Pro-Poor Infrastructure Development: The Challenge of Private Financing for Infrastructure

1
Pro-Poor Infrastructure DevelopmentThe
Challenge of Private Financing for Infrastructure

• Current Initiatives, New Opportunities
• Summary and Outcomes of Presentation to POVNET
  Workshop
• Berlin, 27th October 2004

2
Contents

• 1. Context The challenge of financing pro-poor
  infrastructure development
• 2. The role and contribution of private sector
  finance
• International finance options
• Domestic finance options
• 3. The role of MLAs and donors
• 4. Key issues for donors
• Appendices
• Summary of sources
• Profiles of financing and other donor-supported
  mechanisms
• Summary of donor questionnaire responses
• Summary of cross- cutting Issues

3
Context The challenge of financing pro-poor
infrastructure development
Forecast investment requirements far exceed
current levels of expenditure
Annual investment needs as of GDP 2005-2010
(1) and Estimated Public Sector Spending (2)

• The gap between infrastructure finance needs and
  current estimated expenditure is large
• Public expenditure is insufficient to cover OM
  needs
• Overall figures mask country-specific
  situations. In some LDCs (especially poorer)
  needs estimated to be significantly higher than
  the average.

Note Other sources estimating MDG needs give
larger estimates, eg J Sachs
Source Briceno et al 2004 IMF 2003, quoted in
Estache 2004
4
Context The challenge of financing pro-poor
infrastructure development
A decline in public spending on infrastructure in
the 1990s has been exacerbated by a decline from
other sources
Multilateral Development Bank Commitments in
Infrastructure 1996-2002 (2002 billions)
Total Private Investment in PPI Projects
Developing Countries 1990-2002 (2002 billions)
USbn
USbn
18 bn
16 bn
13.5 bn
Source World Bank Global Development Finance
Source Brienco et al 2004

• Some recent evidence of recovery in multilateral
  expenditure commitments in policy statements
• Actual disbursements believed to be
  significantly lower than commitment levels

5
Context The challenge of financing pro-poor
infrastructure development
LDCs have maintained relatively constant levels
of FDI in infrastructure, but represent a very
small proportion of total flows
Low, Lower Middle and Higher Middle Countries
Source World Bank Global Development Finance
6
Context The challenge of financing pro-poor
infrastructure development
Approximately 70 of financing for infrastructure
comes from the public sector. The biggest impact
will come from making public financing more
effective

• More and better financing for infrastructure is
  needed from all sources
• More effective public financing
• Private finance not suitable for all projects,
  but can serve to release public and ODA sources
  for more difficult projects
• ODA is a small proportion of the total, but has
  characteristics that can help leverage other
  sources
• Understanding what private finance can do will
  help to focus ODA interventions more effectively

Source DFID 2002 Making Connections
Infrastructure for Poverty Reduction WB
Brienco et.al 2004
7
The role of private sector financing
Private sector participation in infrastructure
takes many forms
8
Problems highlighted by donors for private
financing of infrastructure
Source POVNET Infrastructure Task Team
Questionnaire Responses
9
The role of private financing for infrastructure
Private sector investors in all modalities share
a common perception of key areas of risk
Investment Climate

• Political and social stability
• Suitability of enabling environment for
  investment including
• Legal framework for private participation
  (general and sector-specific)
• Appropriate sector and market structures
  (existence of regulation and competition)
• Institutional capacity in key ministries and
  regulators
• Transparent and independent regulation

Risk Management

• Project specific
• Insurance against variations in forecasts
• Existence and applicability of guarantees and
  other insurance instruments
• General
• Exogenous events
• Currency mismatches
• Public finance risks

Project Opportunity

• Quality of project design (bankability)

10
The role of private sector financing
International private finance options
Latin America has attracted the highest levels of
private sector finance, and continues to capture
a significant share
Compound Annual Growth Rate
90 97
90 03
SA 73.0 28.2
SSA 95.3 40.7
MENA 157.8 39.2
ECA 114.4 46.3
EAP 50.9 14.6
LAC 24.4 2.9

