Developing Effective Public Private Partnerships (PPPs) : The World Bank Perspective

1. Developing Effective Public Private Partnerships (PPPs) : The World Bank Perspective Brazilia, Seminar on Improving the Quality of Public Investments and Public-Private Partnerships, April 25-27th, 2005 1

2. Contents • Recent Trends in Private Participation in Infrastructure • Infrastructure Investment • The Economics of Infrastructure • The Real Gap : Cost Recovery and Affordability • Fiscal Space (Public Investment) • Key Drivers of our clients demands • Public Private Partnerships (PPPs) • Leveraging Public Money • The Value for Money Concept • Public Sector options for Infrastructure investment • Development of Local Capital Markets (Chile, Infrastructure Bonds) • PPPs for service delivery to low income communities (Output Based Aid Mechanisms • Public financial support for PPPs (risk management framework) • Way Forward 2

3. Investment in PPI Projects, developing countries, 1990-2003 2003 $US billions $130.9 Total : US$890 billions in more than 2,700 projects Preliminary Figures for 2004 reflect no growth Period of Economic Reforms Russia East Asia Brazil Argentina $49.6 Source: PPI Data Base (PPI, Private Participation in Infrastructure) 3

4. Investment in PPI Projects, By Sector, 1990-2003 Total: US$890 billions Source: PPI Data Base 4

5. Investment in PPI Projects, By Region, 1990-2003 Total: US$890 billons Source: PPI Data Base 5

6. Cancelled or under distressed investments in Infrastructure Projects with Private Participation by sector, 1990-2003 PPI Global Trends: PPI under distress per Sector Source: The World Bank, PPI Project Database. /1 Of this total, Latin America represents US$ 56,291 (65%) i.e., Argentina 6

7. The Economics of Infrastructure Investments • Infrastructure investments are inherently “lumpy” (involve huge sunk costs and create assets that are long-lived and location-specific). • Creation of Infrastructure has economics both of scale and scope (i.e., minimum size of facilities, inelastic adjustment of capacity to demand, long term project completion, etc.). • Infrastructure supply systems contain elements of natural monopoly (competition). • Demand is wide spread (difficult to target). • Revenues are usually in local currency (mismatch if foreign debt financing). • Services have an essentiality component that raise legitimate public policy concerns of affordability. However ……….. • Sound infrastructure allows countries to integrate to the global economy and increases competitiveness (transport and telecom sectors are the highest contributors to a country’s competitiveness) impacting economic growth. • Infrastructure development has a strong impact on poverty alleviation and MDGs. 7

8. The Service Delivery Gap The Service Delivery Gap • There is limited affordability in the provision of most of infrastructure services (when including the costs of the required infrastructure facilities), specially when considering low income end-users. • Infrastructure services has strong characteristics as a public good and creates major positive externalities. • Full cost recovery is only possible in some situations (i.e., air transport). Most of the basic public services have strong limitations to reach full cost recovery even in developed markets (mass transport systems). • There is a role for the provision of “smart” subsidies to make possible the delivery of the service. Tariffs Cost recovery Affordability Time Output Based Aid Approaches 8

9. Fiscal Space : Public Investment Pilots, 2004 (IMF), Preliminary results • Eight selected pilot country studies (i.e., Brazil, Chile, Colombia, Ethiopia, Ghana, India, Jordan, Peru), in cooperation with World Bank and IDB. • Public Investments needs are sizeable in most countries but difficult to quantify. • Countries face important trade-offs between infrastructure spending and other expenditure items (i.e., health and education). • Little empirical evidence that reductions in public investments had an adverse impact on growth. • Countries with relatively high public debt burden have a limited scope for increasing investment via public borrowing. • Significant scope to improve the quality of infrastructure investment. • Changes in fiscal accounting cannot create room for additional spending for infrastructure. • Most of the public enterprises in the pilots did not meet the “commercially run” criteria. • Effective PPPs is encourage as a way to bring in leveraging and efficiency in infrastructure investment. 9

