/^ TH E O RL DB A N K \ S 1 93 e THE WORLD BANK DI TE DB ~~~~~~At9o5t IqR' S~~~~~~~t 512 . I. * .j~~~~~~~~~ E D I T E D B Y Choices for Efficient Private Provision of Infrastructure in East Asia Edited by Harinder Kohli, Ashoka Mody, and Michael Walton The World Bank Washington, D.C. Copyright C) 1997 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing August 1997 The opinions expressed in this report do not necessarily represent the views of the World Bank or its member governments. The World Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility whatsoever for any consequence of their use. 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ISBN: 0-8213-4053-0 At the World Bank, Harinder Kohli is senior operations officer in the vice president's office of the East Asia and Pacific Regional Office, Ashoka Mody is principal financial economist in the Project Finance and Guarantees Department, and Michael Walton is director, Poverty Reduction, Poverty Reduction and Economic Management Network. Contents Foreword v 1 Making the Next Big Leap: Systemic Reform for Private Infrastructure in East Asia 1 Harinder Kohli, Ashoka Mody, and Michael Walton 2 Organizing the Government for Efficient Private Participation in Infrastructure: Lessons from Australia 21 Don Russell 3 Contracting for Private Provision of Infrastructure: The Malaysian Experience 43 Yahya Yaacob and G. Naidu 4 Regulating Private Involvement in Infrastructure: The Chilean Experience 54 Alejandro Jadresic 5 Managing Environmental and Resettlement Risks and Opportunities in Infrastructure 69 Bradford S. Gentry 6 Financing Private Infrastructure: Lessons from India 85 Montek S. Ahluwalia iii Foreword E ast Asian economies face important Earlier versions of the chapters were pre- structural challenges that must be sented at a high-level conference on private addressed if they are to maintain their involvement in infrastructure held in Jakarta, rapid economic growth, improve living stan- Indonesia, in September 1996. Sponsored by the dards, and continue the momentum toward a World Bank and the government of Indonesia, greater role in the global economy. Two of the this conference brought together East Asian challenges broadly confronting the region are government ministers and senior private sector meeting the massive demand for infrastructure representatives to identify and discuss major and adapting the role of the state to the chang- stumbling blocks to broader and more effective ing economic environment. Unless these chal- private participation in infrastructure. lenges are met-and met soon-the region's This book is intended to bring the delibera- strong growth cannot be sustained for long. tions of the Jakarta meeting to a wider audi- To promote growth, East Asian economies ence. A second book, Infrastructure Strategies in have traditionally paid greater attention to infra- East Asia: The Untold Story, edited by Ashoka structure than other developing countries-and Mody, is being simultaneously published by their public delivery mechanisms have generally the World Bank's Economic Development been more efficient. But the continued growth in Institute. This historical overview of East Asian demand for services,, along with changing tech- infrastructure focuses on the traditional public nology and regulatory approaches, requires a role in planning and delivery. Together, these shift from the public to the private sector in infra- two books should provide policymakers and structure ownership and service delivery. In infra- the private sector with a more thorough under- structure and elsewhere, East Asian economies standing of the often difficult tradeoffs faced are beginning to see a transformation in the role of when making choices relating to the delivery of government and in the regulatory framework for infrastructure. private business. A more hands-off approach is The issues raised in this book form part of the gradually being adopted as increasingly sophisti- larger agenda of institutional and structural con- cated economies make strong government inter- cerns in the region. The development commu- vention both ineffective and unnecessary. nity should continue to explore the issues. East The chapters in this book draw on country Asia's past successes sometimes lead observers experiences-in East Asia and in other regions- to believe that development has been taken care to reflect on the options and choices that East of. This is by no means the case. Decades of Asian policymakers face in infrastructure. They development remain, as well as major chal- address issues relating to the design of a lenges. It is my hope that this book will make a strategic approach to private involvement, reg- valuable contribution to the ongoing debate on ulatory choices (including the greater play of the continuing task of development in East Asia competition), different methods of contracting and Pacific. private suppliers, management of environmen- tal and resettlement problems when the private Jean-Michel Severino sector takes the lead, and new ways of financing Vice President private infrastructure. East Asia and Pacific Region v CHAPTER 1 Making the Next Big Leap: Systemic Reform for Private Infrastructure in East Asia Harinder Kohli, Ashoka Mody, and Michael Walton M uch is expected of private financing to support. Recognizing