• Investors have a clear preference for middle
  income countries, particularly in Latin America,
  East Asia and the Middle East
• High growth rates in South Asia and Sub Saharan
  Africa reflect extremely low levels of investment
  in early 1990s
• The drop in private sector investment flows
  after 1998 reflects both the collapse of investor
  confidence following regional crises and the
  completion of major privatisations in key markets

Note MENA data from 1994
Source World Bank Global Development Finance
11
The role of private sector financing
International private finance options
Large differences exist in private sector
investor appetite for different infrastructure
sectors
Investment in Infrastructure Projects with
Private Participation 1990 - 2003, by Sector
Water Sanit
Transport
Telecomms
Energy

• Energy and telecommunications have attracted the
  largest flows of private sector finance
• Mainly driven by privatisation programmes during
  1990s
• Understanding recent international investor
  behaviour in different sectors can help define
  the way forward

Source World Bank Global Development Finance
12
International private finance options
Power
Recent Investment Trends

• During 1990s, widespread bidding out of long
  term power purchase agreements, unbundling of
  sectors, and privatisatiion (mainly generation)
• State, municipal and other local enterprises
  guaranteed tariffs indexed to hard currency,
  sometimes back-stopped by government guarantees
• 1997 Asian crisis financial distress in Russian
  Federation and other transitional economies
  provoked widespread currency devaluations
• Utilities defaulted, wiping out investments by
  trade investors, bondholders and bank lenders
• Widespread withdrawal by international investors
  from emerging power markets. Investment shifted
  to US. Massive investment in new gas-fired plants

Current Status

• Investors and lenders still holding large sums
  of distressed credit
• Confidence in power markets severely eroded
• Options for attracting new private finance for
  power to emerging economies very limited
• Requirements for project quality and
  risk-control at highest ever levels

Key Issues

• Investment requirements dwarf domestic resources
• Sector structures unstable (subject to
  regulatory change)
• Tariff structures designed to address
  affordability do not match investors revenue
  expectations (sometimes do not achieve
  cost-recovery)
• Difficulty in implementing cost reduction
  through controlling non-technical losses
• High up-front costs for alternative (renewable)
  energy sources

13
International private finance options
ICT
Recent Investment Trends

• Technology advances (esp. cellular telephony)
  and policy changes triggered a boom in the 1990s
• Massive investment in licenses, network
  expansion and bandwidth capacity (global capacity
  grew over 200 times between 1995 and 2000
• Dot.com bubble burst in 2001, with knock-on
  impact on entire ICT market

Current Status

• Recent evidence of recovery in ICT, with signs
  of investment shifting away from developed
  economies
• 2001 China accounted for more than half of new
  fixed-line and a quarter of new mobile
  subscribers worldwide
• Africa added more subscribers since 2000 than in
  preceeding decades
• 18 countries grew their mobile networks by over
  200 in 2001. The fastest growth was in Nigeria.
  12 other countries were in Africa

Key Issues

• Continuing private sector reluctance to invest
  in network expansion in rural/poor areas where
  population densities low and customer
  profitability rates unattractive
• Least developed countries particularly
  unattractive (low telephony penetration rates)

14
International private finance options
Transport
Recent Investment Trends

• During 1990s some major investments in private
  transport
• Investors alarmed by some well-publicised
  failures
• Bangkok Expressway
• Mexican tollroads
• Railtrack, UK

Current Status

• By 2002 new private investment recovered to
  levels similar to early 1990s

Key Issues

• Inadequate budget allocations and local
  administrative capacity to manage funding
  (investment, OM) for rural roads
• Imbalance in fundraising potential from local
  sources (tax revenue, voluntary labour
  contributions) between affluent and poor areas
• Inaccurate traffic forecasts give unreliable
  revenue projections
• Tariffs designed to address affordability do not
  match investors revenue expectations (and
  sometimes do not achieve cost-recovery)
• User pays principle difficult to implement for
  road transport
• Beneficiary pays approach to road funds most
  complex in poor/rural areas where difficult to
  identify beneficiaries
• Public opinion sees road transport as a public
  good that should be provided free of charge by
  the state