10. Key Drivers for Our Client Demands • Change in the risk profile of our client base: • 80s : developed and developing countries • 2000s forward • Middle Income Countries • Transition Economies • Post Conflict • Failed States • Sustainability of annual infrastructure investment program closer to 5 % to 6% of GDP in order to maintain economic growth. • Need to fill the service delivery gap (full cost recovery not possible at the required pace for market driven incentives to support investments) • Fiscal Space for Public Investments will be limited at best (limited new borrowing capacities to allocate to infrastructure development) 10

11. Private Public Partnerships : Leveraging Public Money • Need to reconcile infrastructure development needs with criteria for fiscal prudence. • Need to mobilize additional private capital to match the gap if infrastructure development is to keep its pace sustaining economic growth. • Need to maximize private capital mobilization per unit of public sector contribution (e.g., direct investment, subsidies, guarantees, etc.). • Need to develop PPPs approaches as a procurement tool for better and efficient allocation of scarce public sector resources (the concept of value for money). • Need to develop an adequate risk management framework to manage contingent liabilities arising for public money support to PPPs development. 11

12. Leveraging Public Money : Public Sector Options for Infrastructure Investments • Pure Public Option: • Funded via ordinary revenues • Funded via earmarked taxes (i.e., gas taxes for road network development) • Funded via public debt financing (i.e., future tax payers) • Public Private Partnerships Options • Funded via tolls or tariffs (i.e., full cost recovery basis) • Funded via tolls or tariffs with initial co-investment contribution (e.g., Bridge Rosario-Victoria, Argentina) • Funded via tolls or tariffs with minimum revenue guarantee (e.g., Motorway Santiago-Valparaiso, Chile) • Funded via tolls or tariffs with subsidy supplement (e.g., BA metro system) • Funded via shadow tolls or subsidies (e.g., Portugal toll roads) 12

13. PPPs : Spectrum of Options PPPs are contractual arrangements between the public sector and the private sector for the private delivery of public infrastructure services (or other basic services). Procurement tool where the focus is payment for delivery of services rendered. Transfer of the performance risk. Infrastructure Facilities Provision of Infrastructure Services 13

14. The Value for Money Concept (when to use PPPs instead of pure public investments) • PPP projects should be able to provide equivalent or better value for money than a pure public sector project approach • develop base case with which to assess incremental benefits of the PPP approach • Incremental Benefits (“good investment”) may accrue from: • speedier Implementation (fiscal constraints) • total long-term costs (life costs) of the operation • Better service (cost & efficiency) and coverage • Adequate distribution of risks : • Public Sector Contribution • Investment • Guarantees • Subsidies • Others Optimal: efficient sharing of risks Too little: no Value For Money Too much: project failure Risk Transfer 14

15. Public Sector Options for Infrastructure Investments : SSA Toll Roads Case • Parameters: • 40 KM toll road linking two important urban centers (existing road under very poor conditions) • Traffic Study : 70,000 vehicles per day • Total Investment : $ 200 million • Annual operating & maintenance costs: 5% of total investment ($ 10 million) • SSA Credit Rating: B+ • If private options are considered: • Debt : Equity ratio : 75%-25% • Debt services conditions: 10 year @ 10% • Equity expected rate of return: risk free rate + premium = 5%+11% (16%) 15

16. Public Sector Options for Infrastructure Investments : SSA Toll Roads Case • Required Annual Cash Flows (including remuneration to debt & equity) • Operating & Maintenance : $ 10 million • Debt Service : $ 24 million • Equity returns: $ 8 million • Total = $ 42.4 needed in annual revenues ($ 3.52 million per month assuming no seasonality • Required Average tariff per vehicle • $ 3.52 million / 70,000*30 = $ 1.68 per vehicle 16