the limits to private help meet the infrastructure require- involvement under the incremental approach, ments of the rapidly growing East some countries are undertaking broader policy Asian economies. In the first half of the 1990s and institutional reforms aimed at creating an private financing did grow briskly. East Asia led environment more conducive to private partici- the developing world in total international pation, but these efforts are still at an early stage. finance for infrastructure, and a sharply grow- Designing such reforms, improving methods of ing share of that finance went to private projects contracting with private parties, building regu- (figures 1.1 and 1.2). In 1996 almost $13 billion in latory capacity, and developing domestic capital international capital flowed to East Asian infra- markets remain on the policy agenda in all the structure projects, more than $9 billion of it for region's economies. private activities. Domestic sources provided an The chapters in this book illustrate the policy estimated $3 billion for private infrastructure. concerns and choices in moving toward efficient Despite the growth in private investment, it private involvement in infrastructure. Choices remains a small share of all infrastructure invest- arise in the strategy and organization of ment in East Asia, between 12 and 18 percent reform-with regard to sector, the extent of pri- (although there is much variation in this share vate participation, the speed of reform, and the across the region). And because much of this planning and coordinating roles of the govern- investment is backed by implicit or explicit gov- ment. Choices must also be made in the methods ernment assurances, the share of private capital for contracting and regulation, the management at risk is far smaller. Moreover, the growth of pri- of environmental and resettlement issues, and vate financing slowed in 1996, partly because of the development of financing mechanisms to the lumpiness typical of infrastructure invest- increase access to long-term funds. The chapters ments. This book draws on experience in a draw on experience in a range of countries- number of countries-in East Asia and else- Australia, Chile, and India as well as economies where-to analyze the impediments to and in East Asia-to show what choices are available prospects for private financing of infrastructure. and what strategies governments have fol- The challenges in achieving substantial pri- lowed. Experiences from outside East Asia illus- vate risk-taking are many. Most East Asian trate the payoffs of a more integrated and economies have adopted an incremental concerted move toward private provision of approach to private participation in infrastruc- infrastructure. ture. They have sought private investment This overview chapter describes the recent mainly for specific projects, ring-fenced to insu- trends in international financing of infrastruc- late them from the existing structure of delivery. ture projects in East Asia, discusses the key pol- The result has been variable flows of investment, icy and institutional impediments to greater typically backed by substantial government private participation, and assesses the role of 1 2 Choicesfor Efficient Private Provision of Infrastrticture in East Asia Figure 1.1 East Asia leads the developing world Figure 1.2 ... and devotes a growing share of it in international finance for infrastructure ... to private projects lnfrastructure financing raised by developing countries, Intemational infrastructure financing raised in East Asia, by type 1986-96 (US$ billions) of borrower, 1986-96 (US$ billions) 15 10 Fk.TH f~~~~~~~~~~~~~~~~~~~~~~~~~~~~rvt East Asia and Paifc 8 1 2 6 1 2 6 Latin Anerica 1 0 and the Caribbean , \ 1 1986 1988 1990 1992 1994 1996 Middle East and t Source: World Bank 1 997b. 3 NorthkrAbica ^ / SouthAs Europe an / /1 assets in privatizations. Between 1984 and 1996 Central Asia J/ the number of privatization transactions in Latin u = America was about the same as the number of 1986 1988 1990 1992 1994 1996 new investment transactions; in East Asia, by Source: World Bank 1997b. contrast, there were only a third as many priva- tization transactions as new investment transac- domestic capital markets and finance. It then out- tions (World Bank, Private Sector Development lines a national and regional strategy for stimu- Department, Private Infrastructure Project lating private investment in infrastructure. Database). Privatization drew 20 percent of the financial flows for infrastructure into East Asia Trends in international financing in 1993, 35 percent in 1994, and less than 10 per- for infrastructure cent ($800 million of $8.7 billion) in 1995 (World Bank, International Economics Department, East Asia's appetite for infrastructure finance is Privatization Database). evident in the numbers.' In 1996 East Asian economies received $12.7 billion for infrastruc- Recipients of the investment ture through equity, loan syndications, and bond issues, absorbing just under half of the No single country in East Asia has dominated in $27.4 billion in infrastructure finance received international finance for private infrastructure by all developing countries.2 Three-quarters of projects. In 1995 and 1996 Indonesia was the the international flows to East Asia-$9.3 