Intensive municipal therapy

The tax revenues of cities are currently much lower than a year ago. Mayors are hoping that the volume of new development does not slump, making the economic situations of their towns and cities much worse. Which projects are going ahead and how will they be financed?

Emil Górecki, Gergo Racz and Nathan North

The history of Polish municipal authorities in their current form is not long and is in fact only eleven years old – that is, eleven budgets and two crises. The scale of the losses suffered by towns and cities in 2009 was unprecedented. The great majority of them have had to revise their investment plans and consider other sources of funding than tax revenue. Jarosław Kochaniak, the deputy mayor of Warsaw, claims that the city’s investment expenditure for 2009 was, despite the deterioration in the financial situation, higher than in 2008 and the trend will be maintained this year. “We are continuing to increase the pace of investment. Last year we spent over PLN 2.1 bln and this year the figure will be more than PLN 3.4 bln. The economic slowdown and the lowering of tax thresholds have reduced the stream of revenue for cities; this is why we have to use other funds. Our city has successfully issued bonds on the Polish and foreign exchanges and is receiving EU subsidies,” explains the deputy mayor of Warsaw. Maintaining the level of expenditure is a point of honour – and not only for the authorities of Warsaw. After all, municipal investments create additional workplaces and increase tax revenues.

Investments at the cost of debt

The situation of the Polish capital city is relatively good. Its bonds are estimated by rating agencies as having a similar value to Polish government bonds. Every other city is in a much worse situation. Radom has issued bonds worth PLN 160 mln and acquired loans from the European Investment Bank of EUR 200 mln in 2010. “The use of European funds in Masovia province is very low, so maintaining the level of investment must be paid for with increased debt. The ratio of debt vs. the budget currently amounts to 47 pct, which means that debt grew by 20 pct last year. Thanks to this none of our projects have been cancelled so far, even though there is a danger of that in the case of long-term enterprises,” says Igor Marszałkiewicz, deputy mayor of Radom, who is responsible for investment, infrastructure, architecture and structural projects. He goes on to add that the municipality’s annual expenditure will amount to PLN 250 mln in 2010 as well as in the two subsequent years.

The credit crunch has forced the city of Warsaw to postpone a few projects. The list of them includes the central ring road (an investment of PLN 800 mln), Trasa Tysiąclecia on the right bank of the Vistula river and the construction of Krasiński bridge (a PLN 500 mln project), the design of which is nearly ready. As Jarosław Kochaniak explains, the list of projects put on hold includes costly ones that have no chance of a support from EU funds, and those which involve high social costs, such as the need to demolish old residential blocks.

Lower costs, bigger competition

However, the capital city has taken advantage of the crisis, too. “We are very similar to private investors in that we are taking advantage of the increased competition between contractors. Their margins have been lowered and the costs of building materials and man-power have dropped, thanks to which we have received tender offers at prices lower than we had expected. For investors this represents a clear profit,” insists Jarosław Kochaniak. The deputy mayor of Radom does not share his enthusiasm. “I am afraid that the decline in margins is not so significant and offers are at the limit of cost-effectiveness, which results in increased risk and might mean the executed work is of a lower quality,” he warns. At the moment, three or four times as many companies are participating in municipal tenders compared to 2007. Igor Marszałkiewicz is happy about the fact that strong, international contracting companies have started to appear among these firms, since the second to tenth biggest cities in Poland have not previously been attractive enough to them.

Selling municipal properties has turned out to be a problem, as it was supposed to bring substantial revenue to the budgets of many cities. In Warsaw this revenue had a value of PLN 300 mln in 2007, PLN 78 mln a year later and only PLN 5.5 mln in 2009. Approximately 100 properties are planned to be sold this year. Seven tenders have already descended into fiasco, and yet the deputy mayor is claiming that there has been a visible growth in investor interest. He explains that the city has decided not to lower the prices of the offered plots significantly. “It is better to sell fewer of them and put them up for sale a little later with improved terms,” he adds. The slowdown in the sale of plots has also been felt by Radom. The city council there carried out 80 pct of its intended sales in 2009, even though this was not a big programme. “Prices are of course now much lower. However, the amount acquired from sales is less important for us than acquiring an investor,” says Igor Marszałkiewicz.

In hard times, apart from easily measurable factors such as the size of an investment, the completely immeasurable ones start to count – for example, trust. City authorities are among the most reliable payers, which additionally makes their position stronger.

A brave face, yet an uncertain outcome

Even though Kyiv city council does not want to admit this openly, the crisis has led to the scrapping of the Ukrainian capital’s many investment plans. Ukraine is at the forefront of the countries which have lost most as a result of the credit crunch. The council prefers looking on the bright side, though. “You should take into consideration that many experts still consider Kyiv to be one of the best places to attract investment. This is confirmed by a ranking of the 20 fastest developing countries in ‘FDI Magazine’, published by the Financial Times group,” according to a representative of the city’s economic and investment department.

The city has had to implement many changes in its annual social and economic development programme. The catastrophic situation in the construction sector has had the effect of lowering the investment budget. In 2009, the municipality, as the investor behind many projects and much renovation work, had less than half of the funds for this purpose than in 2008. The great majority of these funds will be spent on roads and council flats. The plans for 2010 also include the completion of the construction of a junction near Moscow Square, bringing a fast tramway line into use and finishing the construction of three new underground stations. A total of UAH 45 mln (USD 5.6 mln) is to be spent on road improvements, which is more or less the same as in 2009 and 2008. Representatives of the city council emphasize that Kyiv does not want to pull out of these planned projects; hence, a new system of tax exemptions and other incentives for investors from abroad has been introduced.