15
International private finance options
Water and Sanitation
Recent Investment Trends

• Historically reliant on government financing.
• 203 developing country projects between
  1990-2001 (US 40 bn in private sector financing)
• A number of well-publicised socio-political
  crises related to tariff renegotiations in 1990s
• Private sector investors have almost completely
  withdrawn from the sector in LDCs

Current Status

• Several international water companies, including
  Suez, Veolia Environnnement and Thames Water,
  recently announced exit from direct investments
  in emerging markets
• Private companies will only contract to provide
  services under short term operating contracts

Key Issues

• Water perceived as a public good with
  political sensitivities particularly high.
  Political resistance to raising water prices
• State, municipal or other local enterprises
  retain monopoly control over water distribution.
  Off-take agreements (typically part of overall
  concession agreements) mandate initial increases
  in cost of services and prices rising over time.
  Cost recovery can be difficult.
• Prices do not reflect costs in all sectors
• Subsidies not targeted towards poor ineffective
  cost-recovery from users who can afford service
• Risk of regulatory and political interference
  during the concession term high

16
International Private Finance Options
cross-sectoral issues
Investors identify 5 critical drivers in
evaluating opportunities for PPPs and FDI
Drivers of attractiveness of investment
opportunities

• PPP project scope
• Institutional capacity of public sector
  counterparts and partners
• Risk levels and risk distribution
• Achievable efficiency levels by sector
• Rent levels remaining with operatorsHigher
  risk levels in LDCs may warrant different
  risk-allocation profiles from Developed Countries

Source Estache, INFVP, World Bank August 2004
17
The role of private sector financing Domestic
private finance options
Domestic private finance in LDCs has the
potential to address some of the funding gap from
a range of sources. But there are many
constraints.

• Many of the key constraints can be addressed by
  donor interventions through Technical Assistance
• Financial sector restructuring and direct
  investment by foreign banks in domestic financial
  institutions can help alleviate liquidity
  constraints and strengthen local lending and
  advisory capacity

18
The role of private sector financing Domestic
private finance options
Two key issues for domestic private sector
finance across all sectors
Source Estache, INFVP, World Bank August 2004
19
The role of sub-sovereign domestic finance
Sub-sovereign governments have a growing role to
play in mobilising finance for smaller scale
infrastructure through 3 sources

• The potential to strengthen sub-sovereign
  sources is dependent on effective implementation
  of decentralisation of government, and
  strengthening of local governance
• Sub-sovereign fiscal capability
• Separation of regulatory and service provision
  functions (including local regulation)
• Insulation of management from political
  interference
• Clear policy on affordability, and effective
  provisions for ensuring fair tariffs. Subsidy
  issues to be dealt with explicitly
• New instruments needed for credit enhancement/
  improved creditworthiness at project and local
  government level

20
The role of private sector financing Outstanding
issues for project development
Structuring the right financing approach depends
on specific project characteristics
21
Differences between large and small projects
Distinct approaches are emerging for large and
small scale projects

• Both large and small scale projects are demanding
  increasingly sophisticated project definition and
  deal-structuring approaches
• Opportunities exist to combine approaches and
  innovations in both categories to ensure pro-poor
  objectives are addressed but the process must
  be managed

22
Contents

• 1. Context The challenge of financing pro-poor
  infrastructure development
• 2. The role and contribution of private sector
  finance
• International finance options
• Domestic finance options
• 3. The role of MLAs and donors
• 4. Key issues for donors

23
The role of Multilateral Agencies and Donors
A range of facilities and instruments exist to
support private investment in infrastructure
Types of Donor Credit Enhancement and Support
Facilities

• Guarantees
• Insurance
• Co-financing Schemes
• On-lending
• Equity or Equity Insurance
• Local to Hard Currency Swaps
• Advisory Services

