is successful.

When will we be able to talk about the outcome of the experiment?

The selection of a contractor via a tender is presently being completed. I think we will be able to talk about the results in a year or two.

What other steps do you think are necessary to improve the conditions of roads?

The main issue here is the source of revenues into the road fund. For Ukraine, a decision to improve the quality of its road network is essentially a decision to further increase the excise duties on fuel. Currently, the funds that are collected are not enough to finance the maintenance and construction of roads in full. I see no other option but to increase the excise duties on petroleum products - both imported petroleum products and those produced in Ukraine. This is the only realistic source of funds for financing construction of roads.

No less important is the issue of efficient use of the funds allocated for maintenance and development of the road network. This issue is inextricably linked to the overall level of efficiency and transparency of public administration in the country, particularly in the area of public procurements, since the government is the main player in the road industry because of the specifics of the industry.

By how much is it necessary to raise excise duties for the quality of roads to approach civilized standards?

Here, the question should not be about the ideal margin by which excise duties should be raised. Rather, it should be about the margin by which they can be raised from the political point of view. After all, it is clear that such a move always leads to an increase in fuel prices with all the ensuing consequences for the economy. As a point of reference, one can compare Ukrainian taxes with taxes in Europe. Yes, we all know that the quality of roads in Europe is significantly higher but not everyone is interested in the fuel taxes in Europe, but taxes are also higher there by a factor of 2-10, depending on the country and the type of fuel.

There may be no one to repair certain road segments if a decision is made to privatize the Automobile Roads of Ukraine state joint-stock company

Excise duties increase from time to time in Ukraine, but roads do not improve

Yes, that is the case. The excise duties in Ukraine today are 5-7 times higher than they were 10 years ago, but the roads have not improved. The reason is that rate hikes are always delayed. The level of funding did not correspond to the needs of the industry in any year. Therefore, annual degradation of the road network occurs, the situation is deteriorating from year to year, and it is getting worse. 

How much money is necessary to improve the entire network of automobile roads?

Ukraine has a very long and extensive network of roads, and they are all in different conditions. Therefore, it is difficult to assess the need for funding. I think that the figure of UAH 40-50 billion that Ukravtodor is quoting for bringing the existing road network in order is consistent with the reality.

The current reform does not involve privatization of the Automobile Roads of Ukraine state joint-stock company, the need for which experts have stated repeatedly. Do you think that this is the right way?

The issue of privatization of the state joint-stock company is difficult. The fact is that the current level of competition in the area of road construction is different in different segments. If we are talking about major contracts for the repair and construction of roads - say, a contract for UAH 200 million or UAH 500 million - yes, it is high here. There is interest in such tenders from a large number of private companies. These contracts are profitable because they involve large volumes of work in geographically limited sections of territory. However, there is no such great interest when it comes to small sections, on which work is also geographically scattered. Therefore, it may happen that there will be no one to repair certain sections if a decision is made to privatize the state joint-stock company.

Does that mean that the issue of privatization will not be raised in in the near future?

In any case, privatization in one fell swoop is not the right solution. I think that the role of the state in the performance of road works will remain sufficiently big. However, it is necessary to understand the kinds of works we are talking about. If we are talking about major repairs, then private companies are already operating in this segment. Competition is not yet so developed in the segment of other types of repair and maintenance. Therefore, we are trying to develop a mechanism for road maintenance contracts. One of the objectives of the pilot project is precisely to find a format that will be efficient from the viewpoint of the state and attractive to the private sector. However, I do not rule out the possibility that it will be impossible to attract private companies to perform all types of work and that there will be no choice but to involve state-owned enterprises in the work.

What will happen to the company during the reform?

The state-joint-stock company is expected to be restructured based on the same principle as the distribution of roads between the state and local authorities. Local branches of the company will be subordinated to local authorities, and these branches will engage in maintenance of the relevant local roads. Part of the company will remain subordinated to Ukravtodor and engage in maintenance of state roads.

Tags: road, Ukravtodor