17. Public Sector Options for Infrastructure Investments : SSA Toll Roads Case Scenario 1 : Willingness to pay = zero (A) Pure Public Investment Funded via tax payers (government budget) an/or donors’ assistance Performance risk is assumed by Government Upfront investment of $ 200 million (B0 PPP via 100% shadow toll road equivalent to $ 1.68 per vehicle Concession structured as an performance based scheme with shadow toll paid by government budget allocations [tax payers] on the basis of performance based criteria (i.e., maintenance and safety of road usage). Shadow toll payments likely to need strong backstopped by MLAs and Donors (e.g., guarantees, liquidity facilities) Upfront investment by the PPP special purpose company. 17

18. Public Sector Options for Infrastructure Investments : SSA Toll Roads Case Scenario 2 : Willingness to pay = between zero and $ 1.68 per vehicle ($0.84 per vehicle) (C) PPP via a collected toll fare ($0.84) plus a supplemental subsidy ($0.84). Subsidy can be paid as a shadow toll or can be structured as a traffic minimum revenue guarantee (defining a predetermined level of total revenues). Performance risk is transfer to the private sector. No initial disbursement by the public sector. (D) PPP via a co-investment between the Public and Private sector. Size of public co-investment will be equal to the difference between total investment and the investment amount supported by the existing tariff (i.e., $ 126.7 million in this case). Performance risk is transfer to the private sector. Initial disbursement by public sector. 18

19. Public Sector Options for Infrastructure Investments : SSA Toll Roads Case Scenario 3 : Willingness to pay = equivalent to required tariff ($ 1.68) (E) PPP via a collected toll fare ($1.68) Depending on the robustness of the traffic studies and the willingness to pay [affordability] analysis, government and/or donors might need to provide some type of support to the traffic revenue scheme. Performance risk is transfer to the private sector 19

20. Infrastructure PPPs: Developing Local Capital Markets • There is no best substitute for foreign exchange risk mitigation than matching the currency revenue generation with the currency of debt payment services (matching assets and liabilities). • Financing infrastructure facilities and services (local currency based) in the foreign debt markets adds substantial risk to the structuring of adequate PPPs creating the need for additional public money support. • Local institutional investors (I.e., pension funds, insurance companies, life annuities, etc.) have a natural demand for long-term local currency debt instruments to match their liabilities. • It is in the government’s best interest to stimulate, via adequate securities regulation and institutional investors overseeing, the development of local capital markets as a source of long-term local currency funding for needed PPPs infrastructure projects. • The concessions program in Chile (1993-2002) covered 44 contracted projects with a total value of US$5.7 billion (about 6¼ percent of 2004 GDP). Approximately 75% was funded in the local capital markets via local currency infrastructure bonds (long tenors). 20

21. PPPs for service delivery to low income households : OBAs Output Based Aid: A strategy for supporting the delivery of basic services that depends on public funding (subsidies) where output based payment is linked to service delivery and the performance risk is placed on service provider • Explicit performance-based subsidies incorporating: • ‘Smart’ design characteristics • ‘Targeted’ on key beneficiaries • ‘Efficient’ in amount (enough to fill the gap) • ‘Sustainable’ • Project finance dimension where investments are supported by two types of cash flows (i.e., end-users – affordability, and government/donors) • Delivery within a ‘performance-based’ regime • Established by either competition between suppliers; or • Performance contract with specified outputs • Introduction of competitive tension/dynamic • In market • Through subsidy award process 21

22. Why subsidise basic infrastructure services? ‘To increase consumption of a service to levels that would otherwise not be the case’ as a result of: Limited affordability Public/merit goods Positive externalities Why use OBA approaches (PPP)? To improve ‘subsidy effectiveness’ through: Increased accountability Private Sector Participation (capital and efficiency) Transparency/less potential for corruption Better value for money Fewer economic distortions PPPs for service delivery to low income households : OBAs Millennium Development Goals 22

