COMMENTS WELCOME Is Debt Replacing Equity in Regulated Privatized Infrastructure in Developing Countries? Luis Correia da Silva (OXERA) Antonio Estache (World Bank and ECARES, Universite Libré de Bruxelles) Sakari Järvelä (OXERA) Abstract The main purpose of this paper is to describe the evolution of the financing structure of regulated privatized utilities and transport companies. To do so, we rely on a sample of 121 utilities distributed over 16 countries, and 23 transport infrastructure operators and 23 transport services operators distributed over 23 countries. The paper shows that leverage rates vary significantly across sectors, with the highest rates observed in transport and the lowest in water. Moreover, the paper also shows that the 1997 Asia crisis led operators to adjust their financial structure differently in different regions. Overall, the evidence presented here shows that debt is replacing equity in financing the investment needs of utilities and transport services in developing countries. These results raise some questions as to whether the regulator's mandate should be expanded to monitor the financial structure of companies and as to whether the international community should make a stronger commitment to more transparent regulatory accounting systems. World Bank Policy Research Working Paper 3374, August 2004 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 names 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. Policy Research Working Papers are available online at http://econ.worldbank.org. The paper has benefited from comments and/or discussions with Ian Alexander, Phil Burns, Jose Carbajo, Jose- Luis Guasch, Jean-Jacques Laffont, Anwar Ravat, Martin Rodriguez-Pardina, Richard Schlirf, German Sember, Sophie Sirtaine, Lee Travers, Lourdes Trujillo and Christian von Hirschausen. 1. Introduction One of the main motivations of the infrastructure privatization wave of the 1990s was to obtain a significant contribution from the private sector to the financing of the major investment needs of the poorest countries. Reforms, restructuring and guarantees were generally aimed at maximizing the access to private investment. More specifically, this meant reorganizing the sector to achieve a significant equity contribution in financing new projects. Initially, the private sector responded very positively, as illustrated by the major acceleration in private sector investment commitments during the first half of the 1990s. Average annual investment commitments totalled approximately US$62 billion between 1990 and 2002. This was significant, in that it represented 20 to 25% of the actual investment expenditures in the sector (DFID, 2003). More recent evidence provides a much less positive story (World Bank, 2003). Investment commitments peaked in 1997 and have since continued to drop. With a commitment level of US$47 billion, 2002 figures represented the lowest level of investment commitments in projects with private sector participation since 1994. This represents a decline of 30% compared with 2001, matched by a significant reduction in the number of projects reaching financial closure. This story adds a potentially serious element to the many issues associated with the reversal trend. Indeed, in addition to the fact that the drop in commitments is likely to slow down the ability of the poorest countries to meet their needs, a change in the nature of these commitments may further add to the burden of these countries. This is because, in many countries, there is a growing concern that the financing structure adopted by the operators may be increasingly switching from equity to private, mostly foreign, debt financing. 1 A progressive switch from private equity to private debt is likely to be difficult for two reasons. First, contrary to what is suggested by finance theory, in developing countries debt finance can be more expensive than equity finance when the effective short-term nature of the bonds markets is accounted for and the transaction costs associated are accounted for. This implies that sectors moving toward higher debt financing would be facing higher financing costs for future investment (Alexander et al., 2001).2 Second, every dollar that enters a country would be matched by a much larger proportion of debt contracted by the private operators. The public debt needed to finance the operations in the past would then be replaced by private debt rather than by private equity. Besides the obvious balance of payments consequences, this evolution in the financing structure of the sector raises significant issues from the strict viewpoint of regulation. Indeed, more expensive debt and operators more leveraged in foreign currency imply higher risks, 1See also Alexander and Shin (2003) on evidence of the increased role of bond financing in regulated industries 2 This stems from a couple of reason. First, most of the debt is generally foreign debt since domestic capital markets are seldom developed enough to generate the required financing and in uncertain environments, risk premia tend to be quite high. Second and more importantly, debt financing in developing countries tends to be of short maturity. This implies that debt needs to be reissued or refinanced quite frequently by the operators and fairly high transaction costs. Indeed, interest rates are only a minor part of the cost of debt in developing countries. A large share of the cost is associated with complex fee structures charged by banks which in view of the short term nature of the associated financing instruments tend to be paid almost as frequently as interest payments. 