WeS It b POLICY RESEARCH WORKING PAPER 1868 Government Support For citizens to reap the fu benefits of private investment to Private Infrastructure in infrastructure, inFrastructure prices must be high cncuqgh Projects in Emerging to cover costs, and private M arkets investors mustassurre commercial risk. Good macroeconomic policv Mansoor Dailami matters because it, affects the Michael Klein credibility of a price reg,me and especially the trust in currency convertirwiity essential for foreign investors. The World Bank Economic Development Institute Regulatory Reform and Private Enterprise Division and Private Participation in Infrastructure Group January 1998 | POLICY RESEARCH WORKING PAPER 1868 Summary findings Driven by fiscal austerity and disenchantment with the When governments establish good policies - performance of state-provided infrastructure services, especially cost-covering prices and credible commitments many governments have turned to the private sector to to stick to them - investors are willing to invest without build, operate, finance, or own infrastructure in power, special government support. gas, water, transport, and telecommunications sectors. Privatizing assets without government guarantees or Private capital flows to developing countries are other financial support is possible, even where govern- increasing rapidly; 15 percent of infrastructure ments are politically unable to raise prices, because investment is now funded by private capital in emerging investors can achieve the returns they demand by markets. discounting the value of the assets they are purchasing. But relative to needs, such private investment is But this is not possible for new investments (greenfield progressing slowly. Governments are reluctant to raise projects). consumer prices to cost-covering levels, while investors, If prices have been set too low and the government is mindful of experience, fear that governments may renege not willing to raise them, it must give the investor on promises to maintain adequate prices over the long financial support, such as guarantees and other forms of haul. subsidy, to facilitate worthwhile projects that would not So investors ask for government support in the form of otherwise proceed. grants, preferential tax treatment, debt or equity But guarantees shift costs from consumers to contributions, or guarantees. These subsidies differ in taxpayers, who subsidize users of infrastructure services. how they allocate risk between private investors and Much of that subsidy is hidden, since the government government. Efficiency gains are greatest when private does not record the guarantee in its fiscal accounts. And parties assume the risks that they can manage better than taxpayers provide unremunerated credit insurance, as the the public sector. government borrows based on its ability to tax citizens if the project fails, not on the strength of the project itself. This paper - a joint product of the Regularoty Reform and Private Enterprise Division, Economic Development Institute, and the Private Participation in Infrastructure Group -was presented at the conference "Managing Government Exposure to Private Infrastructure Projects: Averting a New-Style Debt Crisis," held in Cartagena, Colombia, May 29-30, 1997. Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Mansoor Dailami, room G2-071, telephone 202-473-2130, fax 202-34-8350, Internet address mdailami@e?worldbank.org. January 1998. (29 pages) i The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the namnes of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Produced by the Policy Research Dissemination Center GOVERNMENT SUPPORT TO PRIVATE INFRASTRUCTURE PROJECTS IN EMERGING MARKETS Mansoor Dailami and Michael Klein The authors are Principal Financial Economist at the Economic Development Institute of the World Bank, and Chief Economist, Shell International (London), respectively. This paper was presented at the Conference "Managing Government Exposure to Private Infrastructure Projects: Averting a new-style debt crisis" Cartagena, Colombia, 29-30 May 1997. We would like to thank conference participants for comments and suggestions. We owe special thanks to Guillermo Perry, whose vision led us to the conference design and preparation of the paper; Timothy Irwin for editorial suggestions; Danny Leipziger and Mateen Thobani for insightful comments. We would also like to thank Anita Hellstern, Albert Amos, and Matthew Harvey for data compilation and building a unique infrastructure project database. I THE GROWTH OF PRIVATE INVESTMENT IN INFRASTRUCTURE Following the debt crisis of the early 1980s developing countries significantly restricted public borrowing. The combined public sector borrowing requirement of all developing economies shrank from 6 percent of GDP in 1982 to 1 percent in 1993 (figure 1). Figure 1 Public sector borrowing requirement (percent of GDP) Percent 0 -2 ---- -- -- - - -- -- -- -- -- - - -- -- -- ---- - -- - -- - - - - --- - -- -- ---- - -- - -- ----- - / - -- -- -- -- ------ - -3 \/ -6 . 7 . I l I 1980 1982 1984 1986 1988 1990 1992 Source: World Bank 1994. While public funding has been reduced, infrastructure investment requirements remain high. In 1994 the World Bank estimated them at $200 billion a year for developing countries. Since then other World Bank studies have increased these estimates. In East Asia and Latin America alone average annual investment requirements through 2005 have been estimated at $150 and $60 billion, respectively. Investment requirements tend to be dominated by the transport sector, followed by energy, telecommunications, and water. Required investments often reflect excess demand for services. That is, consumers would be willing to pay more for services, but prices are set at levels that are too low to attract suppliers. (Telecommunications may be an exception, as consumer prices exceed cost-covering levels in several countries, albeit sometimes because excise taxes are high.) Driven by fiscal constraints and growing disenchantment with the performance of state-provided infrastructure services, more and more governments have turned to private solutions for financing and providing telecommunications, energy, transport, and water services (World Bank 1994). The trendsetters were Chile, the United Kingdom, and New Zealand. Deregulation of many sectors-including telecommunications, airlines, independent power generation, natural gas production and transmission, and freight traffilc by road and rail-began even earlier in the 1 United States in the late 1970s. During the 1990s the dual trend toward private involvement in infrastructure and deregulation has caught on in almost all countries. Private markets are responding with vigor.' From 1990 to 1996 total net resource flows to developing countries rose from $101 to $285 billion a year (table 1). Private flows rose from $44 billion to $244 billion, while official development finance dropped from $56 to $41 billion. Cross-border flows dominate infrastructure finance, even in countries with very high national saving rates, partly because of the benefits investors gain from diversification but partly because of the underdevelopment of local capital markets in these countries. Table 1 Net long-term resource flows to developing countries Year 1990 1996 In billions In billions As Share of Total of dollars As Share of Total of dollars Total flows 100.6 100 284.6 100 Sources Official development finance 56.3 56 40.8 14 Private flows 44.4 44 243.8 86 Recipients Public sector 62.8 62 84.8 30 Private sector 37.8 38 199.7 70 Foreign direct investment (24.5) (24) (109.5) (38) Portfolio equity flows (3.2) (3) (45.7) (16) Nonguaranteed debt (10.1) (10) (44.5) (16) Bond (0.1) (0.1) (20.8) (7) Source: World Bank 1997a. Increasingly, private capital has funded private projects and firms rather than public expenditures. Between 1990 and 1996 public sector borrowing from private sources rose from $63 billion to only $85 billion, barely offsetting the drop in official development finance. In contrast, private capital (debt and equity) to private recipients rose from $38 billion to $200 billion. Total infrastructure financing raised by developing countries rose from less than $1 billion in 1988 to more than $27 billion in 1996. Finance for private infrastructure rose from virtually nothing in 1988 to more than $20 billion in 1996 (table 2). Although the data on infrastructure capital flows are not strictly comparable with the data on capital flows, cross-border private infrastructure finance appears to account for about 10 percent of all private-to-private cross- border capital flows. About half of cross-border flows are invested from local sources in private infrastructure projects, so that total private investment may currently account for about 15 percent of a total estimated investment requirement of $200 billion a year. 2 Table 2 Private cross-border financial flows to infrastructure (billions of U.S. dollars) 1988 1989 1990 1991 1992 1993 1994 1995 1996 Total 0.1 0.9 2.0 3.5 5.8 12.3 15.7 15.6 20.3 Loans 0.1 0.8 1.4 0.1 1.5 6.3 6.0 11.1 7.7 Bonds 0 0.2 0.5 0.7 1.1 3.9 5.8 3.3 7.2 Equity 0 0 0.1 2.6 3.1 2.1 3.9 1.3 5.4 Latin America and Caribbean 0 0.2 0.3 3.1 3.6 4.7 6.6 2.1 7.8 Loans 0 0 0 0.02 0.2 0.3 1.6 0.7 0.7 Bonds 0 0.2 0.3 0.6 1.0 3.3 3.7 1.4 4.4 Equity 0 0 0.1 2.5 2.4 1.1 1.3 0 2.8 East Asia and Pacific 0.1 0.8 1.5 0.4 2.0 5.7 6.8 8.8 9.3 Loans 0.1 0.8 1.3 0.05 1.2 4.6 3.4 6.1 4.9 Bonds 0 0 0.3 0.2 0.2 0.3 2.1 1.7 2.4 Equity 0 0 0.02 0.1 0.6 0.8 1.3 1.0 2.0 Source: World Bank 1997a Almost half of all private cross-border infrastructure finance appears to have been invested in East Asia, and more than a third was invested in Latin America (table 2 and figure 2). Power projects have attracted the highest share of investment, accounting for more than 40 percent of the total, followed by telecommunications and transport (figure 3). Figure 2 Cumulative private sector borrowing for infrastructure, 1986-95 so 40 30 . 