23. OBAs : Preliminary Results About 30 projects – donor/MLAs financed – to date at various stages of implementation. 23

24. Public Financial Support for PPP • Need to reconcile infrastructure investments needs with fiscal prudence. • Ring-fenced government sponsored vehicles to limit amount of contingent liabilities arising from public support to public-private partnerships projects (i.e., co-investment, guarantees, subsidies, off-take contracts, etc.) and assist to improve governance and transparency of the allocation of government contribution (risk management). • Funded by government’s contribution (tax payers) and donors-multilateral interventions. • Limited experience with government sponsored vehicles (I.e., infrastructure funds, guarantee funds, etc. ) /1 • Relatively unsuccessful experiences with state-owned development banks in the 80s and 90s • Limited experience with dedicated infrastructure financing facilities in the 90s (e.g., Pakistan, India, Colombia) • Keen interest by some of our larger clients (e.g., Russia, India, Indonesia, etc..) /1 IFC has awider experience with private sector driven funds (e.g., infrastructure funds, mezzanine, etc). 24

25. Guarantee fund: Design Principles • Scope of eligible projects: private infrastructure only? • Appropriate credit rating (and hence solvency and liquidity): international or local investment grade? • Size of fund: depends on scope, desired credit rating, and estimated risks. • Types of product: partial credit guarantees, partial risk guarantees, liquidity facilities, ? • Legal structure: closed or open fund? • Involvement of others or not: donors, private firms? • Supporting sub-national entities ? • Governance: board representation, delegated power, reporting, relation to Ministry of Finance, Ministry of Economy/Planning, Sector Ministries. 25

26. Guarantee Fund: Governance Issues • Should decision makers be required to have obtained an estimate of the cost of a guarantee before deciding? • Should the beneficiaries be charged for guarantees? If so, how are prices estimated (based on financial modeling , with some standardization?) • How can government ensure trade-offs are made among guarantees and between guarantees and traditional expenditure? • Setting ceiling on maximum exposure from guarantees and/or maximum estimated cost of exposure. • Incorporating guarantee costs in the budget:. Valuation methodology for costing guarantees. • What information should the government be required to disclose publicly • Full text of contracts exposing government to risk (power-purchase agreements, comfort letters, guarantees, etc.)? Estimate of the cost of guarantees? • How can the government monitor guarantees, long-term purchase agreements, alongside other liabilities? 26

27. Guarantee fund: Potential Structure Ministry of Finance Need for investment grade rating (local and international) To be determined blend of cash and commitments First Tranche GOI Budget Allocation (yearly, program) Projects Energy Transport Water & Sanitation Telecom Selection criteria, test of project value added, pricing of guarantee, terms and conditions Second Tranche MLAs and Donors Third (later) Tranche Private Insurers 27

28. Guarantee Fund: Key Concerns • To what extent could a fund • Successfully limit government’s liability while adequately protecting investors from risks under government’s control? • Permit integrated decisions about alternative forms of support (guarantee versus subsidy; loan guarantee versus guarantee of power-purchase agreement)? • Help attract other donors or financial institutions? Encourage better financial reporting and other disclosure? • Improve incentives to make decisions in Country’s interest? • Facilitate the hiring of staff with expensive specialist skills? 28

29. Way Forward • Need by MLAs and Donors to invest more resources in demonstrating the link between “good” infrastructure investment and economic growth. • Broader use of PPP schemes as a way to maximize public money leveraging for infrastructure development. Need to build solid institutional capacities in the public sector to improve “good” infrastructure PPPs as well (i.e., government as a reliable partner, smart economic regulation, improved mechanism for disputes and arbitration, etc.) • Increasing use of output based subsidies as a way to utilize better private sector resources via effective allocation of performance risks (PPPs to deliver services to poorer communities). • Development of local capital markets (local currency debt instruments) as a mechanism for improving effective access to infrastructure financing by PPPs. • Increase demand for improved risk management practices for contingent public liabilities when supporting infrastructure development (PPPs). 29

30. Thanks World Bank Group Infrastructure Economics and Finance April 26th , 2005