2 higher cost of capital and hence higher tariffs. Ultimately, if there is indeed a marked trend toward increased debt financing, the typical hands-off position of regulators with respect to the financial structure of the regulated infrastructure industries may no longer be sustainable in developing countries, because in an increasing number of experiences debt ratios have been at the core of regulatory conflicts. Several recent experiences suggest that the concern seems to be justified. Both the experience of the 1997 multi-country Asian crisis and, more recently, the 2002 Argentinean crisis have resulted in the direct involvement of regulators in discussions of the financial structure of privatized infrastructure companies as a way of mitigating the social consequences of brutal changes in leveraging associated with foreign exchange crises (e.g. Estache (2004)). For companies that are highly leveraged in dollars, these devaluations resulted in major increases in debt service requirements which necessitated a choice between considerable average tariff increases, or a major scaling down of investment programs at existing local currency tariff levels. In both Asia and Latin America, the de facto erosion of real tariffs has been such that many operators are no longer compliant with the previously agreed conditions for obtaining more funds or refinancing debt with banks, and have hence also slowed down or stopped their investment commitments. But it is not only in developing countries that regulators have become aware, in recent years, of the relative importance of debt financing for regulated industries. The major telecommunications debt bubble of 1999-2000 resulted in a credibility crisis and a depression in equity values that have since diminished the operators' access to capital. In order to participate in the telecoms boom of the second half of the 1990s, major incumbent telephone companies had issued stock and took on excess debt to finance spending and acquisitions. Since the crisis, the companies have seen their market capitalization fall more than half since 2000. As credit rating agencies downgraded companies, the cost of borrowing increased and this in turn eroded the price benefits of the technological progress in the sector.3 With this background in mind, the main purpose of this paper is to document more systematically the evolution of the financial structure of the regulated companies in developing countries and some of the related policy consequences. The paper focuses on some of the basic indicators available on the evolution of the capital structures for a large sample of regulated utility and transport companies in developing countries. The paper will not, however, seek to address the micro-level implications of these developments. When looking at the capital structures of regulated companies, obvious questions arise with regard to the impact of regulation in the companies' financing choices, and the tools the regulators have at their disposal to influence these choices. These issues have recently been analyzed in depth in the context of utility sectors in developed countries (by OXERA (2003)). However, the set of issues in LDCs is more complex, and would warrant more extensive analysis to address them in sufficient depth. The paper is organized as follows. Section 2 explains the collected dataset and methodology used for estimations. Section 3 presents the results for the full set of data. 3For more details see the various consultation papers of UK communications regulator, Ofcom, available on its website www.ofcom.gov.uk. For a discussion in the context of the water sector, see Correia da Silva et al. (2003) or Palmer (2003) 3 Section 4 discusses the evolution of leverage of the sector since the 1997 Asia crisis. Section 5 summarizes the main results and raises the policy issues that seem to emerge from the simple analysis of the data presented in the paper. 2. Data and methodology The paper focuses on stock market listed companies operating in developing countries.4 Distinction is made between utilities and transport companies. This is due to historical differences in the types of regulation and levels of competition between the two sectors, which have also influenced the financing structures in these companies. The utilities sample is further broken down into electricity, gas and water sectors, and the transport sample into infrastructure and services providers. However, the scope for detailed monitoring of the evolution of the financing structure for any company in developing countries is limited, since few regulators in these countries tend to collect this data systematically. Also, in many countries an increasing number of small local companies are taking over the public management and provision of services in sectors such as water and sanitation and transport services. Unless these smaller companies are listed, they will not be covered here. There is, however, a large enough set of companies that report their financial structure in their home countries to ensure the statistical representativeness of the sample collected here. The sample data were collected from the companies listed in the Thompson Financial Datastream database. Datastream holds accounting and financial market data for publicly traded companies in a large number of countries, collected from companies' group financial accounts and regional data providers. The data were collected for a period of 12 years from 1991 to 2002. The total number of observations in each year is presented in Table 1. A more detailed data description is provided in the Appendix. For utilities, the data are for 121 companies from 16 countries. These include 90 electricity companies5, 23 gas distribution companies and 8 water distribution companies. For transport, the data limitations were more constraining and required a more complex screening and aggregation process. Only companies that are at least partly subject to government regulation are considered. Attention is restricted to the following transport sub-sectors: rail and road passenger transportation companies, airlines and airports, and shipping ports. In order to have representative sample sizes, companies had to be aggregated into two categories, depending on whether they were transport service or transport infrastructure providers. The final dataset comprises 23 transport infrastructure and 23 transport service companies in 15 developing countries. 4This is clearly a biased sample but it is the only one for which this kind of data is available. 5For the purposes of this study, both electricity transmission and distribution companies are included under the electricity sector. 