• Donor and multilateral facilities can help
  facilitate deal making and secure private sector
  financing, but only when the project fundamentals
  are right

24
The role of Multilateral Agencies and Donors
Guarantee mechanisms

• Structures developed by IBRD
• Also adopted by InterAmerican Development Bank
  (IDB), Asian Development Bank (AsDB), FMO (Dutch
  bilateral agency), IFC, others
• Other guarantee mechanisms under development
  include
• Local currency hedging PIDG conceptual study
• GuarantCo (not yet launched)
• Garanties démision obligataire - AFD

25
The role of Multilateral Agencies and Donors
Loan Guarantees
Example Development Credit Authority (DCA) -
USAID
USAID
Bulgaria Type Loan Portfolio
Guarantee Amount 6,250,000 Purpose Provides
guarantee to a bank that lends long-term funds to
municipalities seeking to invest in energy
efficient technologies.
50 Guarantee
UBB
Loans
Municipalities
26
The role of Multilateral Agencies and Donors
Bond Guarantees
India Amount 6,400,000 Purpose
Provides a partial bond guarantee for a pooled
funding vehicle for financing water and sewerage
infrastructure projects in seven selected
suburban municipalities in Tamil Nadu, India.
27
The role of Multilateral Agencies and Donors
Political risk insurance (PRI)

• Key features of MIGA
• Does not require host country counter-guarantee
• May be used to insure equity, shareholder loans,
  bank debt or bonds
• Insurance for breach of contract with a
  sovereign entity only provided on a limited basis
  (where contracts with governments require
  offshore arbitration to resolve disputes)

28
The role of Multilateral Agencies and Donors
Co-financing and on-lending

• Advantages to private bank lenders
• Does not affect allocations for country risk
  limits
• Loan provisioning not required in many countries
• In some cases witholding taxes may be avoided

29
The role of Multilateral Agencies and Donors
Other donor on-lending facilities

• Advantages
• Builds financial capacity in domestic financial
  institutions
• Enables domestic financial institution portfolio
  expansion (and growth of expertise)
• Enables donor to leverage local knowledge and
  expertise to make a larger number of small loans
  with limited local staff

30
The role of Multilateral Agencies and Donors
Equity Investments

• Customers include companies, financial
  institutions, other types of project vehicles
• Typically investments do not exceed 25 of total
  capitalisation

31
The role of Multilateral Agencies and Donors
Swaps to local currency
Example ADB US200m cross-currency financing
facility
Philippine pesos
Philippine pesos

• Original project in Philippines
• Plans to replicate in Indonesia, Bangladesh,
  Vietnam, Pakistan

32
The role of Multilateral Agencies and Donors
A number of innovative mechanisms are being
developed for mobilising finance
Programmes are multi-donor unless otherwise
specified Facilitiy details in Annex
33
The role of Multilateral Agencies and Donors
Various donor facilities now exist for project
development
Programmes are multi-donor unless otherwise
specified Facilitiy details in Annex
34
Contents

• 1. Context The challenge of financing pro-poor
  infrastructure development
• 2. The role and contribution of private sector
  finance
• International finance options
• Domestic finance options
• 3. The role of MLAs and donors
• 4. Key issues for donors

35
Key issues for donors Domestic private finance
options
Outstanding issues and priorities
36
Key Issues for donors Domestic private financing
options
Donors can facilitate more effective use of
domestic financing
37
Key issues for donors Identifying the challenges

• Projects vs PartnershipsDonors tend to fund
  stand-alone investment components.
  Participations in PPPs (equity, debt) could
  contribute to lower project risk profiles
• Investment vs. Maintenance Donors could focus
  more on promoting mechanisms that ensure adequate
  finance for OM
• Few linkages between interventions aimed at
  improving finance mobilisation and pro-poor
  interventions. Some exceptions
• USAID Development Credit Authorities
• KfW ICT operator subsidies for rural network
  expansion)
• Risk mitigation initiatives focus on project
  risk, but omit management of partnership risk
• Large literature on PPPs focuses mainly on
• Financing structures
• Governance
• Risk apportionment between lead (FDI) investor
  and Government
• Little attention given to marketing/promotion of
  innovative approaches to (domestic/international)
  investor community and commercial financial
  institutions

