Finding Financial Resources and Mechanism

1

• Finding Financial Resources and Mechanism
• for Development of Municipal Infrastructure
• Workshop on
• Environmental Management and Urban Development
• Ðà N?ng 15 December 2006
• Ð?ng Ð?c Cu?ng, Ph.D.
• Senior Operations Officer
• The World Bank in Vietnam

2
Fiscal Decentralization

• The Budget Law defines very clearly revenue of
  local budget
• Formulas for sharing central and provincial
  budget revenues passed by National Assembly, and
  kept unchanged in 3-5 year period.
• The Budget Law also defines expense
  responsibilities of central and local budget
• Municipal infrastructure is under the local
  budget
• Anywhere limited budget can not meet increasing
  demand for infrastructure development in a rapid
  urbanization environment

3
Reducing budget subsidy for public services

• Budget subsidy has been almost deleted for
  operation and maintenance of water supply
  service. However capital investment is still
  heavily dependent upon budget
• Environment and sanitation services receiving
  subsidy for operation and maintenance
• In big cities, subsidy for public transport is
  increasing
• Users, including Urban Poor, can pay for
  cost-recovery services
• Socialization of public services is expanding and
  increasingly effective

4
Financial Resources for Urban Development

• Budget, including ODA, is limited
• Budget constraint
• Budget allocations can be fragmented, because of
  much higher demand
• Budget allocations are made based on demand. In
  many cases cost recovery has not been paid due
  attention
• Other resources are being used
• Transfer of land use right
• Municipal bond
• Non-tax revenues by law
• Borrowing from commercial banks
• BOO-BOT investments
• Public-Private Sector Partnership
• Financial Markets lack of medium to long term
  capital

5
Real Estate Market and Housing Finance

• Property tax is not yet in place, which is one of
  the main sources of revenue in many other
  countries
• Real Estate Market is under-developed, currently
  frozen, and still lack of transparency
• Many auctions for land use right have been
  delayed, or not attractive. Revenue from land use
  right has been reduced in most provinces
• Housing finance system is under-developed
• Cities lack of resettlement housing stock for
  urban development
• Financial markets lack of financial tools for
  local governments

6
New urban finance tools are being used

• Local Government Bonds
• HCMC first issuance was in 2003, now annual
  issue. Dongnai issued in 2005, and Hanoi
  2005-2006
• Issue Plan and Repayment Plan need to be approved
  by MoF
• Budget Law imposes limits for borrowing 100 of
  annual capital budget for Hanoi and HCMC, and 30
  of annual capital budget for other provinces
• To be able to borrow from the markets, cities
  need to operate likes enterprises
• Other resources, and Public-Private Partnership
• Local Development Investment Fund as a tool
• Mobilize and well manage potential non budget
  capital sources for financing urban development,
  while state budge just plays the role of kick
  off to attract more investment
• Assure effectiveness in implementation of
  revenue-backed infrastructure projects, as well
  as holding accountability of project developers

7
LDIF operations - General

• Direct investment.
• Lending.
• Municipal bonds issuance mandated by local
  governments.
• Management of entrusted funds.
• Others activities (financial advice, investment
  transformation, bonds...)
• LDIFs are provincial entities responsible for
  financing and mobilising private sector capital
  for the development of infrastructure and
  services.
• HIFU was the first LDIF established in 1996.
  Currently, there are (15) LDIFs, of which HIFU,
  BDIF, DNIF and HANIF are the most active.

8
LDIFs STRUCTURE
H?I DUONG DIF 2005
KONTUM DIF 2006
9
LDIF operations Capital

• The equity of the LDIFs is financed by the
  provincial government budget.
• LDIFs also mobilise debt from commercial and
  state-owned enterprises and banks.
• - Approximately 80 of the mobilised capital is
  short-term senior debt (less than 12 months
  tenor) with roll-over features.
• - The remainder 20 is medium-term (1 - 5 years
  tenor) senior debt.
• Some LDIFs are engaged in various activities
  such as infrastructure financing, share trading,
  investments, financial services and managing
  the PCs trust funds.