4 Table 1: Data description Utility sample Transport sample Year Electricity Gas Water Total Infrastructure Services Total 1991 16 2 0 18 3 3 6 1992 19 3 0 22 5 4 9 1993 25 4 1 30 5 6 11 1994 28 6 2 36 5 8 13 1995 30 8 3 41 7 9 16 1996 46 12 4 62 9 10 19 1997 50 15 7 72 11 14 25 1998 51 16 7 74 10 14 24 1999 73 21 8 102 18 19 37 2000 80 21 7 108 20 22 42 2001 84 20 8 112 22 23 45 2002 82 20 8 110 19 23 42 Source: Datastream. As was to be expected in the case of developing countries, the quality of the data is an issue. All necessary data were not available for all companies for all years, and there may therefore be gaps of one or more years in the time series of leverage ratios. This makes the aggregate sample somewhat unbalanced. As a result, although the number of companies in the sample increases steadily over time, there can sometimes be substantial changes in the identity of companies in the sample in each year. Although this does not affect the longer- term trend, it might increase the volatility of average sectoral levels of leverage from year to year. When analyzing the impact of the 1997 Asian crisis, this volatility needs to be controlled, and therefore a balanced sample was constructed. This balanced sample covers the period from 1997 to 2002, and only considers companies that have a full time series of data for those years. For utilities, 54 companies fulfill this criterion, including 37 electricity companies, 14 gas distribution companies and 3 water companies. For the transport sector, the balanced sample contains 20 companies: 8 transport infrastructure and 12 transport services providers. The countries covered in the sample include Argentina, Brazil, Chile, Mexico, Peru and Venezuela for Latin America; China, India, Indonesia, Malaysia, Pakistan, the Philippines, South Korea and Thailand for Asia; and a residual group of important countries in the international investment world for infrastructure, including the Czech Republic, Russia, South Africa and Turkey. All data were collected in domestic currency. Table 2 describes the data types collected for these countries, and their definitions for the purposes of the calculations of the leverage ratios. While leverage can simply be defined as the ratio of the value of a firm's debt to the combined value of the firm's debt and equity, practical estimations can be more complicated, as several definitions of debt and equity can be used. 5 Table 2: Data types collected Data type Definition Market value of equity Share price multiplied by the number of ordinary shares in issue Net debt The total of all long- and short-term borrowings, less total cash and equivalent Total share capital and The total share capital and reserves, including preference reserves shares The equity capital of a firm can be measured in terms of either market or book value. From a theoretical perspective, the market value should be used, as it reflects all available information, and represents the present discounted value of the firm's equity. Using market values, however, may expose the measured leverage to higher short-term volatility. Moreover, if the market value of equity is readily available for publicly traded firms, the market value of a company's debt is often unobservable. Therefore, in many cases, leverage is estimated with the book value of debt. Also, in estimating a firm's leverage, the debt maturities that are to be considered must be decided. This choice can be somewhat dependent on the purpose for which the leverage measure is estimated. In the academic literature, firms' leverage measures have normally been based either on the total amount of debt, or on long-term debt only. The specific financial ratios calculated in this paper are shown in Table 3. Two leverage measures are produced: one based on the market value of equity and the other on the book value.6 For both leverage measures, the debt is measured as the company's net debt, which includes all long- and short-term liabilities but deducts the cash reserves. This is done because a firm may have considerable outstanding debt, but at the same time also hold a significant amount of cash. Therefore, using net debt in the leverage calculations can provide a more accurate indication of the firm's true liabilities.7 Table 3: Financial ratios Ratio Definition Leverage(1) Net debt/(net debt + market value of equity) Leverage(2) Net debt/(net debt + total share capital and reserves) It may be useful to point out that despite the major differences in accounting rules that make international comparisons difficult, the data provided here may provide useful benchmarks for companies not covered by the sample. Whenever possible, we will compare the lessons to be learned from these two approaches. The former is potentially subject to significant levels of volatility, but is the most appropriate from a theoretical standpoint. The 6In general, comparing company financial information across countries can be problematic due to different accounting practices. Although the majority of countries in the sample use accounting principles comparable to the North American GAAP, this is not consistently the case. For example, South Korea and Thailand's models are closer to the model used in Germany and Japan. These differences may have an impact on leverage measures based on book values. 7It is notable that using a company's net debt presents the possibility of negative leverage. If the amount of cash reserves exceeds the amount of debt (ie, net debt for the firm is negative), the observed leverage will also be negative. 6 latter, based on standardized accounting valuations, is much closer to what is readily available for operators in developing countries 3. Evolution of the financial structure during the 1990s This section reports the evolution of the two leverage indicators for developing country utilities in section 3.1, and for transport companies in section 3.2. Whenever the sample sizes are statistically representative, we also report the results for specific geographical areas. 3.1 Results for the full sample of utilities Table 4 shows the results of the leverage analysis based on market and book equity valuation,s respectively. The figures are averages across all identified companies for the three utility sectors, and key results can be summarized as follows.8 · Electricity--when measured using market value of equity, electricity shows the highest leverage; moreover, there is evidence of a clear increase in the average leverage levels over time. Leverage(1) has increased from a low of 15% in 1994 to over 40% in 2002. However, this trend is not observed when the leverage ratios are based on book values of equity. Leverage(2) has fluctuated steadily at around 30%, with no apparent long-term trend. · Gas distribution--according to the market valuation of equity, the average leverage for this sector has increased steadily over the period from below zero in 1991 to close to 40% in 2002. According to the book valuation of the leverage ratio, leverage (2), the trend looks slightly different. After a substantial jump at the beginning of the period, the average leverage has remained stable at between 20% and 30%, increasing to slightly above 30% in 2002. · Water--the average leverage for water companies is generally lower than for companies in the other two sectors, and does not display any clear upward or downward trend. The time-series is also more volatile, and experiences some considerable fluctuations from year to year. Both leverage(1) and leverage(2) have very similar patterns over time, and have largely stayed close to 10­20% in recent years. 