bil- largest recipient, however, receiving almost $4 lion-went to private projects. In the rest of the billion in each of these years-40 percent of all developing world too, the private sector's share flows to private infrastructure projects in the in international capital flows for infrastructure region (table 1.1). Private capital for infrastruc- increased steadily over the 1990s, from about a ture accoumted for about a third of all private third in 1991 to three-quarters in 1996 ($11 bil- flows into Indonesia in 1995 and a fourth in 1996. lion). Indeed, in 1996 the flows to public projects Before 1995, however, the largest annual capital fell sharply, from about $5 billion to just over $3 inflow for private infrastructure into Indonesia billion. was $339 million, in 1992. The huge jump in 1995 A distinguishing feature of private capital and 1996 reflects primarily the financing of a few flows to East Asia is the large share going to new large independent power projects whose nego- projects rather than to finance the transfer of tiations, under way for many years, had finally Making the Next Big Leap: Systemic Reformfor Private Infrastrtctutre in East Asia 3 Table 1.1 International finance for private infrastructure in selected East Asian economies, 1986-96 (US$ millions) Country 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 China 0 0 0 0 0 0 761 145 212 185 904 Indonesia 0 0 34 0 0 0 339 0 161 3,690 3,809 Korea, Rep. of 75 160 12 0 957 285 330 /05 374 772 1,164 LaoPDR 0 0 0 0 0 0 0 0 0 0 20 Macao 0 0 0 0 0 0 0 0 246 0 0 Malaysia /0 0 42 767 266 31 240 1,135 3,714 1,074 703 Philippines 0 0 0 0 23 39 336 707 1,044 2,135 1,072 Thailand 0 0 0 0 291 0 20 3,619 1,0I5 936 1,622 Vietnam 0 0 0 0 0 0 0 0 0 5 12 Total 85 160 88 767 1,537 355 2,026 5,711 6,766 8,797 9,306 Source: Euromoney; Loanware; Bondware; World Bank stafl estimates. been completed. In addition, the partial privati- sector have taken actions likely to boost it. The zation of the telecommunications authority government has prepared a model for build- drew in equity flows, and the award of telecom- operate-transfer projects and applied it to the munications concessions at about the same time Laiban power project. The private sector has created demand for financing to meet the invest- recently raised funds by securitizing existing ment obligations under the contracts. projects and then issuing shares on the Hong Nor does any other economy in East Asia Kong (China) and Shenzhen stock exchanges. show a clear, strong trend (figure 1.3). Perhaps This financing strategy marks a shift from pure the most consistent growth has been in the project finance--where financing is based only Philippines, however. From virtually none in on project cash flows and revenues-to a corpo- 1991, private investment in infrastructure in the rate finance, or pooled, structure, which gener- Philippines grew rapidly until 1995, when inter- ally gives greater comfort to lenders. national capital flows for infrastructure were just over $2 billion. But in 1996 the flows fell to Sectoral shifts $1 billion. The fast growth was due to the private power program for installation of more than The capital flows for private infrastructure in East 3,000 megawatts of power. Now that the pro- Asia have clearly been driven by independent gram's objectives have been substantially met, power generation and telecommunications. While the investments in private power generation are in Latin America telecommunications has taken a tapering off. But demand for private infrastruc- ture finance in the Philippines has been sus- Figure 1.3 No East Asian country shows a clear trend in tained by deregulation in telecommunications, international financing for private infrastructure allowing entry by new providers. International financial flowvs to pnvate infrastructure Other countries show a choppy pattern. In as a percentage of GDP, 1986-96 Malaysia international flows rose from a small 6 amount in 1991 to $3.7 billion in 1994, then declined in 1995 and 1996. Thailand had a peak s inflow of $3.6 billion in 1993 but has had much smaller flows since then. But both countries, par- 4 ticularly Malaysia, have had significant domes- tic financing. 3 China may be the dominant user of interna- tional capital flows for infrastructure in the com- 2 Ar- Indonesia gPhilippines ing years. Inflows into China jumped to $900 Thaland million in 1996, with increasing activity in / Malaysia power and transport. Although private invest- Korea, Rep. of 0 ~~~~~~~~~~~~~~China ment in infrastructure remains well below pro- 1986 1988 1990 1992 1994 1996 jections, both the government and the private Source; Euromoney; Loanware; Bondware; World Bank 1997d and staff estimates. 