In August, Russian President Vladimir Putin flew to the Black Sea resort of Sochi, where his country spent a record $48 billion on the 2014 Winter Olympics. A regular visitor, with an official residence in town, Putin watched mixed martial-arts contests at Oblaka nightclub with Russian Prime Minister Dmitry Medvedev and Kazakh President Nursultan Nazarbayev.
After the first fight, the leaders suddenly were plunged into darkness for almost three minutes, giving them a taste of the blackouts that have plagued Sochi for years. Putin, poker faced when the power returned, strode into the ring to congratulate the fighters as the tournament concluded.
“Here in Russia, we have always valued and respected men who know how to stand firm to the last,” he said.
Putin is bracing for a fight of his own in the mad rush to the Feb. 7 opening ceremony. With concerns about terrorist attacks, lack of snow and anti-gay laws dominating headlines, Sochi has endured its share of pre-Olympics tension.
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Yet another, potentially longer-lasting battle is playing out behind the scenes — involving Putin’s government, some of Russia’s wealthiest industrialists and a state-owned bank. The government is demanding that the country’s biggest companies stand firm on commitments to bankroll the games.
To finance venues and apartments in the Caucasus Mountains and along Sochi’s seacoast, state-owned Vnesheconombank, known as VEB, lent $7.4 billion to a who’s who of Russia’s elite.
Among the biggest loan recipients are companies controlled by Vladimir Potanin, chief executive of the world’s largest nickel producer. Joining him are Oleg Deripaska, CEO of the No. 1 aluminum company; Alexey Miller, CEO of the state-controlled gas provider; and German Gref, CEO of Russia’s largest bank.
The moguls say skyrocketing costs and restrictions on commercial activities mean they risk losses on their investments unless the government helps. They want extended tax breaks and subsidies on the interest payments they owe VEB for Sochi assets.
Sochi 2014 might as well be renamed Putin 2014, says Scott Antel, a partner at DLA Piper in Moscow, who has worked on hotel projects in the region. Antel says Putin twisted billionaires’ arms to get the Olympics off the ground in return for letting their companies run their quasi-monopolies.
“This was a deal with the devil,” Antel says. “You will do your civic duty and build facilities in Sochi so we can have this coming-out party for the new Russian state. This is your indirect taxation to be allowed to continue with your main business activity.”
Deputy Prime Minister Dmitry Kozak, the country’s top Olympics official, dismisses suggestions of coercion. Kozak says investors got good deals — from favorable rates to government-built roads.
“All investors were invited to the project voluntarily,” Kozak says, sitting inside government headquarters. He says investors will have to forfeit Sochi projects if they can’t repay their loans.
“If they default, then they will lose their equity and lose their business,” Kozak says of companies building Olympic projects. “The shares will be sold at auction.”
The Winter Games have already proved a gamble for Putin.
Russia’s economic growth was set to slow to 1.5 percent in 2013 just as Sochi soaks up the single biggest infrastructure investment since the Soviet Union collapsed in 1991.
“It’s the single most important event for Putin’s presidency,” says Chris Weafer, a senior partner at Moscow-based consulting firm Macro Advisory. “If it is deemed to be a failure, there will be a focus on the cost.”
The reason Sochi’s price tag has quadrupled from Putin’s original $12 billion estimate depends on whom you ask. Boris Nemtsov, who ran unsuccessfully for mayor of Sochi in 2009, says as much as $30 billion has disappeared through corruption, a charge Kozak denies. Locals blame inflated prices for labor and materials. Others say the $48 billion figure is misleading because it covers infrastructure that will remain after the games.
Putin is brooking no failures in his Olympics obsession. Last February, he fired Akhmed Bilalov, vice president of the Russian Olympic Committee. Putin publicly criticized him for cost overruns and delays in the $245 million ski-jump complex, which was seven times over budget. The Russian Prosecutor General’s Office opened a criminal case in April, accusing Bilalov of misspending funds as head of state-owned OAO Northern Caucasus Resorts.
Putin has unleashed the unparalleled spending to try to transform Sochi, a fading resort city 1,000 miles south of Moscow with beaches and mountain views, into a year-round destination.
The spa region favored by Soviet leaders now has about 12,000 new hotel rooms. Near the Olympic Stadium, whitewashed apartment blocks dot the seaside. In the mountains, white-knuckle chairlifts have been replaced with modern equipment to lure Russian skiers from their beloved French resort of Courchevel.
Backers are betting nightclubs and malls will turn sleepy Caucasus villages into hot spots. The priciest project: Government-owned OAO Russian Railways built an $8.7 billion rail line and highway to provide a 30-minute link between ski sites around Krasnaya Polyana and Adler on the coast, both of which are part of Sochi’s sprawling Adler district.
If the hoped-for influx of post-Olympics tourists doesn’t materialize, Putin’s government may end up with heavily indebted ghost towns around Adler and Krasnaya Polyana.
“There’s massive infrastructure, and there’s no plan to attract business,” Macro Advisory’s Weafer says.
Basic Element, Deripaska’s holding company, has made one of the biggest private investments. It oversees Sochi projects worth $2.4 billion, using about $1 billion of loans from VEB.
Among them: a $778 million Olympic athletes’ village on the coast; a $186 million cargo port that could be turned into a yacht marina; and a $440 million overhaul of Sochi International Airport, with two VIP terminals, one being built just for Putin and the government.
Other projects are burdened with debt and scant cash flow after delays in turning them into commercial businesses. Basic Element in 2011 counted on preselling some of the 1,500 apartments it built in the coastal Olympic Village, where palm trees from Italy adorn courtyards with pools. The company plans to turn the complex into a resort called Sochnoe, marketing it as a Russian Cote d’Azur.
VEB wouldn’t allow apartments to be sold early, says Andrei Elinson, deputy CEO of Basic Element. Deripaska’s companies must start repaying the principal of a $687 million loan in 2014 and are trying to renegotiate, he says.
“The government has to forgive the interest payments for a certain amount of the loan lifetime,” Elinson says. “We’re also discussing the cancellation of property taxes.”
VEB is caught in the middle. After Putin’s government tapped the bank to lend billions to finance the Olympics and rescue companies amid the financial crisis, VEB’s capital adequacy ratio approached 10 percent in July, nearing the minimum allowed under the bank’s requirements. If investors default and VEB can’t quickly sell the assets to cover the loan, its capital could take a further hit.
“In the case of default, the Olympic projects will form a big hole in VEB’s balance sheet,” VEB Deputy Chairman Sergey Vasiliev says.
Kozak says investors must be prepared to repay. VEB charged just 0.4 percentage point above the Russian central bank rate, 8.25 percent, in November on most loans. Meanwhile, the government built electricity networks, roads and the train line.
Kozak dismisses the notion of tax breaks.
“We cannot give tax preferences to those we already supported and leave others on their own to face their debts,” he says.