8All results are unweighted averages across the relevant samples. Furthermore, the use of the median rather than the mean was preferred due to some data outliers. 7 Table 4: Average leverage by sector, based on all identified data (%) Leverage 1 - Market based Leverage 2 - Accounting based Year Electricity Gas Water Electricity Gas Water 1991 28.6 -2.5 n.a. 28.7 -14.2 n.a. 1992 26.7 0.4 n.a. 32.7 0.9 n.a. 1993 17.8 5.0 -21.6 25.9 21.3 -107.2 1994 14.2 9.2 -10.5 18.8 24.6 -16.4 1995 21.7 14.5 7.9 33.1 29.3 5.8 1996 18.7 10.1 5.8 20.1 25.7 4.9 1997 22.7 18.3 7.5 20.0 25.8 32.7 1998 36.4 23.8 24.4 24.6 28.8 36.4 1999 36.1 29.3 10.2 23.2 35.1 18.4 2000 35.1 36.7 1.8 25.3 29.6 6.2 2001 39.5 39.2 17.4 26.0 33.6 13.0 2002 44.0 39.2 26.3 31.6 38.2 7.9 Source: Datastream and authors' calculations. The sample covers companies from different geographical areas and institutional backgrounds. Therefore, apart from considering sectoral differences, it is of interest to compare leverage ratios across geographical areas. Table 5 presents the average results for leverage(1) and leverage(2), calculated across countries in three geographical areas. The results are again unweighted averages and are based on all identified data. Overall, the figures show some regional differences in the way the utilities are financed. The most important results can be summarized as follows. · South America--measured by leverage(1), South American utility companies have increased their leverage levels considerably over the last 10 years. The average level of leverage has been rising throughout the period, reaching almost 60% in 2002. However, the same trend is not observed with regard to leverage(2). When book value of equity is used, the leverage has remained practically constant, at close to 30%. A slight jump can be observed from 2001 to 2002. · Asia--the average leverage for Asian utilities follows a very similar pattern to the South American utilities. The average increase in leverage(1) has not been as large over the last five years, but the trend has been very similar. The average leverage(2) has fluctuated between 20 and 40%. · Other--the third group of countries consists of mainly Eastern European countries. The capital structures of utility companies in these countries have typically been characterized by low levels of debt. Both market and accounting based measures of leverage have remained low over the period, fluctuating around 0%. · Overall: the Asian and South American utility sectors appear to be characterized by very similar levels of leverage. In Eastern European countries, the utility companies seem to be significantly less debt-financed. 8 Table 5: Average leverage by geographical area, based on all identified data (%) Leverage 1 - Market based Leverage 2 - Accounting based Year South Asia Other South Asia Other America America 1991 25.4 27.9 -3.6 28.2 31.1 -25.7 1992 27.0 26.2 -24.2 29.5 48.4 -79.4 1993 19.6 6.9 3.8 21.5 27.0 12.0 1994 13.3 9.8 7.9 17.3 25.4 1.7 1995 21.0 18.4 5.4 27.9 32.5 -15.1 1996 21.7 13.6 0.2 26.2 26.1 0.2 1997 23.1 31.4 0.5 21.1 33.5 0.5 1998 41.8 28.2 -0.1 31.4 28.9 -0.1 1999 38.7 33.0 8.8 31.2 33.1 8.6 2000 42.8 35.0 2.0 28.7 29.6 6.3 2001 52.1 36.1 4.7 30.4 33.0 1.4 2002 59.3 39.2 -10.0 37.7 37.0 -5.4 Source: Datastream and authors' calculations. 3.2 Results from the full sample of transport companies Table 6 reports the estimated levels of leverage across the two types of transport company in developing countries. The numbers clearly show that the average leverage levels in the transport services sector appear to have been increasing over the period. The increase seems more pronounced when the market value of equity is used in the calculations. In the transport infrastructure sector, the development has been slightly different. The leverage levels seemed to have reached their peak around 1999, after which there has been a rapid decline. A similar pattern is observed for both market and book value based measures. 9 Table 6: Average leverage by sector, based on all identified data (%) Leverage 1 ­ Market based Leverage 2 ­ Accounting based Year Infrastructure Services Infrastructure Services 1991 26.2 37.7 21.6 53.5 1992 3.6 44.2 16.9 59.7 1993 19.3 31.2 37.2 48.1 1994 15.3 20.7 50.9 40.8 1995 25.4 33.4 41.6 47.8 1996 23.2 22.4 36.6 38.7 1997 38.1 62.7 36.5 53.0 1998 41.1 60.6 45.5 62.0 1999 41.1 54.7 31.4 67.6 2000 46.8 47.4 23.9 55.1 2001 36.5 57.3 18.9 46.5 2002 13.8 58.2 10.9 50.5 Source: Datastream and authors' calculations. The key results for each sector can be summarized as follows. · Transport services--transport service providers in developing countries appear to be characterized by relatively high levels of leverage. When the market value of equity is used in the calculations, there is evidence of a gradual upward trend over the past decade. The average leverage(1) has increased from below 40% in 1991 to 58% in 2002. When leverage is measured by the book value of equity, the average leverage appears to fluctuate at around 50%, without any clear upward or downward trend. However, a dip is observed in this measure of leverage after 1999. This is not only high when compared to other sectors, it is also high compared to similar sectors in developed, countries where leverage rates, as defined, here tend to be around 30%. · Transport infrastructure--the increase in average leverage up to 2001 was more pronounced in this sector. When measured with leverage(1) in Figure 3.1, the average leverage has increased from close to 0% in 1992 to close to 40% in 2001. However, a significant decrease is observed from 2001 to 2002. However leverage(2) does not exhibit a similar upward trend in the mid­1990s. Although the average leverage(2) seemed to have increased from 20% to 50% between 1991 and 1994, this has been followed by a steady decline to 10% in 2002. The geographical disaggregation for transport companies is less meaningful because of the smaller sample size. The main distinction that can be made is between Asian companies and companies from other parts of the world. This is reported in Table 7 below. For Asian companies, the trend in leverage has been broadly similar, regardless of whether market or book values of equity are used, although, pre-1996, the level of leverage(2) remained higher than that of leverage(1). Both leverage measures experience a substantial jump after 1996 and peak in 1998, but have been decreasing steadily