10
LDIF operations Investment activities

• The infrastructure portfolio of the active
  LDIFs comprises equity and debt investments.
• HIFU has also invested in infrastructure
  development joint stock companies such as CII,
  Kenh Dong water supply and Thu Duc water supply
  BOO.
• The focus of LDIFs investments are
  commercially viable revenue-backed projects.
• The current investment processes of the
  LDIFs draw on lending guidelines of the MoF, the
  PCs, large state-owned banks, and local
  investment laws and decrees.
• Investment sectors include transport, water
  supply, health care, education, industrial parks
  and residential property development.
• LDIFs typically invest a maximum of 15-30
  of the target project equity.
• The target rate of return on equity
  investments is approximately a premium of 4 over
  current market interest rates.
• LDIFs have a strategic advantage in
  structuring and providing long-term finance for
  revenue-backed provincial infrastructure projects
  

11
Meeting municipal infrastructure demand will
continue to be a difficult challenge for Vietnam

• Investment gap for municipal infrastructure is
  increasing rapidly across the country
• - Investment climate surveys highlight the lack
  of municipal infrastructure as a key risk to
  growth
• In the near to medium term the private financial
  market in Vietnam is unlikely to fully meet the
  countrys infrastructure financing needs
• - However, the short-term measures to inject
  long-term capital must encourage / anticipate the
  role of private sector in infrastructure
  development
• The responsibilities for municipal infrastructure
  are being devolved to the provincial governments
• - Provincial government agencies lack the
  necessary technical and institutional capacity

12
Feedback from private investors
13
Why are the LDIFs important?

• For the Central Government
• Support decentralization
• Promote private sector involvement in municipal
  infrastructure development
• Increase the efficiency of provincial government
  operations
• For Provincial Governments
• Reduce the municipal infrastructure financing gap
  through mobilization of public and private sector
  capital
• Establish specialized public sector expertise for
  working with the private sector
• Improve investment efficiency and quality of
  public infrastructure delivery by emphasizing
  cost-recovery
• Enhance public sector disclosure and safeguard
  standards

14
LDIFs have become a key operational tool for the
provincial governments

• The Role of LDIF in Provincial Government
  Operations
• Specialized agency for streamlining the process
  for private sector investment in public
  infrastructure
• Contracting vehicle with a unique legal standing
  that allows the provincial government to directly
  partner with the private sector through joint
  ventures
• Legal entity that the provincial government can
  use to mobilize funds for infrastructure
  development
• Budgeting tool for earmarking budget for priority
  infrastructure investments

15
however, important actions are required to make
LDIF operations more sustainable

• Absence of timely technical assistance to LDIFs
  on appraising projects and managing financial
  risk can cause them to run into financial
  problems
• LDIF processes and procedures for partnering with
  the private sector need to be made more
  consistent and transparent
• Lack of long-term capital can drive LDIF
  investments away from long-term, developmental
  infrastructure
• LDIF borrowing practices need to be reviewed and
  revised to manage financial risk
• In the long-term, the LDIFs over-reliance on
  provincial budget allocations can result in LDIF
  operations becoming increasingly non-transparent

16
There are significant differences between LDIFs
and the Development Assistance Fund (DAF)

• LDIFs
• Investment decisions are made at the LDIF
  management / PPC level
• Engage in direct (equity) and indirect (loans)
  investments
• Primary focus is on cost recovery projects
• Private participation is the key objective
• Engage in commercial resource mobilization

• VDB
• Investments require central government approval
• Not allowed to engage in direct (equity)
  investments
• Subsidized loans and grants are the norm
• No private sector partnerships are allowed
• No commercial resource mobilization is allowed

17
LDIFs have a distinct capital structure,
involving three types of capital

• Charter Capital Equity contributions from the
  provincial budget
• Mobilized Capital Short-term borrowings from
  SOEs and SOCBs, used on a roll-over basis
• Entrusted Capital Provincial government budget
  channeled through LDIFs investments are not
  appraised by the LDIFs

Source MoF and LDIFs with World Bank adjustment
18
LDIF management is appointed by the Provincial
Peoples Committee (PC)