4 Choicesfor Efficient Private Provision of Infrastrttcture in East Asia Figure 1.4 Loans have been the main source financing. Following the privatization of assets, of international finance for private infrastructure Latin American infrastructure enterprises have in East Asia turned to bond and equity markets for most of Financing for private infrastructure projects, by source, 1 986-96 (US$ billions) their international financing. In East Asia there 8 has been a significant rise in international bond and equity finance, but syndicated loans have 7 been the main source of finance, accounting for 6 more than half in 1996 and an even larger share Loans in 1995 (figure 1.4). This is explained largely by 5 private power projects, which have relied mostly 4 on syndicated loans, with debt-to-equity ratios in 3 / the range of 75 to 25. In East Asia telecommuni- Bornds cations financing, like financing for private 2 / ^*^*,^>. power, has followed the limited recourse model I I Equiy (in which repayments are based largely on the 0 . j&~7 project's ability to refinance the debt). The 98 9 9 992 9 196 telecommunications sector has relied more on Source: Euromoney; Loanware; Bondware; World Bank staff estimates. bond and equity issues than has the power sector, but syndicated loans have also been important. decisive lead, in East Asia neither sector has dom- Policies and institutions for private inated. Power took the lead in 1992, but was over- infrastructure taken by telecommunications after a substantial investment in Thailand in 1993, and since then the The review of international finance for private two sectors have traded the lead a few times. infrastructure in East Asia shows that the flows Despite some privatization of telecommuni- are significant relative both to public flows and cations in East Asia, a substantial share of the to flows to other regions.3 But investment has flows into the sector has come through build- been low relative to expectations. There has been operate-transfer schemes (in Indonesia and much activity in signing memoranda of under- Thailand) that give private operators responsi- standing and even in signing actual contracts: in bilities in a geographic area for a fixed period. mid-1996 some $120 billion worth of projects The investment commitments for these projects were reported as past the contract award stage. require "lumpy" financing. By contrast, much of But the recent history of long development peri- the flow into Latin America has come through ods and high attrition rates for projects suggests privatization of state-owned assets, followed by that many now under discussion could unravel steady growth in new investments. Both regions before financial closure. World Bank estimates of have received relatively low levels of financing investment requirements in infrastructure for for transportation projects in recent years-not the next decade are $1.2-$1.5 trillion (World surprising given the problems faced by many Bank 1995b). With international finance for pri- such projects. But international finance statistics vate projects totaling some $9 billion a year in underestimate transportation investment in 1995 and 1996 and domestic finance playing a East Asia, since domestic capital markets, espe- modest role in most countries, a fillip is clearly cially in Malaysia and Thailand, have been needed to ensure the infrastructure expansion active in financing transport activities. critical to sustaining East Asia's development in the next century (box 1.1). The changing instruments Is the slow progress in private investment in infrastructure a sign of intrinsic problems with The mix of financing instruments in East Asia dif- private involvement? Is there, for example, a fers from that in Latin America, reflecting the dif- limit on the availability of long-term financing? ferences in the sectoral pattern of demand for Participants at the Jakarta conference tended to Making the Next Big Leap: Systemic Reformfor Private Infrastructure in East Asia 5 suggest not. The key constraints lie in the frame- work for private provision of infrastructure. It is Box A.l Why expanding infrastructure services in the resulting lack of bankable, low-risk projects, not the lack of finance, that is at the heart of the A continued push to develop infrastructure services in East present predicament. But this is not to deny the Asia is crucial to its development as it enters the 21 st cen- importance of increasing long-term finance- tury. Why? * Growth. Demand for modem infrastructure grows andsof developtEastsing wea omiestic capitalmaat least as fast as the overall economy-and for kets in most East Asian economies. many sectors significantly faster. Failure to meet this demand could undercut the potential rapid What is the target? growth. If investment is not boosted in China's increasingly congested transport system, for Although the share of private investment in East example, the economy's growth will be choked Asian infrastructure is between 12 and 18 per- off. The govemment of the Republic of Korea esti- cent, this overall figure is pulled down by the mates that infrastructure shortages resulted in a low private share in China. The high level of pri- gross domestic product some 16 percent short of low pnlvate share m Chin a. The hlgh level of prI- its potential in the mid- 1 990s. vate involvement in some East Asian economies Competitiveness. Good power, transport, and suggests that the prospects for private partici- telecommunications services are necessary in pation are much greater than current levels in rich and poor economies alike to sustain growth most of the region. and competitiveness in an increasingly integrated Hong Kong (China) has traditionally had world. In Indonesia industrial firms that use cap- considerable private involvement in all sectors tive power pay more than twice the price of except water (Kwong 1997). Much private provi- power from the grid. * Quality of life. Poor