since then. 10 For companies in other countries the trends of the two measures behave differently over time. Leverage(1) remained at relatively low levels until 1997, after which there was a considerable increase; the average leverage(1) reached close to 60% in 2001. Leverage(2), by contrast, exhibits a reasonably stable trend over the period. Apart from the peak in 1998 the measure has been fluctuating between 20% and 40%. However, the trends over time can be somewhat sample­specific. In the years prior to 1998 there are only a few companies in the `other countries' sample, suggesting that the average leverage presented here is not likely to be a fully representative indicator of transport companies' capital structure choices across these countries. Overall, it appears that the trends in transport companies' leverage have been similar across this geographical distinction. The levels of leverage have also been converging towards the end of the period. Table 7: Average leverage by geographical area, based on all identified data (%) Leverage 1 ­ Market based Leverage 2 ­ Accounting based Year Asia Other Asia Other 1991 52.3 21.2 48.1 21.6 1992 33.2 11.4 43.0 30.6 1993 26.7 26.2 40.7 38.3 1994 18.9 34.6 46.1 38.4 1995 29.4 23.9 48.8 25.0 1996 23.2 24.8 38.7 19.6 1997 52.3 6.8 53.8 16.4 1998 59.6 59.2 60.6 63.9 1999 52.8 54.8 53.7 43.9 2000 46.3 47.6 39.3 24.8 2001 37.6 57.8 34.2 38.5 2002 37.1 52.1 30.7 30.0 Source: Datastream and authors' calculations. 4. A more precise look at the evolution since the 1997 Asian crisis In developing countries, the concern with the financing structure of regulated companies started approximately with the slowdown in the interest in project finance resulting from the 1997 Asian crisis. Since this crisis also corresponds to the beginning of the overall slowdown in the commitments made by the private sector to infrastructure investment in developing countries, it is important to make a more precise assessment of the evolution of the situation. Having a high-quality sample of data is essential for this purpose. Indeed, while the relatively high volatility of average leverage levels observed due to the unbalanced full sample does not have much impact on the overall long-term trend, which was presented in section 3, it may interfere with the analysis of the impact. To control for this, results were also produced for the balanced sample which covers a much lower number of countries and companies, but which includes the same companies for each year between 1997 and 2002. The utilities sector is covered in section 4.1 while transport is covered in section 4.2. 11 4.1 Impact of the Asian crisis on the financial structure of utilities Table 8 presents the results for the balanced sample with regard to the average leverage levels in the three utility sectors for the 5-year period following the Asian crisis. Table 8: Average leverage by sector, balanced data (%) Leverage 1 ­ Market based Leverage 2 ­ Accounting based Year Electricity Gas Water Electricity Gas Water 1997 22.2 13.4 7.5 19.2 25.0 41.9 1998 41.3 20.8 24.4 24.6 28.5 36.4 1999 35.6 26.5 21.6 23.2 32.5 40.0 2000 42.7 31.6 19.2 25.9 27.3 27.6 2001 39.6 30.2 26.0 28.4 32.9 17.8 2002 42.9 27.4 48.6 34.5 29.1 8.7 Source: Datastream and authors' calculations. According to the market valuation of assets, there appears to be a clear upward trend in leverage ratios in all sectors. As expected, the acceleration started right after the 1997 crisis as companies saw the real market value of their equity drop. Moreover, for many of the companies, the debt level did not change, or actually increased, in local currency terms, because, for many of the operators, the debt is often contracted in foreign currency. After a 2- year slowdown in the acceleration, the debt/equity ratio has again started increasing following the stock market bust in 2000. The highest leverages are still observed in the electricity sector, and the lowest for the water sector, suggesting that lenders perceive risk to be lower in the energy sector than in the water sector in developing countries. For the electricity sector the results from the balanced sample closely resemble those based on all identified data reported earlier. The average leverage(1) has increased significantly from just above 20% in 1997 to above 40 % in 2002. The book valuation tells a slightly different story. For electricity and gas, leverage(2) does not exhibit an increase similar to that revealed by the market valuation leverage. It stays virtually constant between 20% and 30% after the 1997 Asian crisis, with only a slight upward trend. For water companies, however, there is a marked difference between the two leverage ratios. Leverage(1) starts from an average level of below 10% and gradually increases over the period to almost 50% in 2002. In contrast, the average level of leverage(2) for water companies was close to 50% in the beginning of the period, and has declined substantially over the period to about 10% in 2002. For this sector, however, it is important to remember that the companies' local equity valuation may have been driven up by a series of strategic changes in the size and management of the global parent companies with which they were associated. The sector is now controlled by four major players that have acquired many of their smaller competitors during this period--i.e. many of the smaller Spanish water companies that were key players in Latin America in the earlier years of privatization have been acquired by the two largest French companies. Also, the equity appreciation of these 12 companies enjoyed through their diversification in other business lines is likely to have had some local spillover effects. It is also worth highlighting an interesting regional finding arising from the results. Both leverage indicators suggest that the financing policy of operators in Latin America was much more dramatically influenced by the Asian crisis. Indeed, while there was a small increase in Asia from 25% to 40% in the leverage rate based on market values, the major increase was observed in Latin America, which has seen its leverage rate more than double as a result from the Asian crisis. These developments are shown in Table 9. Table 9: Average leverage by geographical area, balanced data (%) Leverage 1 ­ Market based Leverage 2 ­ Accounting based South Asia Other South Asia Other Year America America 1997 20.9 25.6 -2.6 21.1 30.6 -2.7 1998 42.3 28.2 0.1 30.2 28.9 0.1 1999 37.7 34.3 5.5 33.7 36.4 3.6 2000 50.0 33.3 2.0 38.2 29.6 0.8 2001 51.8 36.3 4.7 42.5 32.5 1.4 2002 52.9 42.9 -12.8 51.4 29.2 -6.0 Source: Datastream and authors' calculations. 