20 _ 10 30. Sub-Saharan Afrca South Asia Latin America and the Caribbean 3 Figure 3 Sectoral composition of infrastructure financing in developing countries 198690 1991-95 Telecomriunications 4% Other infrastructure \33°/ l Source: EuromoneyLoanware and Bondware and World Bank Staffestirrates. Between 1990 and 1994 private infrastructure finance to developing countries grew at an annual average rate of 67 percent, reflecting the low base from which it started. Since 1994 growth has averaged 14 percent a year, well below the 19 percent growth rate of total private capital flows to developing countries (figure 4). (See also annex tables Al-A4). Figure 4 New private flows to infrastructure, 1990-96 200 180 160 140 120 100 80. 60 40 20 0 > n N C9 e In (Dl _ TotaInet flots oprivate projects - Totainet flovs toprivae infrastructure Source: World Bank 1997a 4 WHY INFRASTRUCTURE Is DIFFERENT To understand why private financing of infrastructure has not kept pace with overall financial flows to private entities it is necessary to recognize how infrastructure differs from other industries. First, infrastructure services are often considered essential by consumers, and they are frequently provided by monopolists. Together these factors increase political sensitivity to the prices charged. Pressure from consumers to keep prices low makes it politically difficult for governments to maintain prices that cover costs. Indeed, the World Bank (1994) estimated that user fees fell far short of costs in gas, electricity, and water. Second, infrastructure projects typically require large sunk investments that take ten to thirty years to recoup. Over such long periods of time investors are exposed to serious risks, in particular the risk that public authorities will not honor their agreements on tariff policy and payments to investors (Klein and Roger 1994). Once investors are committed to projects-and can pull out only by taking a huge loss-governments may be tempted to lower prices or not raise them as agreed. Investors thus risk being the victims of what has been called the "obsolescent bargain." These factors help explain the familiar privatization-nationalization cycle that has been observed repeatedly (figure 5). Private entrepreneurs may initially develop infrastructure-building the first electricity networks, for example.2 As these networks expand toward territories operated by other entrepreneurs, companies merge with or acquire their neighbors, creating larger, consolidated firms. These new firms are perceived as possessing significant monopoly power, and the services they provide-once considered luxuries-are now considered essential, creating pressure for monopoly regulation. Regulation, in turn, reduces prices and profitability, which discourages maintenance and new investment. In the face of declining quality and a slowdown in the industry's growth, the government nationalizes the firn. Low prices and inefficiency sap the finances of the state-owned firn, obliging the government to subsidize it. The very availability of subsidies, however, encourages more inefficiency. Eventually, concerns about fiscal subsidies and inefficiency create pressure for prices increases and privatization-and the cycle begins again. 5 Figure 5 The privatization-nationalization cycle 7 aeova veron o /a2pa fe nreases d srice cuts\ /3 \1 Regulabon ofeeand ser s franchises e s c nicienc investors are tpclyuDecline in cannot fullyproectinestrsgansttheeffrtofadtemindebility orofitability possiby of cuc l W bthdwawal a / adj t b e of ptakeover if acrpital a s Source: Gomez-sbanez and Meyer ( o 993). Because of the problem of sunk costs, and the historical experience of the "obsolescent bargain," investors are typically unwilling to make investments without adequate, frequently complex, contractual protection (Dasgupta and Sengupta 1993; Edlin and Reichelstein 1996). The negotiation of such contracts is time consuming and costly, however, and even the best contracts cannot p ully protect investheorm synicatedts of a deter ined goverkns ent. Enforceability of these contracts is essential, but it is difficult to achieve. Investors are condinually faced with the possibility of changing contractual agreements or failure by the govecnment to implement tariff adjustments because of political considerations. Even if arbitration and settlement of disputes in a third country are agreed oin radvance-such as in the case of the Enron-Dahbol power project in India-such procedures cap contimitonsuming and can add to the cost of the project. The heavy foreign financing of infrastructure creates additional risks. Most infrastructure projects in developing countries are financed with significant amnounts of foreign capital. A typical financing mix consists of 20-40 percent equity (provided by project promoters) and 60- 80 percent debt, in the form of syndicated commercial bank loans, bond issues, bridge and backup facilities, and multilateral and export credit agency loans and guarantees. Exposure to currency risk, which is a relatively minor concern for foreign investors in export-oriented manufacturing industries, is a critical feature of infrastructure project investment. Project revenues are often generated in local currencies, while servicing of foreign debt and equity involves payrnent in foreign currency. Fluctuations in the exchange rate of the domestic currency, as well as capital controls limiting currency convertibility and transferability, create risk for foreign investors and financiers. 6 While prospects for currency convertibility and transferability have improved in many developing countries with the liberalization of their capital accounts and the surge in foreign capital inflows, the scope for exchange rate hedging and risk management through the use of forward markets or derivatives remains limited. With the exception of Malaysia, Thailand, Brazil, and Mexico, where currency swap and forward markets have grown in the past two years, foreign exchange markets in developing countries suffer from a lack of instruments and liquidity. The case of the Argentine private natural gas transport company, COGASCO, illustrates several of these problems. COGASCO started operating in 1981, with a guarantee from the central bank that it would be able to convert into hard currency its peso revenues from gas deliveries to state- owned Gas del Estado. In 1982 Argentina's foreign exchange reserves were low because of the conflict with the United Kingdom, and the government would have had trouble honoring its convertibility guarantee. Gas del Estado then reviewed the contract with COGASCO and claimed breach of contract, complaining that COGASCO had found a more efficient way to run a liquid petroleum gas extraction plant than foreseen in the contract. The dispute meant that COGASCO was not paid, mooting the issue of currency convertibility. Because the investor's costs were sunk it had little leverage with the government and the government was unable to renege on its comrnmitment. The dispute lasted until the late 1980s, when COGASCO and its parent company went bankrupt and foreign investmnent in the gas sector ground to a halt. Because of this kind of risk, investors require high ex ante rates of return. In many cases real rates of return on equity exceed 20 percent (see annex table AS). This often results in prices that are higher than they were before privatization, when the real cost of capital was not taken into account. PROVIDING FINANCIAL SUPPORT TO ATTRACT PRIVATE INVESTORS To render projects attractive to investors despite these risks, governments have to raise user fees or provide special financial support to projects. Whichever route they choose, they need to provide credible assurances to investors that sensible binding obligations (the "rules of the game") will be honored. Governments use an array of mechanisms to provide financial support to private infrastructure projects (table 3).3 Some of these mechanisms, including preferential tax treatment, grants, and equity or subordinated debt contributions for which governments do not expect commercial returns, directly enhance project cash flow. In contrast, guarantees are targeted at particular risks, such as the risk that a state-owned party will renege on an obligation. 