infrastructure services mean a sion has also occurred in Malaysia, where power, poor quality of life despite rapidly rising incomes- transport, water, and telecommunications have especially in urban areas. In many countries house- all had some infusion of private capital (Naidu holds' access to services remains far lower than and Lee 1997). It is difficult to determnine the would be predicted on the basis of income levels. extent of private investment in Malaysia because Poor households that have to buy water from ven- the government has continued to have a signifi- dors pay some sixty times the price of piped water .fiancial commitment even i, "private" pro- in Bandung and almost twenty times the price in jcnts through equity in privatized enterprises and Manila and Ho Chi Minh City. Congestion in cities from Bangkok to Shanghai adds hours to people's through grants of land rights, direct subsidies, daily commute, in air quality conditions way below and concessional loans. But it is likely that the Word Health Organization standards. private share is more than half. Source: World Bank 1994 and 1995b. Private involvement is also high in the Philippines, where World Bank estimates sug- gest that about 40 percent of new investment in participation. China has made progress in the infrastructure has been financed through pri- power generation sector with the introduction vate projects (Mikesell 1997). Much of the invest- of model contracts for the Laiban power project. ment in private power projects has benefited It has recently had success too with pooling from government backing of the payment oblig- existing power projects to attract fixed income ations of the National Power Corporation (box investors, using the proceeds for new project 1.2). The recent spurt of private investment in development. Pooling structures are also being Indonesia probably places it at the same level as used for toll road projects (see the section below the Philippines. The Indonesian government has on financing mechanisms). The Republic of refused to provide guarantees, but its "comfort Korea has historically had little private involve- letters" have been viewed by the market as ment in infrastructure. But it recently raised its assurances that obligations will be honored. target for private financing of infrastructure Elsewhere in East Asia private investment in requirements, aiming for a 40 percent share by infrastructure has been limited. But most 2001-02, up from the original target of 10 economnies are gearing up for greater private percent. 6 Choicesfor Efficient Private Provision of Infrastructtre in East Asia strategy been? Rather than experiment with Box 1.2 Managing guarantees in the Philippines ways to attract investment to specific projects in In July 1987 the Philippine govemment launched a program power and telecommunications, it has focused to attract priate investment for power generation CWorld on creating market structures and regulatory Bank 1994, p. 67). The govemment provided full faith and institutions conducive to private entry. The credit guarantees to back the obligations of the National result: rivatized sectors are seein rapid invest- Power Corporation under lcng-term power purchase g r i agreements with private suppliers. These guarantees coy- ment, face no financing constraints, and receive ered the entire risk of the corporation's payments: failure to no explicit or implicit public sector support. pay for any reason would triggerithe guarantee. W\th much Chile has grown 7 percent a year for a decade experience in private power generation and thus a track and, like most East Asian economies, faces record of honoring payment obligations, the govemrnment is rapidly expanding demand for infrastructure in a positon to scale back on theguarantees it provides. In services. Of a total projected infrastructure 1995 it adopted a policy aimed at doing so, with four investment of $18 billion over the next six years, objectives: * To unbundle the risks iso as to be able to sharply some $13 billion-72 percent-is expected to 0 tdemarcate covered04risks. t t;00000 ;; iicome from the private sector. * To reduce coverage to 75-80percent of payment In East Asia the scale of private sector obligations. involvement in infrastructure will depend on 3 To introduce the concept of guarantee "fall-away' societal preferences and on institutional and pol- (for example, the guarantee of foreign exchange icy conditions. Major infrastructure segments, coverage falls away when the Philippine govem-r such as feeder roads, will probably continue to be mentachieves an investment-grade credit rating; publicly financed, and in most of the region's andretainsthatratingfor two years) economies well over half of spending in the next * To create administrative mechanisms for more * v careful review, pricing, and budgeting of guaran- decade will be public. Traditional concerns about tees, including possibly retaining! reserves against improving the efficiency of public sector invest- * guarantee daims. i mentprograms and infrastructure operation and The principles of risk unbundling, reduced coverage, maintenance will continue to be important. and guarantee fall-away have already been adopted in some recent guarantees. NowthePhilippine government is inves-0 Setting up the policy and institutionalframework