4.2 Impact of the Asian crisis on the financial structure of transport operators Table 10 presents the results for the balanced sample with regard to the average leverage levels in the two transport sub-sectors. The results from the balanced sample analysis are somewhat different to those based on all identified data. Namely, the leverage ratios from the balanced sample show significantly higher stability than the unbalanced sample ratios over the same time period. The availability of data for transport companies has increased considerably during the past five years and, as a result, the number of companies in the full sample almost doubled between 1997 and 2002. Therefore, the trends observed in the full sample over this period may reflect new data becoming available, rather than companies choosing to alter their capital structures. The results from the balanced sample suggest that this might indeed be the case. However, evidence from both samples suggests important information about the transport companies' capital structure choices. 13 Table 10: Average leverage by sector, balanced data (%) Leverage 1 ­ Market based Leverage 2 ­ Accounting based Year Infrastructure Services Infrastructure Services 1997 45.1 52.8 46.9 51.6 1998 41.1 60.6 46.4 62.3 1999 41.1 54.7 39.5 64.9 2000 49.9 47.4 30.6 64.3 2001 47.4 53.9 31.3 56.0 2002 29.7 56.1 17.2 59.4 Source: Datastream and authors' calculations. The main messages arising from Table 10 can be summarized as follows. First, both the Asian crisis, and, to a lesser extent, the 2000 stock market bust did have an initial impact on the leverage of these companies. However, it appears that this impact was short­lived, and, at least in terms of the market­valued leverage rate, has returned to its initial level. Second, up to 2001 there seems to have been a negative correlation between leverage in infrastructure and service transport companies. Indeed, they seem to have reacted with opposite signs to the Asia crisis. The transport service companies have seen their leverage increase, while the leverage of transport infrastructure operators has declined significantly since 1997. While there is no simple explanation to this fact, it may be reasonable to assume that the infrastructure sector is likely to be slower to react to shocks since their investments tend to be heavier and start from stronger initial equity commitments. These commitments tend to be more effective at reflecting risks and hence require fewer adjustments. Also, large investment commitments and hence borrowing requirements in the sector are easier to spread out over time than they may be for services. Overall, the transport services sector continues to be characterized by a relatively high level of leverage, measured by both leverage(1) and leverage(2). Both measures point toward an average leverage of 55­60%. Also, the trends of the two measures appear to be very similar over this period. As for transport infrastructure, the two measures of leverage appear to behave quite differently over time. Leverage(1), based on the market value of equity, has increased over the period and remained above 40% up until 2001. A significant drop to 30% is observed in 2002. While the book­valued average leverage(2) starts at a similar level as the market­valued leverage(1) in 1997, it has decreased more quickly, standing at 17% in 2002. 5. Summary and policy implications The evidence presented in this paper seems to confirm the anecdotal evidence: debt is replacing equity in the financing of the investment needs of utilities and transport services in developing countries. Even if this observation is not obvious from the leverage calculated from book values of equity, it is quite strong when considering the market valuation of equity over the past 10 years. Moreover, the results presented here point toward an acceleration of 14 this trend, which is particularly strong during the periods of global shocks that followed the 1997 Asian crisis. Similar increases have been observed in developed countries. The data collected suggest differences across sub-sectors. With a market valuation of equity, since the 1997 crisis, the average leverage levels in electricity have been growing above 40% while the rates for water and gas have reached the 25-30% range. The companies in the transport services sector appear to hold higher levels of debt, regardless of whether market or book valuations are used. In general, the data point to leverage levels of around 10- 20% for infrastructure and close to 50-60% for services, depending on whether the market or book valuation is adopted. Finally, the data suggest significant regional variations in both levels of leverage and in trends over time. South American companies appear relatively highly leveraged when using market valuations of equity, and increasingly so, driving the overall trend. Leverage rates have in fact been well over 50% in recent years.9 Asian operators are also showing an upward trend in their leverage but at a much lower rate. The level has been in the 30-35% range for utilities and somewhat higher for transport companies. However, there appears to have been a decrease in leverage of Asian transport companies over the last five years, which is not observed elsewhere. Other regions, and in particular Eastern Europe, have been characterized by significantly lower levels of leverage than Asia and Latin America, and no obvious change in trend. From a policy viewpoint, this analysis points to a number of emerging issues that may deserve consideration. The first is the choice of the correct asset base in the context of regulatory decisions. This paper has shown that the stockmarket valuations and the book values of the operators' equity have tended to vary significantly, since the observed increases in the market value-based leverage ratios were at least partly driven by depressed equity valuations.10 Figure 1 underlines the importance of this point. The average book-to-market values for companies operating in privatized infrastructure sectors have increased significantly over the past 10 years. This suggests that, while for most standard regulatory decisions, the book value provides an easier and less volatile asset base, it can be misleading in that it does not allow the regulators to get a sense of the real concerns the operators have to address in their management of infrastructure services. An increase in the relative importance of debt in the financing of public services can be, and has in the past been, an issue that only appeared too late on the radar screen of the regulators. The evidence reviewed here would suggest that it is important for regulators to monitor both book and market valuations of the assets. The second policy issue is the extent to which regulation can mitigate the equity flight from the sector documented in this paper. Experience suggests that there are three main ways in which regulation can help. The first is the specific design of regulation. There is evidence suggesting that the cost of equity is lower under rate of return regulation or hybrid regimes than under price cap regulation (Estache et al., 2003; Foster et al., 2003; Rodriguez-Pardina and Sember, 2003). Increasing the willingness to contribute equity can thus be facilitated by 9See Foster et al. (2003) for a similar conclusion. 