7 Table 3 Types of sovereign or supranational support for private infrastructure projects Multilateral Government Informal Multilateral Government Government Multilateral Government Preferential Banks and Guarantees Agreementsa Banks and Equity Debt (Senior Equity Grants Tax Export Credit Export Participation and Sub- Participation Treatment Agency Debt Credit ordinated) Agency Guarantees Country Honduras: India Mexico: Mexico Peru: Malaysia Pakistan: Philippines: Brazil Linha Chile: 450- and Electricidad de Dabbol 695- City Toluca Toll Aguaytia Kuala Lumpur Rousch 412- Pagbilao 735- Amerala MW Empresa Project Cortes S. De MW power Road 145-MW Sepang Airport MW power MW power (10-yr., 15 Electica R.L de C.V plant; gas-fired plant CCPP plant, coal fired, kIn, 6-lane Pangue (Elcosa 1 60- combined power plant residual fuel 25-year PPA road) MW oil fired cycle; oil; 30-year with National power plant; imported PPA with Power Corp. 15-yrs. PPA liquefied Water and natural gas Power (LPGYoiI Development distillate; 20 Authority year PPA vwith Maharashtra State Electricity Board; tariff 2.4 ($S126) per rupees KWh Project cost $70 million $922 million $313 million $235 million $3,924 million $507 million $933 million $174 million $465 million Date 1994 1995 February 1992 October 1996 1993 1996 1993 June 1996 1993 financial closure Example by IFC: $10.5 m 12-year Concession OPIC: $60 $390 m in $40 m standby IFC: $60 m $112 million $10 million in mechanism senior debt counter- guarantees m political equity loan by ADB: S40 m grant from the deferred tax (LIBOR + 375 guarantee traffic volumes risk provided by National CDC: $35 m Rio de Janeiro duties bps, 12-yr. from the by vehicle guarantee the Development municipal maturity) goverunent category, if government of Finance Corp. government of India for traffic volumes Malaysia (NDFC) FMO: (Dutch) tariff- fell short of $140 m sub- $10 m senior payments by amounts ordinated debt debt (LIBOR + the specified in channeled to 375 bps, 12-yr. Maharashtra contract, the Pakistan maturity) State Concessionaire Fund from the Electricity entitled to World Bank IFC B: SlOm Board; and request an ($70 m) and loan, 8-yr. termination extension of the JEXIM maturity guarantee concession term ($70 m) (capped at to permit IFC: $3.5m $300 m) recovery of its subordinated investments. debt FMO: (Dutch) $1.0m subordinated debt a. Informal agreements include comfort letters, side agreements, nonbinding tariff increases, and other similar agreements. The govermment's obligations to provide support can be defined in laws, decrees, statutes, licenses, concessions, contracts or other legally binding documents. Most countries have also signed some of the more than 1,200 bilateral investment treaties that define investor rights. Investors and their counterparties normally agree on suitable methods for dispute resolution. If local courts are not credible, the parties can agree to international arbitration. Most countries 8 have agreed to international conventions, which establish appropriate arbitration mechanisms and render arbitral awards enforceable. In some cases counterparties may lack the cash flow with which to pay investors. Investors thus often seek additional assurances that any compensation due them under the terms of their contract will actually be paid. For example, the central governments may be asked to provide assurances that a publicly owned electric utility will honor its contracts with the private generating plants from which it buys power. Investors may also seek guarantees that their local currency earnings will be convertible and transferable out of the country. In sum, infrastructure investors require special assurances that money due to them will be paid when due, in the currency they require. In this sense, all forms of government support ultimately amount to cash flow support to a project and have a significant fiscal impact. Support through Government Guarantees Governments often provide financial support by means of guarantees (box 2.1 and table 2.4). Central governments often guarantee the performance of subsovereign entities, including public enterprises and provincial or municipal governments.4 Box 1 Government guarantees in OECD countries Governments throughout the world provide guarantees to private investors in a variety of activities Prominent among such guarantees are deposit insurance for bank depositors and pension or social security insurance. Guarantees for housing, agriculture, students, exports, and public corporations dominate the picture in OECD countries; little is known about the make-up of guarantee exposure in developing countries. Even in OECD countries information on guarantee exposure is sketchy. Data suggest that total guarantee exposure may amount to 15-20 percent of GDP, or more than a quarter of gross debt. This does not, of course, capture implicit guarantees, under which govermnent may feel obliged to bail out failing firms or banks or help uninsured citizens in need (in the wake of natural disasters, for example). Guarantee programs can provide valuable support for private economic activity. But they can be costly: in recent years several industrial countries have suffered large losses under some of their guarantee programs, including deposit insurance and export credits. During the 1980s OECD export credit agencies incurred losses equivalent to about 20 percent of new business, while collecting premiums of only 3 percent. Most of the export credit losses were on medium- and longer-term credit. This experience prompted a change in guarantee management procedures. The United States has instituted more transparent accounting principles for its guarantee operations under the 1991 Credit Refonn Act. The experience of export guarantee schemes is relevant for governments considering guaranteeing long-term infiastructure investment, as risks are similar (medium- to long-term country risk), although the risk in infrastructure investment may be higher because of the risk of regulatory failure or creeping expropriation for firms with immobile investments, such as power plants. 9 Table 4 Types of government guarantees in private infrastructure projects Type of guarantee Projects Contractual obligations of government entities * Guarantee of off-take in power projects Birecik Hydro Power Plant, Turkey Electricidad de Cores, Hungary Paguthan & Dabhol Power Plants, India Mt. Aop Geothermal Plant, Philippines * Guarantee of fuel supply in power projects Termopaipa Power Plant, Colombia Lal Pir Power, Pakistan Policy/political risk * Guarantee of currency convertibility and Lal Pir Power, Pakistan transferability * Guarantee in case of changes of law or regulatory Rousch Power, Pakistan regime Izmit Su Water Treatment Plant and Pipeline, Turkey Financial market disruption/fluctuations * Guarantee of interest rate North-South Expressway, Malaysia * Guarantee of exchange rate North-South Expressway, Malaysia • Debt guarantee Toll roads, Mexico Termopaipa Power Plant, Colombia Market risk * Guarantee of tariff rate/sales risk guarantee Don Muang Tollway, Thailand Western Harbour Tunnel, Hong Kong Buga-Tulua Highway, Colombia Toll roads, Mexico * Revenue guarantee South access to Concepci6n, Chile M5 Motorway, Hungary 10 Through central government guarantees, project risks, such as the ability of a public utility to pay its private suppliers, can be transformed into countries risk. Countries can reduce their exposure by replacing full credit guarantees with more narrowly defined guarantees such as power purchase agreements. Such unbundling of risks presumes that the parties can be trusted to honor their commitments; if they cannot be trusted, investors will prefer full guarantees. This helps explain why countries with low credit ratings rely heavily on full financing by export credit agencies or multilaterals, whereas countries with higher credit ratings offer guarantees for specific risks (see table 2.5). Support by multilaterals and export credit agencies appears to substitute for an international contract enforcement