• The Chairman of the Board of Management is
  nominated, and all its members are appointed, by
  the Peoples Committee
• The head of the Board of Supervision is appointed
  by the Peoples Committee
• All members of the Board of Execution are
  appointed by the Peoples Committee

19
The legal and institutional structure for the
LDIFs is in the early stages of development

• The draft Decree on Organization and Operation of
  LDIFs
• There are no national standards / regulations for
  LDIF accounting, financial management and
  personnel policy
• PPCs have the discretion to pick national
  standards applicable to SOEs and SOCBs when they
  establish LDIFs in their provinces
• The PPCs of the top-4 LDIFs have to date
  maintained the viability of their LDIFs
• Loans priced at or above SOCBs
• Most staff converted to independent employment
  contracts
• The Ministry of Finance has limited ability to
  regulate LDIFs
• No specific national law on the LDIFs
• The Law on Budget is limited to the use of
  charter capital
• No GoV role in the provision of technical
  assistance or capital

20
Capital under LDIF management has been growing at
a very fast pace
Charter capital

• Charter Capital increased by an average annual
  growth rate of 45 between 1997 and 2004
• Mobilized Capital increased by an average annual
  growth rate of 65 during the same period

Source MoF and LDIFs with World Bank adjustment
21
LDIFs have also been very efficient in executing
investments

• The growth rate of direct investments (equity)
  over the period 2001-2004 was approximately 85
  per year
• LDIF lending has increased by approximately 10
  times between 1997 and 2004

Source Ministry of Finance
22
LDIFs are becoming a key instrument in the
investment strategies of provincial governments

• Specialized Agency Role
• LDIFs are increasingly getting involved in
  specialized investment structures (e.g., Thu Duc
  Water BOO in HCMC)
• Direct Investments are beginning to involve
  establishment and management of Joint Stock
  Companies (JSCs) which invest in infrastructure
  projects
• Lending operations also increasingly involve
  syndications

Provincial Government Investment Channeled through LDIFs (2004) Provincial Government Investment Channeled through LDIFs (2004) Provincial Government Investment Channeled through LDIFs (2004) Provincial Government Investment Channeled through LDIFs (2004)
HIFU HANIF DNIF BDIF
13 33 9 7-8


Source HIFU, DNIF, BDIF, HANIF, and Ministry of
Finance Note HANIF data does not include ODA
channeled into Hanoi through the provincial
government operations
23
There is evidence that LDIFs can leverage private
capital in infrastructure development

• Over the last five years the equity investments
  of HIFU have obtained private capital leverage of
  4.8x

24
Investment in developmental infrastructure
remains a key focus of LDIFs
Sector Focus of LDIF Investments Sector Focus of LDIF Investments Sector Focus of LDIF Investments Sector Focus of LDIF Investments Sector Focus of LDIF Investments
HIFU HANIF DNIF BDIF
Transport v v v
Water Supply v v v v
Urban Environment v v
Municipal Infrastructure v v
Municipal Social Infrastructure v v v
25
LDIFs have demonstrated financial viability, and
their pipelines look strong
HIFU HANIF DNIF BDIF
Project Pipeline
2005 Investments (VND Mil) 1,503,663 225,000 208,000 654,900
2006 Investments (VND Mil) 1,841,460 110,000 238,000 NA
2007 Investments (VND Mil) 2,788,102 70,000 325,000 NA
Financial Performance
Net Income 2003 (VND Mil) 40,175 6,900 10,465 6,908
Net Income 2004 (VND Mil) 82,265 7,253 11,851 8,452
Source Ministry of Finance and LDIFs
26
The Financial Intermediary (FI) model offers
opportunities and risks for Vietnam

• LDIFs are a form of FIs, which are specialized
  institutions employed by developing countries
  with underdeveloped financial markets to
  facilitate financing of infrastructure
• FI can be a public or a private sector
  institution
• The primary source of capital for FIs is
  typically ODA and/or national or sub-national
  government budget
• Numerous variations of FI models have been
  developed and implemented in countries around the
  world
• FI programs are designed to meet the
  time-specific needs of a country
• Provision of technical assistance is an important
  part of FI programs
• Sound regulations / strategic planning are often
  the key to success

