Saturday, February 02, 2008

The Armenian Railway Deal -- more is needed

Recently a Russian firm acquired the rights to manage the Armenian railroad system. The Railway Gazette provides a good summary of the background leading to this transaction, with more detail on the Armenia Rail Concession web site. The system has experienced serious reduction in service and is in desperate need of funding.

Cargo and passenger travel, in millions

In general, and for a variety of reasons, the government and the public seem uncomfortable with privatizing publicly owned assets. At the same time, the public enterprises seem unable to raise capital. The public-private partnership model, where ownership remains with the government but management is delegated to a second party, is perhaps a good compromise. In addition to the railways, other examples include Zvartnots airport (Argentina) and the water system (France), among others.

It is wonderful to see the government go through the railways deal. But this raises the question of why it is taking so long for the government to embark on such transactions. The slow privatization process since 1991 has run many productive assets to the ground, and landed others in the hand of oligarchs. Add to this the fact that foreign investments in the form of FDI are small relative to the country's needs as well as to that taking place in the neighboring countries. And so let's hope more such transactions take place.


nazarian said...

Maybe the Russians know something that we don't. Otherwise, why would they want to invest in a closed system?

David said...

Do you believe that the government is equipped to efficiently manage the enterprises it controls? Does it have the expertise in logistics, management, marketing, finance, …? Does it have a track record of good governance?

Anyway, the railway is a business with a stream of revenue and expenses. Firms may maximize their profits by enhancing their revenues (perhaps carrying more cargo) or controlling costs (they don’t have to hire gov’t cronies). From the little I know about this deal, the railway will generate revenues to the government for the first time since 1991. The question is whether importers and exporters will pay more (gov't will regulate fares), and that depends on the expertise and technology that the firm will bring in to reduce cost and shipping time. See my earlier piece on trade logistics!

nazarian said...

I see I have a fellow free marketer.

My point in the earlier note was not about the revenues and cost reductions, or the skills of the operator.

I was wondering whether the Armenian railroad itself has a future because it can only service the needs of the Armenian enterprises. Most of the railroad traffic is used to transport commodities right now and is unlikely to change in the future. The commodity prices will probably continue to rise and the exporters will probably be able to absorb the increased cost of railroad transportation.

I just wonder if there is going to be enough demand in this tiny market in order to justify the purchase price and the promised investments in the system.

David said...

Think about it.
Trans-World Telecom (TWT), registered in Guernsey, bought 49 percent of the monopoly Armentel in 1995 for $10 million. Three years later, it was sold to the Greek OTE, and TWT left with some $70 million.

Pernod bought the Cognac factory for $25 million in 1998. Today it makes about $15 million a year in profits.

OTE bought Armentel for about $150 million. It earned about $50 million in profits a year before wat sold it to the Russian/Norwegian Vimpelcom in late 2006.

The electricity distribution network was a major fiscal drain, but now it so profitable that it is one of the largest taxpayers in the country.

One can go on and on. And yes, as with the other transactions, the railways may very well be profitable. Other things equal, it may reduce the cost of transportation; there will be fewer workers whose severance will be paid for by the World Bank, fewer delays depending on the capital and technology infusions, ... But I don't know exactly how the cost structure will change. But I do expect for trade to continue its rapid rise, and with it the revenue stream of the railways.

The point is Armenia has tremendous potential and presents great opportunities for investors. However, things could be much brighter if it were not for the skill gap!

In any event, and again, many of the public enterprises should have been privatized in the early 1990s!