tigating optons for a present value budgeting system that would reduce the budgetary incentives to provide guaran- tees (such incentives anrse because issuing a guarantee requires no cash, so that no financial charge is made against tance of a clear policy and institutional frame- the department or agency authorng the guarantee). work for private involvement to simultaneously Source: Philippines 1995. tackle four related objectives: * Reducing the price distortions and risk fac- tors that are central causes of the weak But experience outside East Asia (and in pipeline of bankable projects. Malaysia and Hong Kong, China) shows that * Ensuring that projects are approved effi- much higher shares of private infrastructure ciently, fairly, and in a timely fashion. investment are possible. The most striking shifts * Ensuring that private providers deliver high- toward private investment have occurred in quality services efficiently and at reasonable Argentina and Hungary, where at least 70 percent cost. of infrastructure investment is private. In Chile * Dealing with important societal concerns the private sector's share in infrastructure invest- about the environment, resettlement, and the ment is about half (Mikesell 1997). provision of basic services to the poor. The Chilean experience offers a contrast to Not all elements of the framework need be in the East Asian strategy (see chapter 4). In Chile place before private entry begins. Indeed, many the energy and telecommunications sectors are conference participants emphasized that there is now almost fully private, there is growing pri- no magic formula, and most countries have been vate involvement in transport, and a major pri- proceeding in an evolutionary, learning-by- vatization of water is planned. What has Chile's doing fashion. But an evolutionary policy does Making the Next Big Leap: Systemic Reform for Private Infrastructutre in East Asia 7 and transport may also face direct market risk. Recognizing these risks is a first step in design- Project development, when risks are greatest, is financed ing government policies and institutions that almost entirely with equity funds. A drawn-out contract minimize them. award process and a lack of transparency can greatly increase Second, there are important differences project preparation costs, so high retums are expected from between infrastructure activities that are poten- this exploratory work. tween mpetitiv e anthose that are poten - During the construction period project sponsors typi- tially competitive and those that are intrinsically cally seek 70 percent debt financing. Since capital markets monopolistic (box 1.4). Natural monopolies tend to be cautious about financing construction, banks are require special measures to prevent the granting called on to play a prominent role, and because of the risks of favors to potential monopolists, limit the demand relatively large spreads. Since commercial bank abuse of monopoly power, encourage efficient resources are limited-and there are few banks experi- service provision, and ensure the maintenance of enced in intemational project finance-it is important to asset quality. Much of the initial private sector recycle bank resources into new projects by refinancing pro- activity in East Asia has been in telecommunica- jects through capital markets once they are operational. In principle, govemments do not bear construction risk in most tions and power generation, both potentially projects, but as ultimate guarantors in many projects they do competitive activities. bear residual risk. The following sections outline how the four Once projects are up and running, cash flows are sub- objectives-reducing price distortions and risk jectto market and regulatory risks. The solution is to reduce factors, ensuring timely and fair project the regulatory risks before operation by establishing sound approval, ensuring low-cost, high-quality ser- sectoral frameworks, including for the environment and for vices, and addressing societal concerns-can be resettlement. achieved, in monopolistic and potentially com- petitive activities and in all project phases. not come without costs. From the perspective of potential private investors, evolution is policy Managing the transition in potentially instability and a lack of strategic commitment, competitive activities and it can substantially raise their perceived risks and required returns. Addressing these The countries that have gone furthest in private concerns sometimes will mean striking a bal- involvement in infrastructure have all used com- ance between efficiency and the need to main- petition in power and telecommunications. Of tain commitments to the private sector when the the countries represented at the Jakarta work- rules of the game change because of deeper sec- shop, Australia, Chile, and Malaysia have multi- toral reforms. Authorities in Victoria, Australia, ple, competing operators in telecommunications. struck such a balance by grandfathering a guar- This approach is based on the view that, since antee to a major power project. there are several technical options for supplying In laying out the elements of a sustainable services (radio, satellite, cable networks, tradi- policy framework, conference participants em- tional wire lines), there is little reason to restrict phasized