27
Strategic planning is required to manage the key
risk associated with the FI model

• Policy Capture Risk that the government may use
  the FI for political objectives, e.g. directed
  credit of subsidized loans which undermine
  financial viability
• Private Sector Crowding-Out FIs often receive
  low-cost capital and free technical assistance,
  and can stop the private sector from entering the
  market
• Mismanagement Over-capitalization and lack of
  transparency can lead to mismanagement of funds
• Contingent Liability / Fiscal Risk The implied
  government guarantee of FIs market borrowings
  may give rise to the moral hazard problem

28
The prospects of LDIFs depend upon the ability of
the PPCs and the GoV to meet key challenges

• Key conditions for LDIFs to become efficient FIs
• Investment Policy Define an investment
  eligibility criteria and develop portfolio
  monitoring and risk management systems
• Corporate Governance Corporate governance
  structure must be strengthened to make the LDIFs
  more independent from the operations of the
  provincial government. LDIF business model should
  explicitly focus on continued commercialization
  and independence
• Borrowing Rules The current ad hoc borrowing
  operations of LDIFs should be revised with an aim
  to a) tie the borrowing to the assets/charter
  capital, b) make the borrowing activities more
  transparent, and c) subject to a) and b) above,
  increase the tenor of the borrowing
• Public-Private Partnerships A consistent and
  transparent framework for partnering with the
  private sector should be introduced
• Legal and Institutional Framework GoV needs to
  finalize legal and institutional framework,
  including the standards for accounting and
  financial management of LDIFs

29
The success of LDIFs will primarily depend upon
the incentives provided to PPCs

• The PPCs and LDIF Performance
• The differences between the provincial
  governments commitment to the LDIFs is an
  important driver of the significant gaps between
  the performances of LDIFs
• Incentives available to the provincial
  governments will define the development of LDIFs
• Key focus should be on establishing an arms
  length relationship between the provincial
  governments and the day-to-day operations of the
  LDIFs
• It is very unlikely that the GoV can be
  successful in improving the performance of LDIFs
  with regulations alone, i.e., GoV should consider
  offering a combination of technical assistance,
  legislative support and provision of long-term
  capital

30
Development of LDIFs should be viewed as a
long-term objective

• Investment Capital
• Injection of private equity
• Increase in senior debt
• Private Sector Participation in LDIF Management
• Long-term Role
• Transition away from primary market towards
  narrow market function
• Support to market players on benchmark
• Maturity extension
• Securitization

• Corporate Governance
• Corporatization (from provincial government
  operations)
• Transparency
• Reform of PPP rules
• Investment Policy
• Eligibility Criteria
• Risk Management
• Investment Capital
• Borrowing structure
• GoV / ODA assistance

• Investment Capital
• Demonstration of sound financial and corporate
  management practices
• Senior debt through market transaction
• Standard Setting
• Increased syndication
• Establishment of standards in partnership with
  public/private partners
• Investment Track-Record

Short-term
Long-term
Medium-term
31
Summary The success of LDIFs depends upon the
commitment of the PPCs and the GoV on 5 key issues

• Key conditions for LDIFs to become efficient FIs
• Investment Policy Define an investment
  eligibility criteria and develop portfolio
  monitoring and risk management systems
• Corporate Governance Corporate governance
  structure must be strengthened to make the LDIFs
  more independent from the operations of the
  provincial government. LDIF business model should
  explicitly focus on continued commercialization
  and independence
• Borrowing Rules The current ad hoc borrowing
  operations of LDIFs should be revised with an aim
  to a) tie the borrowing to the assets/charter
  capital, b) make the borrowing activities more
  transparent, and c) subject to a) and b) above,
  increase the tenor of the borrowing
• Public-Private Partnerships A consistent and
  transparent framework for partnering with the
  private sector should be introduced
• Legal and Institutional Framework GoV needs to
  finalize legal and institutional framework,
  including the standards for accounting and
  financial management of LDIFs