mechanism. Table S Patterns of sovereign or supranational support for private infrastructure projects Number Pattern Multilateral Banks and Export Credit Agency 37 Greater incidence of debt assistance by multilateral Debt banks and ECAs in non-investment grade emerging markets (27). Government Guarantees 28 Nearly three times as many goverment guarantees in non-investment-grade countries (24) than in investment-grade countries (9). Informal Agreements' 28 Although 9 agreements were issued in Mexico, use of infonnal agreements is more common in investment grade countries (11). Multilateral Banks and Export Credit Agency 26 Slightly more examples among non- investment- Guarantees grade emerging markets (15) than in investment- grade countries (11). Govemment Equity Participation 18 Greater incidence of government equity participation in investment-grade countries (I1). Govemment Debt (Senior and Sub-ordinated) 14 Equal split among noninvestment- and investment- grade countries. Multilateral Equity Participation 13 Much greater incidence of equity share-holding by multilateral barnks arid ECAs in non-investment- grade emerging markets (I1). Govemment Grants 12 Greater incidence of govemnment participation through grants in non- investnent grade countries (8). Preferential Tax Treatment 2 Limited use of preferential tax treatment in investment grade countries. Note: Financing packages of 78 projects (39 power, 26 transport, 7 water/waste, 4 telecommunications, and 2 gas) were disaggregated and then tabulated by type of mechanism and source of funds. All 78 projects has direct participation by the private sector through the provision of debt, equity, or both. a: Informal agreements include comfort letters, side agreements, nonbinding tariff increases, and other similar agreements. Valuing and Charging for Government Guarantees Guarantees provide (contingent) cash flow support to projects and are, in many respects, similar to loans or grants. To be able to compare all forms of assistance, it is useful to calculate the subsidy implicit in each form of support. These "subsidy equivalents" help determine, for example, whether it is cheaper for the government to provide a guarantee or some other form of support. (For more on the role of guarantees in infrastructure finance see Dailami 1997.) 11 The fact that government guarantees can be valued and may be expensive to government does not imply that governments should charge investors for the guarantees. When government guarantees merely substitute for low prices, charging the full cost of the guarantee would defeat the purpose of the guarantee. When the guarantor can manage or bear the risk better than the investor, however, the value to the guaranteed party is higher than the cost to guarantor, and the investor may be willing to pay part or all of the cost for a guarantee. Some commercial risks are insured by private insurance companies for this reason. Governments, however, should not be insuring commercial- risks, even on a fee basis. To the extent that private insurers are willing to provide cover for political risk, they need to charge for the value of a guarantee. Governments, however, would be extracting rents from good policy by charging for such guarantees: charging for political risk guarantees would be akin to demanding protection money. Governments should instead ensure that the benefits to investors of such guarantees are passed on to consumers-by awarding projects competitively, for example. Complications Arising from the Risk of Sovereign Default Sometimes the government's power of taxation enables it to honor any obligations it has entered into to provide support to a private infrastructure project. Official export credit and mortgage insurance schemes in the United States are examples. In some developing countries, however, the risk of sovereign default is real, and its implications must be considered in structuring government support to private infrastructure companies. The key task is to evaluate infrastructure projects financially within the country risk environment prevailing in developing countries (see Dailami and Leipziger 1997). When there is a risk of default, one or more creditors or investors may lose all or part of their investment. By obtaining government guarantees an investor or creditor obtains a position near the front of the queue for repayment and secures access to sources of compensation not related to the project, generally taxation. By obtaining a supporting guarantee from an institution such as the World Bank, a private investor can buy a place right at the front of the queue, benefiting from the preferred creditor status of the World Bank. It is not clear, however, whether such guarantees simply improve some investors' positions relative to others' or whether it contributes to a better overall outcome (see Dooley 1997). The key issue is whether and how the structure of government liabilities may affect the outcome of government liability renegotiations. Even if renegotiation of government liabilities over extended periods of time preserves the net present value of creditor or investor claims, there may be real economic losses, since assets funded by investors may not be used as efficiently as they would otherwise have been during the often acrimonious work-out process. For example, a water concession may not be maintained as well during a dispute as otherwise. 12 Different creditors or investors hold different types of claims. They thus have varying interests to negotiate. Some "tough" investors may hold up renegotiation, thus imposing real losses (due to the less efficient use of assets during the renegotiation), for which the tough investor does not pay. When a government issues guarantees to an infrastructure investor it tends to create yet another type of claim. In particular, the guarantee may be issued to an investor who has some physical control over the assets. This gives the guarantee holder bargaining power that differs from that of a holder of sovereign debt, for example. To some extent that may be justified for the same reason that trade credit gets treated preferentially during debt renegotiations so as not to disrupt basic economic activity with adverse consequences for all. To achieve a solid and reasonably speedy settlement in order to minimize economic disruption resulting from inefficient asset use, a mechanism needs to be in place that allows creditors and investors to resolve their differences quickly. This is achieved more easily if the claims held by different investors are similar and the government has the flexibility to come up with various ways of settling its obligations. When a country properly accounts for its contingent liabilities and reserves for them fiscally, they appear more like normal debt. In fact, it may be preferable for the government to support projects by providing debt finance rather than guarantees. If so, it could be argued that, to provide governments with the right incentives to do so, exposure under government guarantees should be valued like debt and not be reduced by adjusting for probability of default. In a sense such an ultra conservative policy is equivalent to debt management policies in various advanced OECD countries. Germany, for example, actually values certain guarantees the same way as debt with the same maximum exposure. Beyond making claims more similar to each other, can a commitment mechanism be chosen to facilitate speedy claims resolution? The COGASCO example, mentioned earlier, illustrates that project-based renegotiation can last as long as sovereign debt settlement, with deleterious consequences for investment in a particular sector. It may therefore be useful to involve multilateral creditors, because their interests and actions may be most closely aligned and they may thus help advance resolution most speedily. It is thus by no means clear that finely tuned risk allocation is always the right approach. Blunter instruments, such as straight sovereign debt, may at times be preferable. The argument for seeking participation by multilaterals may have little to do with the nature of the risk management or product they provide and more with the role they are likely to play in debt renegotiation. REFORMING POLICY TO ATTRACT INVESTORS Although guarantees can provide some comfort to investors, a country's interests are better served by thorough-going policy reform. The best way of attracting private investment is by establishing stable macroeconomic policies, adequate tariff regimes, a track record of honoring 13 commitments, and reasonable economic policymaking. In many OECD countries and other industrial economies, such as Singapore, investors may not require guarantees or other government support, and they may be willing