two aspects of infrastructure delivery, new entry into telecommunications networks. In First, there are different phases in an infrastruc- power generation Chile and the Australian state ture project and each has distinct risks (box 1.3). of Victoria have competitive structures. Private sector representatives expressed great Competition in East Asia is extremely lim- concern about risks in the development phase ited, even in telecommunications. Indonesia and in the contracting process, the granting of Thailand have awarded private telecommunica- permits, and the management of environmental tions providers concessions to serve specific and resettlement issues. There was also concern geographical areas, but have also granted them about risks during the operational phase, such monopoly rights in those areas. Awarding con- as changes in contractual agreements (including cessions to several providers creates the poten- early termination), inability to obtain payment tial for "yardstick" competition, in which for services rendered, and inability to convert suppliers are rewarded on the basis of compar- domestic into foreign currency. Projects in water isons with suppliers in other jurisdictions, but 8 Choices for Efficient Private Provision of Infrastrmcture in East Asia Box 1.4 Policy issues in competitive and monopolistic infrastructure sectors Technological change has made power generation and long- can often turn to higher-cost alternatives, such as waterven- distance telecommunications potentially competitive and will dors, alternative energy sources, or competing transport soon dothe sarnieforelectricitycdistribution and local calls. Many modes. But substantial market power and special pricing other activities are at least in part natural monopolies, especially problems remain as policy issues. Competition is a desirable network industries, such as electricity transmission, gas and goal, but achieving and enforcing it can be a demanding task water supply, and road and rail transport. foripolicymakers. Relapses into monopoly characten'stics are Different policy issues arise in monopolistic and corm- common. petitive activities. In natural monopoly sectors consumers Policy objectives in competitive and monopolistic infrastructure sectors Development phase Service delivery phase Potentially competitive sectorsm(electricity * Designing market structures for the public i implementing general compettion policy, generation, long-distance telecommunications) to private transition. including network interconnection Establishing rules for environmental and arrangements. resettlement issues. Providings explicit subsidies for basic services Reducing thepublic sectors direct role in lforthe poor. contracting. Natural monopolies (electricity transmission * Efficiently managing the contactingt process, * Regulating the sector to ensure fair pricing, and distribution, toll roads, ports, water using -competition for the market." low-cost service delivery, high-quality service, supply) : Managingenvironmental and resettlement and4adequate future investment. issues. Providing explit subsidies for basic services forthei poor. Source: Wbrld Bank 1994, Smith and KJein 1994. this type of competition is necessarily weaker "spot" supply-the daily supply to the trans- than direct competition. mission grid. In spot markets only the plants In power generation in East Asia private able to win the right to supply the daily grid entry has been through long-term, take-or-pay requirements on the basis of their low costs are power purchase agreements between private paid. There is an incipient movement in the suppliers and government-owned power com- Philippines to create competition in power sup- panies. Under a take-or-pay contract the power ply along these lines. company makes a commitment to pay the pri- Other countries in East Asia are also consid- vate operator a capacity fee, which typically cov- ering sectoral reforms in power. Reform is high ers at least debt and operating costs, whether or on the agenda in China, for example. Countries not it actually uses the power. Thus, even where where private entry is at an early stage can skip there are multiple private generators, they do the stage based on BOTs and power purchase not compete directly. Investments under such guarantees. But there are important precondi- contracts typically occur through build-operate- tions for successful competition. The utility buy- transfer (BOT) arrangements and are primarily ing power must be creditworthy, or new entry is a device to help governments finance new unlikely to occur. Price reforms are necessary to capacity by deferring payments. ensure the sector's viability. Reforms of the The experiences of both Chile and Victoria, power utility may also be needed, often includ- Australia, in introducing competition in power ing privatization. And competition requires a supply illustrate gains in both efficiency and regulatory infrastructure, including "power investment. Victoria attracted surprisingly high pools" and mechanisms to ensure fair dispatch bids on assets sold even without offering a com- (and thus the choice of generating plants with mitment through a take-or-pay contract (box the lowest marginal cost of supply). 