10Note the wedge between book and market valuation of assets can also come from a bubble in the valuation of equity, not just from a depression in this valuation. 15 the adoption of less-efficiency-oriented regulatory regimes. Second, guarantees and various types of insurance can reduce the overall risks of projects, and hence reduce the risk of equity flight from the sector (Erhardt and Irwin, 2003). Third, the level of debt can be limited by other instruments, such as leasing agreements and allowing specific arrangements with infrastructure vendors. In some business lines, creative business development will allow improvements, but in most regulated industries facing low-income wage earners as their main client, cost control of some type is likely to be the solution. The main question that remains to be solved is then the extent to which cost cutting and creative business development appear the best ways to improve the operators' capability to finance their investments and debts. Figure 1: Average book-to-market ratio for the companies in privatised infrastructure sectors 2.0 1.5 1.0 0.5 0.0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Transport service Transport infrastructure Electricity Gas Water Source: Datastream, authors' calculations. Overall, these suggestions do not eliminate the fundamental problem that these sectors still need to find the necessary levels of finance to deliver on their investment commitments. Ineffectiveness in reducing the equity flight from the sector is likely to reduce the speed at which countries will be able to rely as much as they had hoped for on the private sector to help them finance their investment needs. But there is also a macroeconomic reason for concern. It is not unreasonable to expect that for some countries foreign participation is highly concentrated in these sectors, and increased international debt levels resulting from a switch from equity in public services may have balance of payment effects. These concerns do not imply that regulators should regulate the financial structure of the company, but it certainly implies that it may be important for regulators to better monitor the leverage rates and their evolution to minimize the risks of unexpected shocks. It will also require a much serious commitment by all stakeholders to deliver the regulatory accounting systems needed to increase the transparency of the monitoring of the financial viability of companies that ultimately are responsible for delivering basic services in the poorest countries of the world. 16 Bibliography Alexander, I. and Shin (2002). `Bond finance: a growing source of funds for utility and infrastructure companies?', International Journal of Regulation and Governance, 2 (1), June Alexander, I., Estache A., and Oliveri A. (2001) `A few things transport regulators should know about risk and the cost of capital', Utilities Policy, Volume: 9, Issue 1. Correia da Silva, L., Jenkinson, T. and Mayer, C. (2003), `Capital Structures of Water Companies', in Helm ed.: `Water, Sustainability and Regulation, The Next Periodic review and Beyond', Oxford: OXERA. DFID (2002), DFID (2002), "Making connections: infrastructure for poverty reduction", mimeo, available at http://62.189.42.51/DFIDstage/FOI/dc/7mar02_making_connections.pdf Erhardt, D. and Irwin, T. (2003), `The Problem of Leverage, High-powered Regulation, and Implicit Guarantees in Private Infrastructure Projects', World Bank, mimeo Estache, A., Guasch J.L. and Trujillo L. (2003), `Price Caps, Efficiency Payoffs and Infrastructure Contract Renegotiation in Latin America', in Bartle, I. ed; `The UK Model of Utility Regulation: a 20th anniversary collection to mark the "Littlechild Report" retrospect and prospect', CRI Proceedings 31. Estache, A. (2004), `Argentina Privatization: A Cure or a Disease?', in Hirschhausen, Christian, Thorsten Beckers, and Kay Mitusch eds: `Trends in Infrastructure Regulation and Financing International Experience and Case Studies from Germany'. Edward Elgar, Cheltenham, UK and Northampton, MA, USA. Gomez-Ibanez, J.A. (2003), `Regulating infrastructure: Monopoly, Contracts, and Discretion', Harvard University Press, Cambridge. OXERA (2002), `The Capital Structure of Water Companies', report prepared for Ofwat, October. Rodriguez-Pardina, M. and Sember G. (2003),'The Quest for "Just and Reasonable" Cost of Capital Determination in Latin America: A Comparative Study', Macroenergia, Buenos Aires, mimeo. Palmer, K. (2003), `Financing the Water Industry', The Utilities Journal, 34­35, June. The World Bank (2003), `Private Parrticipation in Infrastructure: Trends in Developing Countries in 1990 ­2001, The World Bank, Washington, DC 17 Appendix: Description of the main sample for utilities Name Country Sector No. of No. of Included in observations observations balanced for for sample Leverage(1) Leverage(2) Central Costanera Argentina Electricity 9 9 YES Capex S.A. Argentina Electricity 7 7 YES CELESC - Sta Catarina Brazil Electricity 8 9 YES CERJ Brazil Electricity 3 3 CESP Brazil Electricity 12 12 YES Energetica Mato Gros Brazil Electricity 4 4 Elec Paulista Ctep Brazil Electricity 4 4 AES Tiete SA Brazil Electricity 4 4 Duke Energy Int'l Brazil Electricity 4 4 Sao Carlos Empreend Brazil Electricity 4 4 CIA De Minas Gerais Brazil Electricity 9 11 YES CIA Paulista - Cpfl Brazil Electricity 12 12 YES Light De Eletricidad Brazil Electricity 12 12 YES Centrais Eletricas Brazil Electricity 12 12 YES Bandeirante Energia Brazil Electricity 4 4 Emae-Aguas Energia Brazil Electricity 4 4 Tractebel Energia SA Brazil Electricity 5 5 Caiua Eletricidade Brazil Electricity 4 4 Elektro - Eletricida Brazil Electricity 4 4 Light Participacoes Brazil Electricity 7 7 YES Electropaulo Metropo Brazil Electricity 7 7 YES Centrais Elet