to accept "change of law" risk, which may affect tax rates or other project cost or revenue parameters. In many emerging markets, however-including relatively advanced economies, such as Chile- investors may not find the right policies in place, or they may doubt the government's ability to sustain such policies over long periods of time. Governments still have a variety of options for reducing the need for special project support. Projects are subject to country- and project-specific risks. Risks related to a country's overall health tend to be of prime importance. Risks such as currency and interest-rate risks reflect macroeconomic volatility and the risk that the government will not honor its obligations (country risk proper). That governments with stable macroeconomic policies can attract private infrastructure investors more easily is reflected in the sovereign debt ratings given by various rating agencies and services (see annex table A5). As country ratings improve, governents are able to attract more and more project finance (table 6) (although project finance accounts for only a small percentage of GDP in the most creditworthy countries, where corporate finance is used to finance deals).5 Table 6 Credit ratings, deals per capita, and deals as a percent of GDP, by country, 1996 Country Rating Deals per capita Country Rating Deals as a percentage ($/population) of GDP Qatar BBB 8,564 Hong Kong A 13.5 Hong Kong A 3,229 Indonesia BBB 7.1 Australia AA 705 Thailand A 5.7 Greece BBB- 282 Chile A- 4.9 Chile A- 234 Pakistan B+ 4.5 United Kingdom AAA 227 Malaysia A+ 4.2 Saudi Arabia NR 214 Australia AA 3.7 United States AAA 185 Greece BBB- 3.2 Malaysia A+ 178 Saudi Arabia NR 3.1 Thailand A 159 Turkey B 2.4 Canada AA+ 151 India BB+ 2.1 Argentina BB 99 Argentina BB 1.2 Italy AA 78 China BBB 1.2 Germany AAA 76 United Kingdom AAA 1.2 Indonesia BBB 73 Brazil BB- 0.8 Turkey B 63 Canada AA+ 0.8 Brazil BB- 37 United States AAA 0.7 Pakistan B+ 21 Italy AA 0.4 India BB+ 7 Germany AAA 0.3 China BBB 7 Qatar BBB NA Note: Population and GDP data are for 1995. Source: Euromoney; World Bank 1997b; World Bank staff estimates. 14 Problems with Financial Support without Policy Reform The jury is still out on the consequences of government guarantees and other forms of financial support: although they may have increased the volume of investment, they may not have solved the underlying problems. Several examples illustrate the types of problem that can remain when projects go ahead, with various forms of governments support, in the absence of serious policy problems. The Mexican toll road program generated several billion dollars of non-performing assets in the domestic banking system. No explicit guarantees had been issued to creditors, but local banks expected the government to bail them out once the toll roads ran into financial difficulties. The government was forced to come to the banks' aid at the worst possible time-during the currency crisis of 1994/95. The failure of private toll roads has caused problems in other countries as well. In Thailand the Bangkok expressway required government rescue after the authorities declined to raise tolls in line with earlier agreements. In Spain the government was obliged to pay out $2.7 billion when exchange rate guarantees were called during the 1970s and 1980s. Other types of projects have also been affected. Malaysia's power company, TENAGA, contracted with private generators (backed by a government guarantee) to supply more power, but consumer tariffs were left unchanged. As a result TENAGA was not able to carry the full cost of private generation forward and was squeezed financially, forcing it to negledt maintenance and investment. Power cuts throughout the country followed-exactly the outcome the new generation capacity was intended to prevent. In Mexico a water concession in Aguascalientes was concluded in 1993. To guard against currency risk, variable-rate debt financing was obtained in the local markets. Water prices were thus not indexed to exchange rate movements but (partially) to changes in interest rates on domestic debt and inflation. Following the foreign currency devaluation in 1994/95 inflation and domestic interest rates rose, which should have caused large nominal tariff increases. A political decision was made, however, not to raise tariffs as foreseen in the concession contract. Instead the government took on the financing of new investment that the concessionaire was supposed to have made. These cases have some key features in common. First, problems were resolved by negotiation, as they usually are in cases of government-related risks. In contrast, disputes over technical or commercial risks are often resolved in court. Second, the government generally ended up bearing a substantial part of the costs-costs that could have been avoided if the government had allowed consumer prices to cover full project costs. These examples reveal how the basic forces that drive infrastructure privatization assert themselves. Private investors do not-and should not-pay for projects; they can only finance them. Either consumers or taxpayers have to pay for projects in the end. If the government 15 cannot raise money from taxpayers, consumer prices must be adequate. Therefore, when privatization is motivated by fiscal constraints, user fees must be raised to cost-covering levels. Projects that cannot be funded by user fees should not, in the absence of important positive externalities, be built. Government support could lower overall project cost only if the government had a lower cost of capital than private parties. Although government borrowing costs are often ostensibly lower than private borrowing costs, governments borrow at lower rates not because they tend to operate lower risk projects but because taxpayers stand behind them, providing unremunerated credit insurance. If taxpayers were remunerated for their exposure, the ostensible advantage of government finance would presumably disappear. If not, governments should finance everything, including large corporations-a return to GOSPLAN, which appears nonsensical (Klein 1996). Government support to private projects compensates private investors for the risks they are unwilling to bear given the prices they receive. Investors may be attracted to infrastructure projects without guarantees if the expected returns are high enough (that is, when rates charged to consumers are high enough).6 In that sense the search for guarantees or other forms of government support is a search for suckers who can be made to pay what others are not willing to pay. Guarantees themselves do not appear to affect the cost of capital, which is determined by the risks of the project, not the financing structure. As recent review of the effect of World Bank partial credit guarantees (Huizinga 1997) suggests, the existence of guarantees did not reduce nonguaranteed interest rates, and the duration of nonguaranteed debt remained relatively short. Privatization of Existing Assets Recent transactions have shown that even countries with subinvestment grade ratings can attract sizable private investment without special government guarantees if sound sector policies are made credible. Privatizing existing assets reduces the role of government and with it fears of noncommercial interference. In Argentina, Peru, and Bolivia, for example, where certain sectors, such as electricity, were privatized, private investment has been made without government guarantees. Privatization also allows investors to earn high rates of return without raising consumer tariffs, since investors discount the sale value of assets to the point at which existing tariffs generate the required rate of return, rather than by raising tariffs, as they would have to do in greenfield projects. In fact, tariffs can actually fall after privatizations, as they did in the Buenos Aires water concession, in which the assets of the system were given to the private investor free of charge.7 Privatization has also attracted more equity investors than have new investment projects. Since equity markets are easier to develop than long-term debt markets in most developing countries, privatizations have been able to rely more on local currency financing than have greenfield investment projects. The typical new investment project requires about two-thirds foreign 16 finance, whereas the typical privatization has attracted two-thirds of its finance from local markets (International Finance Corporation 1996). Many privatizations have occurred in subinvestment grade countries (that is, in countries with credit ratings of less than BBB-), including Argentina, Peru and Bolivia. Privatization has allowed these countries to attract investment despite their unstable macroeconomic