38
Helping international and domestic financing to
coincide
Two indirect routes to bridging the gap?
Investment in domestic financial institutions
LDC Infrastructure Investment needs

• Complex partnerships including
• Credit and investment guarantees
• Currency political risk insurance
• Specialist financing vehicles

39
Closing the gap between needs,opportunities and
private sector investors
Can the views and contributions of all parties be
helped to converge?

• A key challenge is managing the process in a
  complex environment
• Increasingly sophisticated approaches to
  deal-structuring and marketing needed
• Innovations in funding, risk management, pro-poor
  interventions not yet packaged/promoted in terms
  investors can easily evaluate
• More attention needed to linking innovative
  mechanisms to specific projects and to managing
  the process of deal-structuring
• Soft issues and qualitative objectives are hard
  to measure and manage in a quantitative
  environment

40
Closing the gap between needs,opportunities and
private sector investors
The key issues are not the lack of finance

• What is needed to achieve alignment of all
  parties
• Local and national politicians and civil society
  need to see private investment as beneficial
• Creating an attractive investment climate
• Ensuring institutional capacity and commitment to
  facilitate private investment
• Defining and structuring projects to a point
  where theyre ready for presentation to investors
• Opportunities for donors to facilitate the
  process
• Support government initiatives to communicate
  objectives and rationale
• Provide more direct support in project
  development and marketing to investors
• Extend scope of TA to include non-technical
  process- management support

41
Appendices

• Summary of sources
• Profiles of financing and other donor-supported
  mechanisms
• Summary of donor questionnaire responses
• Summary of cross-cutting issues

42
Appendix 1

• Sources
• Donor responses to DAC POVNET Infrastructure Task
  Team questionnaires
• International Financing Sources in Support of
  Pro-Poor Growth Infrastructure Development,
  Osius 2004 (USAID Consultant)
• Domestic Finance Mobilization for Pro-Poor
  Infrastructure An Exploration of
  Sub-Sovereign Finance Issues and Policy Guidance
  , Diehl 2004 (DFID Consultant)
• A survey of recent economic literature on
  selected emerging infrastructure policy issues in
  LDCs, Estache, World Bank, 2004
• Donor Practices and the Development of Bilateral
  Donors Infrastructure Portfolio, Hesselbarth,
  2004 (KfW Consultant)

43
Appendix 2

• Profiles of financing and other innovative
  mechanisms

44
Innovative Mechanisms Mobilising Finance
45
Innovative Mechanisms (TA for Institutional
Strengthening)
Foreign Investment Advisory Services (FIAS)
(Multi-Donor)

• TA to streamline processes and regulatory
  frameworks to promote investment and mobilise
  local capital.
• Strong focus on land reform and collateralisation
  of assets, not specifically for infrastructure.

46
Innovative Mechanisms (Risk Management and
Guarantee Schemes)
47
Innovative Mechanisms (Project Pipeline
Development)
48
Innovative Mechanisms (Pro-Poor Focus)
49
Appendix 3
Summary of consolidated donor questionnaire
returns
50
Problems of Financing Infrastructure (1)
Institutional barriers to mobilising equity and
Long Term Debt in domestic financial markets
Issue Cited
Additional Comments
51
Problems of Financing Infrastructure (2)
Institutional barriers to attracting equity and
long term debt from international investors
Issue Cited
Additional Comments
52
Problems of Financing Infrastructure (3)
Weak institutional capacity
Issue Cited
Additional Comments
53
Problems of Financing Infrastructure (4)
Absence of enabling framework for private
investment in infrastructure
Unattractive project financing profiles
Insufficient protection for investors against
risk
Sustainability of investment flows
54
Problems of Financing Infrastructure (5)
Other (Cited by only one respondent)