Bohemian, but responsible

In the Czech capital the main effect of the credit crunch upon the public procurement programme has also been on the city’s projected budget for 2009. In the boom years of 2005 to 2008, Prague enjoyed healthy budget surpluses; but this was followed last year by a CZK 5 bln (EUR 200 mln) shortfall on the projected tax revenue of CZK 53.38 bln.

In the event, last year the city authorities spent CZK 3.4 bln less than the planned total expenditure of CZK 56.14 bln. According to Jiří Wolf, Prague city hall’s spokesperson, this was achieved through a series of austerity measures implemented in response to the crisis, including “pushing back the deadlines” for certain projects, as well as cuts to the budgets of projects totalling CZK 0.9 bln. However, as Mr Wolf insists: “In compliance with the city’s long-term policy, this was not a case of reducing investment in projects of strategic importance.” A total of CZK 19 bln was allocated for investment projects in 2009, half of which Mr Wolf claims are “strategic investments” – and a similar sum is expected to be invested this year.

One example of such a project carried out by the city recently was the installation of flood prevention measures, to avoid a repeat of the devastation caused by the Vltava bursting its banks in 2002, The measures should lead to long-term savings in the event of future flooding, since according to Mr Wolf the floods “had destructive ramifications for all levels of infrastructure,” – and indeed caused billions of euros of damage to the city.

Light at the end of the tunnel

Among the most important projects currently taking place, Mr Wolf mentions the construction of a waste-water treatment plant as being a long term priority for the city, “but the most significant and costly long-term projects city-wide are those in transport infrastructure, in particular the expansion and new construction of metro lines and the completion of the city’s inner ring road,” he adds. The biggest single construction works taking place for the Prague ring road is on the Blanka complex of tunnels in the Letná area of the city, which has been underway since 2005. The costs for this section, which involves the construction of 5.5km of tunnels, have been estimated at CZK 25 bln.

Has Prague been able to benefit from the fall in construction costs due to the recession? In Mr Wolf’s view, any such benefit from cost reductions in the short-term are negligible, since public procurement requires long-term planning and analysis. “Certain short-term effects related to the external economic environment can be negligible, or they can entail a certain delay in terms of time.” In fact, he points out that the construction cost index actually increased last year by 1.4 pct y-o-y, and is now 13 pct higher than in 2005.

No changes the priority

In Budapest infrastructural developments have not been affected in any noticeable way by the crisis-driven changes in conditions. At the moment, the city has two major investments underway: the construction of the new M4 metro line and the refurbishment of the Margit bridge, one of the busiest Danube crossings, linking the Buda and Pest sides of the city. Although both schemes were originally scheduled for completion years ago, a multitude of business and political obstacles have prevented the M4 from progressing any sooner, while the Margit bridge project was also possibly delayed due to concerns over the inevitable traffic disruption that it could entail.

The first section of the metro project, that is currently app. 60 pct completed, is to cost an estimated HUF 366 bln (EUR 1.38 bln) – HUF 181 bln of which is to be covered by EU development grants. According to the existing plans, the M4 is to be built in three phases, eventually spanning 12.7 km.

But further delays are to be expected and not necessarily because of the economic pain inflicted on the city by the credit crunch. DBR, the project’s coordinator, is in financial dire straits and in all likelihood will be unable to pay Eurometro, one of its contractors carrying out engineering work on the project. Without this, the investment will not be allowed to continue. DBR came up with a solution that would involve it directly taking over the engineering to save money and continue the project uninterrupted. However, this strategy is surely unviable, since DBR would either be violating the regulations concerned with construction or would be in breach of contract, neither of which would be acceptable to the Hungarian public procurement arbitration committee, KDB. DBR has requested leniency, citing the advanced state of the project and the fact that the continuing difficulties could imperil the substantial EU development grants approved for it. The situation is currently unresolved and untangling the matter will almost certainly be a task for the next government, which will take office after general elections are held in April.

No matter if you’re left or right

The only major reason to believe that one way or another the M4 will eventually be built is that the investment is supported by both leading political parties. István Tarlós, the right wing candidate to become Budapest mayor in municipal elections in the autumn – and if the polls are to believed, the likely winner – has already stated that the 
M4 has to be completed considering the money already invested and the work put into the venture.

The ongoing reconstruction of the Margit bridge has been scheduled for completion sometime in 2011 and is estimated to cost HUF 27 bln (EUR 100 mln). The progress of this project is likewise assured by the availability of EU grants covering the financial side of it, even though it has sparked controversy at the local level, along with accusations of corruption.

It is still difficult to imagine how these and any other potential projects can move forward, given that the central government has imposed a substantial amount of cuts for 2010 in the budgets of local governments. Around one third of the total amount is to be borne by Budapest. Accordingly, the newly passed annual budget of the city projects a HUF 47 bln deficit for the whole for the year. The Hungarian capital is thus expected to spend nearly HUF 539 bln in 2010, with app. HUF 5 bln allocated for renovating playgrounds, parks and underground crossings.

In 2009, the city approved annual spending totalling HUF 532 bln, around 40 pct of which was then earmarked for financing developments. The year marked the closing of a window to start new development projects that could be categorized as major EU-backed ventures, and so the city council voted to take out HUF 33 bln in loans to cover the co-financing of the investments. For 2010, the city’s funding is to be reduced by HUF 15 bln to HUF 20 bln.

For the time being, the city council is expressing confidence that it has a viable budget planned for 2010 and that the centrally allocated sum, along with the approved EU development funding, will be sufficient to keep the projects going. The local political opposition, on the other hand, has criticized the budget, warning that Budapest will sink deeper into debt this year and will require another HUF 50 bln in loans to stay afloat. They claim that by 2013, the capital’s debts could reach HUF 240 bln, and combined with the arrears accumulated by city-owned companies, this burden could become unmanageable. ν