environments, allowing them to make the most of existing assets rather than to add new investments. Greenfield Projects Government guarantees and financial support are more difficult to avoid for new investments, for which prices must be raised. Well-structured project finance for greenfield projects may allow governments to avoid guarantees or other forms of support, however. Under project finance investors look to cash flow generated by the project to amortize debt and to pay interest payments and dividends.8 Project finance can help investors structure a project so that different risks can be separated and allocated to the parties most willing to bear them. An example is the Mamonal power project in Colombia, where a foreign power generator sells electricity directly to private firms at cost-covering prices. This project structure has allowed the project company to set high user fees and rely on payment discipline by creditworthy corporate customers rather than on government guarantees. Several countries are trying to reduce reliance on sovereign support for new infrastructure projects. Most of the countries that have been successful in doing so have had investment-grade ratings. Indonesia attracted investors by issuing comfort letters on foreign exchange convertibility in its PAITON power project. China and India have declared that they are unwilling to issue sovereign guarantees for private infrastructure projects. In China, an investment-grade country, investors have been willing to accept guarantees from provincial governments in place of the national government. In India, a subinvestment-grade country, the verdict is still out, but it appears that projects going ahead require heavy backing from state- owned financial institutions. Colombia, an investment-grade country, has been able to move away from sovereign guarantees in projects in which ECOPETROL, the state-owned oil company, is backing payment obligations (Centragas and Transgas). Several Colombian entities have recently issued investment-grade paper (for the El Dorado airport expansion and the city of Bogota). Petropower, a Chilean co- generation project, was able to issue bonds in the U.S. capital markets without the help of the government or supranational agencies. Although Argentina is not an investment-grade country, Transportadora de Gas del Norte in Argentina was able to issue investment-grade paper with the help of IFC participation (other innovative capital market issues are described in annex table A6). 17 Rethinking the Problem of Future Investment Requirements The "financing gap" may in fact be a "policy gap"-what is needed is not so much the mobilization of new financial resources on a vast scale but a thorough-going reform of policy. Raising consumer prices to cost-covering levels would generate some $123 billion a year, allowing infrastructure companies to fund most of the $200 billion a year needed for infrastructure from internal cash generation, leaving only $77 billion to be funded in the financial markets (World Bank 1994). In addition, private participation could create efficiency gains of $55 billion a year, reducing financing requirements to $22 billion (figure 6). Moreover, the increase in tariffs to consumers should reduce demand and therefore investment requirements. To be politically able to raise consumer prices and to obtain the benefits of greater efficiency, governments should proceed with privatization. If they choose to go this route, however, the long-run financing problems will be minimal-financing requirements from sources other than internal cash generation may not be much larger than the existing level of private capital flows. 18 Figure 6 Estimated cost of mispricing and technical inefficiency Billions of U.S. dollars 250 Investment 200 Fiscal 150 burden _ 123 c W X loo | - l Resource loss Subsidies incurred Costs incurred from Annual infrastructure from mispricing technical inefficiency investment * Water * Roads * Development finance [] Railways * Power E All other sources a. Costs for the water sector are due to leakages; for wailways--fuel inefficiency, overstaffing, and locomotive unavailability, for roads-- added investment caused by poor maintenance; for power--transmission, distribution, and generation losses Source: Ingram and Fay, background paper; Appendix table A.4. The shift to private infrastructure finance reduces the financing requirements of the country as a whole only if private investors generate efficiency gains (that is, they provide the same level of service at lower cost). For efficiency gains to materialize the private sector needs to bear risks it can manage better than the public sector. As long as financial structures are found thdt shift some of those risks away from the government-even if limited guarantees remain-benefits cah be obtained from privatization. The fact that privatization reduces the likelihood of noncommercial interference by government can be the source of major efficiency gains (Gahlal Tandon, and Vogelsang 1994). Managing Guarantee Exposure during the Transition In the long run, governments can attract private investment in infrastructure without providing guarantees if they have good policies in place. The most difficult challenges arise duritig the transition from publicly to privately funded infrastructure, when guarantees are most common. Even during the transition, however, government guarantees risk simply postponing the day bf reckoning. Assuming that private investors cannot consistently be duped into investiing iti unsustainable projects, providing guarantees imposes costs on taxpayers in the future. For this reason alone governments should develop ways of quantifying all their exposures to private infrastructure projects and reserving for them fiscally. Two governments in the developing world-the Philippines and Colombia-are trying to develop ways to manage their guarantee exposure. Both countries are establishing ways of valuing their exposure and creating fiscal reserves against it. Managing guarantees correctly will demonstrate the fiscal cost of not implementing good policies and help garner support for more lasting reform. Governments must also recognize their exposure from implicit guarantees. Ways must be found to manage implicit guarantees by letting investors (at least equity investors) go under in case of failure. Mechanisms must be established that allow new investors to take the place of old ones to ensure service continuity to consumers. If this cannot be done, implicit guarantees should be treated like explicit ones, and reserves should be budgeted to cover these contingent liabilities. CONCLUSION Governments can attract private investment in infrastructure in two ways. They can offer financial support to investors-in the form of grants, cheap loans, or guarantees-in order to compensate them for low tariffs, unstable macroeconomic conditions, poor performance by state- owned enterprises, and other problems. Or they can address the policy problems that underlie investors' concerns by raising prices to cost-covering levels, ensuring macroeconomic stability, and establishing a sound regulatory framework. Both methods can attract investors, but the provision of government support tends not to reduce overall costs. Instead, it allocates costs to taxpayers, who have no choice but to accept them. The costs of providing guarantees may be deferred, but they are real-as the examples of the Mexican and Spanish toll roads show so vividly. In contrast, policy reforms such as price increases and the establishment of credible regulatory frameworks improve project fundamentals, making them attractive to investors without imposing extra costs on captive taxpayers. 20 REFERENCES Chen, A.H., J.W. Kensinger, and J.D. Martin. 1989. "Project Financing as a Means of Preserving Financial Flexibility." Working Paper. Austin, Texas: University of Texas. Dailami, M. 1992. "Optimal Corporate Investment in Imperfect Capital Markets: The Case of Korea." In S. Ghon Rhee and R.P. Change, eds. Pacific-Basin Capital Market Research. Amsterdam: North-Holland. Dailami, M. 1997. "Infrastructure Project Financiability: The Role of Government Guarantees." Unpublished World Bank discussion paper. Dailami, M., and D. Leipziger. 1997. "Infrastructure Project Finance and Capital Flows: A New Perspective." Paper presented at the Development Economic Study Group Conference, Birmingham, England, September 7-8, 1997. Dasgupta, S., and K. Sengupta. 1993. "Sunk Investment, Bargaining, and Choice of Capital Structure." International Economic Review. February: 203-220. Dooley, M.P. 1997. "Governments' Debt and Asset Management and Financial Crisis: Sellers Beware." Edlin, A., and S. Reichelstein. 