Matogr Brazil Electricity 4 4 CIA Eletrec. Bahia Brazil Electricity 7 8 YES CIA Energetica De Br Brazil Electricity 4 4 CIA Do Ceara-Coelce Brazil Electricity 4 4 Espirito Santo Centr Brazil Electricity 4 4 General De Electric Chile Electricity 12 12 YES Empresa Electrica ­ EMELARI Chile Electricity 5 5 Electrica De Iquique Chile Electricity 5 5 Colbun SA Chile Electricity 12 12 YES Empresa Electrica ­ EDELMAQ Chile Electricity 5 5 Empresa Elect ­ PEHUENCE Chile Electricity 12 12 YES Emp Elect Pilmaiquen Chile Electricity 12 12 YES Empresa Electrica ­ EMELAT Chile Electricity 5 5 Empresa Electrica - ELECDA Chile Electricity 5 5 Empresas Emel S.A. Chile Electricity 3 3 Almendral S.A. Chile Electricity 4 4 Electrica Rio Maipo Chile Electricity 12 12 YES Emp Nac Electricidad Chile Electricity 7 7 Enersis S.A. Chile Electricity 10 10 18 CIA Electrica Chile Electricity 4 4 Chilectra S.A. Chile Electricity 12 12 YES Gener S.A. Chile Electricity 10 10 Shenergy Company Ltd China Electricity 9 9 YES Inner Mongolia China Electricity 3 3 HC Elec Pow Develop China Electricity 2 2 Shandong Intl.Power China Electricity 2 2 Huaneng Pwr.Intl. China Electricity 3 5 Beijing China Electricity 6 7 YES SP Power Development China Electricity 4 4 SZ Electric Power Co China Electricity 2 2 Zhejiang Southeast China Electricity 6 6 YES Prazska Energetika Czech Republic Electricity 7 7 YES Stredoceska Energeti Czech Republic Electricity 4 4 Jihomoravska Energet Czech Republic Electricity 7 7 YES Severomor Energetika Czech Republic Electricity 7 7 YES Vychodoc. Energetika Czech Republic Electricity 7 7 YES Jihoceska Energetika Czech Republic Electricity 7 7 YES Zapadoces Energetika Czech Republic Electricity 7 7 YES Severoces Energetika Czech Republic Electricity 6 6 Ahmedabad India Electricity 10 10 YES Gujarat Industries India Electricity 8 8 YES Bses Limited India Electricity 12 12 YES Tata Power Co India Electricity 10 10 YES Tata Hydro-Electric India Electricity 7 7 CESC Limited India Electricity 2 2 Sarawak Enterprise Malaysia Electricity 11 11 YES Tenaga Nasional Bhd. Malaysia Electricity 10 10 YES Powertek Malaysia Electricity 6 5 Malakoff Malaysia Electricity 10 10 YES Hub Power Company Pakistan Electricity 6 6 YES Kohinoor Energy Ltd Pakistan Electricity 4 4 Duke Energy Peru Electricity 3 3 Luz Del Sur Servicio Peru Electricity 3 3 Manila Electric (Meralco) Philippines Electricity 11 11 YES First Phil. Holdings Philippines Electricity 10 10 YES Krasnoyarskenergo Russia Electricity 6 6 YES AO Lenenergo Russia Electricity 3 3 AO Mosenergo Russia Electricity 4 4 AO Sverdlovenergo Russia Electricity 3 3 Unified Energy Russia Electricity 5 5 Electrosila Russia Electricity 2 2 AO Bashkirenergo Russia Electricity 2 5 Korea Electric Power South Korea Electricity 12 12 YES Electricity Generating Thailand Electricity 8 8 YES 19 Aksu Enerji VE Turkey Electricity 3 4 Zorlu Enerji Turkey Electricity 3 4 Ayen Enerji Turkey Electricity 3 4 Ak Enerji Electrik Turkey Electricity 3 4 Cukurova Elektrik Turkey Electricity 5 5 Metrogas S.A. Argentina Gas Distribution 9 9 YES Transpra Gas Del Sur Argentina Gas Distribution 4 6 Distrib. De Gas Argentina Gas Distribution 4 4 Gas Natural Ban Argentina Gas Distribution 4 4 Cia De Gas De Sao Paulo Brazil Gas Distribution 4 4 GASCO S.A. Chile Gas Distribution 12 12 YES CEM SA Chile Gas Distribution 9 9 Gujarat Gas Co Ltd India Gas Distribution 7 7 YES EOX Group Bhd Malaysia Gas Distribution 7 7 YES Gail (India) Ltd India Gas Distribution 6 6 YES Petronas Gas Malaysia Gas Distribution 7 7 YES Sui Southern Gas Co. Pakistan Gas Distribution 1 1 Sui Northern Gas Pakistan Gas Distribution 2 2 Kyungnam Energy South Korea Gas Distribution 9 9 YES Korea Gas Corp. South Korea Gas Distribution 4 4 Daegu City Gas South Korea Gas Distribution 4 4 Seoul City Gas South Korea Gas Distribution 8 8 YES Daehan City Gas South Korea Gas Distribution 8 8 YES Kyung Dong City Gas South Korea Gas Distribution 6 6 YES Kukdong City Gas South Korea Gas Distribution 7 7 YES Pusan City Gas South Korea Gas Distribution 6 6 YES LG GAS South Korea Gas Distribution 6 6 YES Aygaz A.S. Turkey Gas Distribution 12 12 YES Saneamento Sao Paulo Brazil Water 5 5 Aguas Andinas S.A Chile Water 6 6 Shanghai Raw Water China Water 10 10 YES Ades Alfindo Putrasetia Indonesia Water 9 9 YES Intan Utilities Malaysia Water 5 5 Puncak Niaga Hdgs. Bhd Malaysia Water 6 6 YES Ionics Inc. Philippines Water 8 8 YES Eastern Water Resources Thailand Water 6 6 YES 20 Appendix 2: Description of the main sample for transport Name Country Sector No. of No. of Included in observations observations balanced for for sample Leverage(1) Leverage(2) Gpo.Concio.Del Oeste Argentina Infrastructure 3 3 Doc Imbituba PN Brazil Infrastructure 4 4 Agunsa Chile Infrastructure 4 4 Froward Chile Infrastructure 4 4 Puerto Chile Infrastructure 4 4 Ventanas Chile Infrastructure 12 12 YES Shai.Intl.Airport China Infrastructure 2 2 Shai.Shentong Metro China Infrastructure 4 4 Zhejiang Expressway China Infrastructure 5 6 Citra Marga Nusaphala Indonesia Infrastructure 8 8 YES Bintulu Port Holdings Malaysia Infrastructure 2 2 Johor Port Malaysia Infrastructure 7 7 YES Malaysia Airports Hdg. Malaysia Infrastructure 4 4 Ncb Hdg.Bhd Malaysia Infrastructure 11 11 YES Plus Expressways Bhd Malaysia Infrastructure 1 1 TMM Mexico Infrastructure 11 11 Asian Terminals Philippines Infrastructure 7 7 YES Intl.Ctnr.Term.Svs. Philippines Infrastructure 11 11 YES KCTC South Korea Infrastructure 12 12 YES Bangkok Expressway Thailand Infrastructure 8 8 YES Celebi Hava Servisi Turkey Infrastructure 3 3 Turk Hava Yollari Turkey Infrastructure 5 5 Terminales Maracaibo Venezuela Infrastructure 2 2 Varig Pn Brazil Services 4 7 LAN Chile Services 6 6 YES China Eastern Airline China Services 6 7 YES Hainan Airlines China Services 6 6 YES Shai.Qiangsheng Hldg China Services 3 3 SHANDONG Airlines China Services 3 3 Shn.Hong Kai Group China Services 2 2 Steady Safe Indonesia Services 8 8 Zebra Nusantara Indonesia Services 8 8 YES Malaysian Airline Sy. Malaysia Services 10 10 YES Nationwide Express Malaysia Services 7 7 YES Park May Malaysia Services 10 10 YES See Hup Consolidated Malaysia Services 5 5 Tiong Nam Transport Malaysia Services 9 9 YES Holdings 21 Holdings Transmile Gp. Malaysia Services 6 6 YES PIAC Pakistan Services 4 4 Aeroflot Russia Services 4 4 Putco South Africa Services 4 4 Value Group South Africa Services 4 4 Chunil Express South Korea Services 12 12 YES Korea Express South Korea Services 12 12 YES Korean Airlines South Korea Services 11 11 Thai Airways Intl. Thailand Services 11 11 YES 22