1996. "Holdups, Standard Breach Remedies, and Optimal Investment." American Economic Review 3: 478-501. Galal, A., L. Jones, P. Tandon, and I. Vogelsang. 1994. Welfare Consequences of Selling Public Enterprises: An Empirical Analysis. Washington, D. C.: World Bank. G6mez-Ibafiez, Jose A., and John R. Meyer. 1993. Going Private: The International Experience with Transport Privatization. Washington, D.C.: Brookings Institution. Haberer, L. 1996. Global Project Finance. New York: Standard & Poor's. Huizinga, H. 1997. "Are There Synergies Between World Bank Partial Credit Guarantees and Private Lending?" Policy Research Working Paper 1802. World Bank, Department Research Group, Washington, D.C. Ingram, Gregory, and Marianne Fay. 1994. "Valuing Infrastructure Stocks and Gains from Improved Performance." Background paper prepared for the World Bank's World Development Report 1994. Inter-American Development Bank. 1995. Directory of Innovative Financing. Washington, D.C.: Inter-American Development Bank. 21 Intpmrtional Finance Corporation. 1996. Financing Private Infrastructure. Washington, D.C.: World Bank and International Finance Corporation. Kensiigcr, J.W., and J.D. Martin. 1988. "Project Finance: Raising Money the Old-Fashioned Way." Journal of Applied Corporate Finance 3: 69-81. K1ein, Michael. 1996. "Risk, Taxpayers, and Role of Govemment in Project Finance." Policy Research Working Paper 1688. World Bank, Washington, D.C. Kle6, M., and N, Roger. 1994. "Back to the Future: The Potential in Infrastructure Privatization." Finance and the International Economy: 8. Ncvitt, P.K., and F. Fabozzi. 1995. Project Financing. Sixth Edition. London: Euromoney Publications. Project Finance International. 1997. "PFI League Tables 1996-PF Business Nears US$50 bn." Project Finance International, 113, 29 January 1997. SayeT, R ed. 1997. Project and Trade Finance. Vives, A. 1997 Infrastructure Finance Directory. Washington, D.C.: Inter-American Development Eank. World Banlk. 1994. World Development Report. Washington, D. C.: Oxford University Press. Wor1l Bank. 1997a. Global Development Finance 1997. Washington, D. C.: World Bank. 'World Bank. 1997b. World Development Indicators 1997. Washington, D.C.: World Bank. 22 Table Al Signed project finance deals, by country, 1996 Standard & Poor's Value of Value of signed Value of long-term, foreign Number signed project finance signed currency of signed project deals, by project sovereign project finance population finance deals debt rating finance deals ($ million/ per GDP as a percent Country (March 11, 1997) deals ($ millions) capita) ($ millions) of GDP United States AAA 103 48,669 185.0 6,952,020 0.70 Hong Kong A 36 19,376 3,229.3 143,669 13.49 Indonesia BBB 72 14,145 73.0 198,079 7.14 United AAA 41 13,227 227.0 1,105,822 1.20 Kingdom Australia AA 44 12,731 705.3 348,782 3.65 Thailand A 31 9,432 158.8 167,056 5.65 China BBB 64 8,383 6.9 697,647 1.20 India BB+ 28 6,911 7.4 324,082 2.13 Gennany AAA 9 6,236 76.4 2,415,764 0.26 Brazil BB- 23 5,796 37.2 688,085 0.84 Qatar BBB 3 4,710 8,563.6 ---- Canada AA+ 23 4,469 150.9 568,928 0.79 Italy AA 6 4,443 77.7 1,086,932 0.41 Turkey B 14 3,890 63.1 164,789 2.36 Saudi Arabia NR 6 3,833 214.4 125,501 3.05 Malaysia A+ 13 3,575 177.5 85,311 4.19 Argentina BB 19 3,447 99.1 281,060 1.23 Chile A- 15 3,321 233.9 67,297 4.93 Greece BBB- 2 2,951 282.1 90,550 3.26 Pakistan B+ 13 2,738 21.1 60,649 4.51 Note: Population and GDP data are for 1995. Source. Project Trade and Finance Database; World Bank 1997b; Standard & Poor's; World Bank staff estimates. 23 Table A2 Top ten emerging markets for project finance deals, 1996 Country Number of projects Total project value ($ millions) Indonesia 72 14,145 Thailand 31 9,432 China 64 8,383 India 28 6,911 Brazil 23 5,796 Turkey 14 3,890 Malaysia 13 3,575 Argentina 19 3,447 Chile 15 3,231 Pakistan 13 2,738 Source: Project & Trade Finance March 1997. Table A3 Top ten emerging markets, 1995-1996 1995 1996 Country $ millions Country $ millions Indonesia 3,384 Indonesia 4,306 Qatar 1,911 Colombia 1,557 Mexico 1,066 Philippines 1,097 Pakistan 1,062 Argentina 735 Turkey 929 Mexico 272 Colombia 660 Thailand 272 China 621 India 267 India 523 Chile 167 Chile 500 Poland 128 Hungary 397 Pakistan 97 Source: Project Finance International 1995; Project Finance International 29 January 1997. 24 Table A4 Privatization transactions in selected emerging markets, 1991-1995 Infrastructure Number of privatization as a infrastructure Total number of percent of total Country privatizations privatizations privatizations Argentina 11,424 14,378 79.5 Mexico 4,958 21,278 23.3 Malaysia 4,248 8,735 48.6 Hungary 4,064 7,013 57.9 Indonesia 3,428 4,014 85.4 Peru 2,520 4,457 56.5 Venezuela 1,983 2,501 79.3 China 1,370 7,033 19.5 Czech Republic 1,361 2,297 59.3 Pakistan 1,011 1,565 64.6 India 973 4,447 21.9 Russia 787 1,255 62.7 Bolivia 770 811 94.9 Philippines 629 3,338 18.8 Brazil 491 9,606 5.1 Chile 403 619 65.2 Turkey 347 2,401 14.4 Thailand t80 953 18.9 Poland 172 2,932 5.9 Latvia 160 160 100.0 Slovak Rep. 28 1,482 1.9 Estonia 6 245 2.6 Nigeria 3 176 1.6 Vietnam 1 3 22.2 Colombia --- 905 0.0 Jordan 15 0.0 Kazakhstan -- 315 0.0 Oman --- 62 0.0 Slovenia --- 521 0.0 South Africa --- 5 0.0 Uruguay --- 2 0.0 Zimbabwe --- 307 0.0 Total 39,583 114,964 34.4 Source: World Bank Privatization Database; International Economics Department; World Bank staff estimates. 25 Table A5 Sovereign credit ratings, country risk assessment, and sovereign defaults in selected emerging markets Standard & Moody's long- Poor's long-term term foreign Institutional foreign currency currency Euromoney Investor Years in default sovereign sovereign country country since 1975 (foreign debt rating debt rating ratings ratings' currency external Country (April 9, 1997) (April 9, 1997) (March 1997) (March 1997) bank Debt) Malaysia A+ Al 83.32 67.5 None Thailand A A2 77.09 61.1 None Czech Republic A Baal 74.54 62.8 None Chile A- Baal 79.94 62.0 1983-1990 Slovenia A A3 73.97 52.1 1992-1995 China BBB A3 70.50 58.0 None Indonesia BBB Baa3 70.95 51.6 None Latvia BBB NR 55.04 29.1 None Hungary BBB- Baa3 70.06 47.6 None Oman BBB- Baa2 69.92 52.8 None Colombia BBB- Baa3 63.68 47.7 None Poland BBB- Baa3 56.58 47.9 1981-1994 Slovak Rep. BBB- Baa3 63.46 43.9 None India BB+ Baa3 64.61 46.3 None South Africa BB+ Baa3 69.88 46.0 1985-1987, 1989, 1993 Philippines BB+ Ba2 63.14 42.3 1983-1992 Uruguay BB+ Bal 63.42 41.7 1983, 1987, 1990-1991 Peru BB+ B2 48.19 32.0 1976, 1978, 1980, 1984-1995 Mexico BB Ba2 64.14 42.6 1982-1986, 1988-1990 Argentina BB Bi 59.17 39.9 1982-1993 Jordan BB- Ba3 53.20 33.8 1989-1993 Russia BB- Ba2 43.97 23.5 1991-1995 Brazil BB- BI 59.11 38.8 1983-1994 Kazakhstan BB- Ba3 40.25 20.9 None Pakistan B+ B2 48.94 27.7 None Turkey B Bl 53.39 40.8 1978-1981 Venezuela B Ba2 49.08 33.1 1983-1988, 1990 Vietnam NR NR 52.41 32.5 1985-1995 Zimbabwe NR NR 42.00 32.3 None Estonia NR NR 53.21 33.6 None Nigeria NR NR 26.78 14.8 1982-1992 Bolivia NR NR 45.93 24.9 1980-1993 Note: a The scale for Euromoney and Institutional Investor country credit ratings range from 0-100. The highest possible score is 100 and the lowest possible score is 0. Source: Standard & Poor's; Moody's; Euromoney; and Institutional Investor. 26 Table A6 Capital market innovations, 1991-1996 Project Location/ Year Capital Market Innovation Project Country of Origin 1991 Developer took long-term project risk. Midlands Power Project United States 1992 Project received investment grade rating and obtained Sithe Energy 144A Bond Offering United States capital market financing in precompletion stage. Project risk undertaken by developer in transport sector Mexico City-Toluca Toll road Mexico project in an emerging market. Longer maturities. Securitization of toll road revenues through offshore debt fund for a 144a issue. 1993 Developer took long-term market risk. Deer Park Refinery United States Pooling debt of multiple projects. Project financing to Refinancing of Project United States receive an investment grade Partnerships Owned by Coso Energy First IPP in Latin America Mamonal Power Project Colombia First major private infrastructure project in Eastern MI/Ml5 Motorway Hungary Europe. Project also did not have government guarantees. Project risk undertaken by developer in power sector in Subic Bay Power Project Subic Bay, Philippines emerging market 1994 Construction risk was undertaken by project developer. Indiantown Cogeneration United States Debt of multiple projects was pooled to provide Energy Investors Fund Pooled United States liquidity for investors in an otherwise illiquid long-term Portfolio Refinancing fund. Limited recourse refinancing of an IPP in the public Kilroot Electric Bond Issue Northern Ireland, United bond markets in Europe. Kingdom Take-or-pay contract with state-owned utility allowed YTL Power Generation Local Malaysia for much longer maturities (10-years versus 50 years). Currency Bond Issue First investment-grade project finance bond issue from Centragas Bond Issue Colombia an emerging market. Construction and operation risk in emerging market. First financing in the U.S. for a Chinese power project. LIPTEC 144a Bond Offering China Blind pool / power projects. Rated Asian project financing of raising funds in the Regco Project Financing Thailand United States. Debt fund created to secure private loan. Eligible for Rockfort Power Project Jamaica CARIFA bonds. Used multilateral bank guarantees to fund IPP. Market risk for power project in emerging market. Alicura Hydro Project Argentina Discrete pool in emerging market. Tribasa Toll roads Mexico Limited recourse financing for water and environmental Chihuahua Norte Municipal Chihuahua, Mexico project. Indexed project revenues to inflation. Wastewater Treatment Plant 27 Project Location/ Year Capital Market Innovation P,cject Country of Origin 1995 Privately financed undersea telecommunications cable. Fiberoptic Link Around the Globe 23 political jurisdictions 18-country political risk package. (FLAG) between UK and Japan Offering of limited recourse notes in high-yield notes Califomia Energy Co./Salton Sea United States market. Funding Corp. Debt Refinancing Toll road financing syndicated in the equity and bond M2 Toll Toad New South Wales, markets. Australia Power transmission and cross-border project with Lineas de Transmisi6n del Litoral Argentina, Paraguay multilateral bank guarantees. S.A. Emerging market debt issue exceeded sovereign debt YPF Structured Export Notes Argentina rating ceiling. Notes secured with a portion of future Private Placement receivables through long-term oil purchase agreement. Debt fund established. Used multilateral bank Hub River Power Project Pakistan guarantees to fond IPP. 1996 Capital market refinancing in an emerging market. Pehuenche Bond Offering Chile Precompletion financing obtained by emerging market Ibener Power Project Chile without political risk insurance, multilateral bank support or PPA. Latin American company to enter US 100-yr. bond Endesa 3-Tranche Bond Offering. Chile market. Long-tenn refinancing of project finance with Paiton Energy Co. Bond Offering Indonesia investment grade. Latin American r.municipality syndicated loan. Bogotd Syndicated Loan Colombia Toll road financing syndication in the equity bond Guangdong Provincial Guangdong Province, market by a local government entity within an emerging Expressway Shareholding China market. Municipal government financing of greenfield toll road. Linha Amerela Rio de Janeiro, Brazil Source: Inter-American Development Bank 1995; Vives 1997. The authors would like to thank Albert Amos, Anita Hellstern, and Matthew Harvey for valuable research assistance. The key sources for the infonnation presented here are Project Finance International (1997), Sayer (1997), Vives (1997), and World Bank (1997a). 2 Some countries may begin with public ownership, but the cyclical forces are the same. 3 In fact, they have been doing so for some time. Land grants and credit guarantees for international bond issues were extended to railroads in India and South Africa in the nineteenth century, for example. 4 Such guarantees are primarily meant to support providers of long-term debt. Project fmancings are typically funded with a very high share of debt, usually ranging from 60 to 80 percent of total project cost. Reliance on steady uninterrupted adherence to scheduled debt repayment is key to the remuneration of long-term creditors, who 28 do not benefit from the high returns that equity holders may expect. Guarantees of continuous creditworthiness are thus of great value to creditors. In project financing, debt often accounts for 60-80 percent of total project cost. In contrast, corporate finance, equity, particularly in the form of internal cash generation, tends to dominate funding. For a discussion of corporate finance in developing countries see Dailami (1992). Project financing has also been revived in industrial countries as a method of financing large-scale investment projects (see, for instance, Kensinger and Martin [1988]; Chen, Kensinger, and Martin [1989]; and Nevitt and Fabozzi [1995]). 6 In some cases risks are so high that no investors will invest, and funding is effectively rationed. 7 There is no fundamental difference between a concession in which the government remains the notional owner, as in the French water system, and a full asset sale, in which the government retains special supervision rights defined in a license, as in the water privatizations in England and Wales. 8 Under corporate finance investors look towards the cash flow of the whole company that sponsors the project. Corporate finance allows project sponsors to use other existing revenue-eaming activities to "collateralize" investment in a project. Various hybrid schemes exist such as project finance of a toll road expansion that benefits at the same time from toll collection on already completed stretches of highway. 29 Policy Research Working Paper Series Contact Title Author Date for paper WPS1842 Motorization and the Provision of Gregory K. Ingram November 1997 J. Ponchamni Roads in Countries and Cities Zhi Liu 31052 WPS1843 Extemalities and Bailouts: Hard and David E. Wildasin November 1997 C. Bernardo Soft Budget Constraints in 37699 Intergovernmental Fiscal Relations WPS1844 Child Labor and Schooling in Ghana Sudharshan Canagarajah November 1997 B. Casely-Hayford Harold Coulombe 34672 WPS1845 Employment, Labor Markets, and Sudharshan Canagarajah November 1997 B. Casely-Hayford Poverty in Ghana: A Study of Dipak Mazumdar 34672 Changes during Economic Decline and Recovery WPS1846 Africa's Role in Multilateral Trade Zhen Kun Wang November 1997 L. Tabada Negotiations L. Alan Winters 36896 WPS1847 Outsiders and Regional Trade AnJu Gupta November 1997 L. Tabada Agreements among Small Countries: Maurice Schiff 36896 The Case of Regional Markets WPS1848 Regional Integration and Commodity Valeria De Bonis November 1997 L. Tabada Tax Harmonization 36896 WPS1849 Regional integration and Factor Valeria De Bonis November 1997 L. Tabada Income Taxation 36896 WPS1850 Determinants of Intra-Industry Trade Chonira Aturupane November 1997 L. Tabada between East and West Europe Simeon Djankov 36896 Bernard Hoekman WPS1851 Transportation Infrastructure EricW. Bond November 1997 L.Tabada Investments and Regional Trade 36896 Liberalization WPS1852 Leading Indicators of Currency Graciela Kaminsky November 1997 S. Lizondo Crises Saui Lizondo 85431 Carmen M. Reinhart WPS1853 Pension Reform and Private Pension Monika Queisser November 1997 P. Infante Funds in Peru and Colombia 37642 WPS1854 Regulatory Tradeoffs in Designing Claude Crampes November 1997 A. Estache Concession Contracts for Antonio Estache 81442 Infrastructure Networks WPS1855 Stabilization, Adjustment, and Cevdet Denizer November 1997 E. Khine Growth Prospects in Transition 37471 Economies Policy Research Working Paper Series Contact Title Author Date for paper WPS1856 Surviving Success: Policy Reform Susmita Dasgupta November 1997 S. Dasgupta and the Future of Industrial Hua Wang 32679 Pollution in China David Wheeler WPS1857 Leasing to Support Small Businesses Joselito Gallardo December 1997 R. Garner and Microenterprises 37664 WPS1858 Banking on the Poor? Branch Martin Ravallion December 1997 P. Sader Placement and Nonfarm Rural Quentin Wodon 33902 Development in Bangladesh WPS1859 Lessons from Sao Paulo's Jorge Rebelo December 1997 A. Turner Metropolitan Busway Concessions Pedro Benvenuto 30933 Program WPS1860 The Health Effects of Air Pollution Maureen L. Cropper December 1997 A. Maranon in Delhi, India Nathalie B. Simon 39074 Anna Alberini P. K. Sharma WPS1861 Infrastructure Project Finance and Mansoor Dailami December 1997 M. Dailami Capital Flows: A New Perspective Danny Leipziger 32130 WPS1 862 Spatial Poverty Traps? Jyotsna Jalan December 1997 P. Sader Martin Ravallion 33902 WPS1 863 Are the Poor Less Well-Insured? Jyotsna Jalan December 1997 P. Sader Evidence on Vulnerability to Income Martin Ravallion 33902 Risk in Rural China WPS1864 Child Mortality and Public Spending Deon Filmer December 1997 S. Fallon on Health: How Much Does Money Lant Pritchett 38009 Matter? WPS1865 Pension Reform in Latin America: Sri-Ram Aiyer December 1997 P. Lee Quick Fixes or Sustainable Reform? 37805 WPS1866 Circumstance and Choice: The Role Martha de Melo December 1997 C. Bernardo of Initial Conditions and Policies in Cevdet Denizer 31148 Transition Economies Alan Gelb Stoyan Tenev WPS1867 Gender Disparity in South Asia: Deon Filmer January 1998 S. Fallon Comparisons Between and Within Elizabeth M. King 38009 Countries Lant Pritchett