1.5). While the models for introducing competi- Competition eases the task of regulation, tion differ from one country to another, they since it fosters efficiency and fair pricing. But share the goal of stimulating competition for merely permitting new entry is not always Making the Next Big Leap: Systemic Reformfor Private Infrastnrcture in East Asia 9 Box 1.5 Beyond power purchase agreements- Box 1.6 Leaving the contracting choice to the managing the transition to competition in power market-the gas pipeline in Chile generation A pipeline to transport natural gas over the Andes from In the Philippines a framework for competitive elecricity Argentina is an important option for energy supply in Chile. supply is beginning to emerge and will probably be put in Once constructed, such a pipeline would be a natural place in the next three to five years. The country will then monopoly. Negotiations to construct a pipeline started have to decide how to handle existing power purchase between the govemment and potential developers, who agreements. For guidance, it can look to the Australian state emphasized the need for govemment guarantees to make of Victoria, which has already made the transition to the project viable. But the govemment, judging that it had competition. little basis on which to negotiate; left the developers to nego- The first major private entry in Victoria's power gener- tiate directly with the potential users. Of the twvo consortia ation sector was through the sale of the half-finished, I ,000- that competed for the right to serve customers, one even- megawatt Loy Yang B plant. Negotiations were long, costly, tually struck a,deal with a group of consumers at a price far and complex but eventually ended in a deal involving a thirty- lower than that originally proposed to the govemment- three-year take-or-pay power purchase agreement and the with no govemment guarantee of the purchase contracts. state electricity utility taking all the construdion risk. When Source: Jadresic in this volumne. Victoria later introduced full competition in generaton and complementary reforms in transmission and distribution, it chose to grandfather the power purchase agreenaent.with monopolies or, as in much of the power and Loy Yang B in order to avoid destabilizing the business telecommunications investment in East Asia, environment-despite potential efficiency losses. because service provision has not yet been The priority given to a stable business environment, deregulated. Investment in noncompetitive combined with deep sectoral reforms, has led to strong pri- vate interest-withoutthe govemment having to offer guar- g i d v antees. One measure of private interest is the purchase of management of the choice of project and the the thirty-year-old Hazelwood power plant for three times award of contract, an approach that raises dif- its book value, with no power purchase agreement. This ferent concerns for the public and private sale, along with sales of distribution companies, has helped sectors. Government representatives at the con- transform the state's finances. ference particularly emphasized the need to Source: Russell in this volume. ensure fair deals for society and avoid the exces- sive profits (and political fallout) associated with highly favorable contracts. Private sector enough to make market structures competi- representatives expressed concern about lack of tive. Market structures created at the time of clarity in the rules of contracting and the cost of restructuring or privatization can have long- the process, which is financed entirely with lasting influences. Chile allowed a vertically equity and must therefore yield a high return. integrated power company, creating a poten- Where direct competition in supply is lim- tial for the company, as owner of the grid, to ited, another potential source of discipline is give preference to the generating plants it competition "for the market," or for the right to owned. By contrast, Victoria, Australia, moved supply. Such competition requires governments to five generating companies and an indepen- to identify projects, invite competitive bids, eval- dently owned grid when it deregulated. Even uate the bids, and award contracts. To exploit the after the principle of competition is estab- potential of such competition, governments need lished, the regulator or competition authority to establish the basic rules and legal framework needs to keep an eye out for anticompetitive for eligible projects, identify qualified suppliers, tendencies. and conduct individual transactions that result in prices that are fair and beneficial to consumers Ensuring competition for the market and timely and are perceived as such. Where private and efficient contracting involvement is mature and consumers are well informed, the government can withdraw from Many infrastructure projects are not in compet- the contracting process-as the Chilean govern- itive activities, either because they are natural ment did in natural gas supply (box 1.6). 10 Choicesfor Efficient Private Provision of Infrastricture in East Asia East Asia already has some of the basic legal largest portfolio of private projects in East Asia, structure in place for private sector entry, but a virtually all projects have been directly pro- large agenda of legal reform lies ahead. In such cured. Proponents of noncompetitive bids cite countries as Cambodia, Mongolia, and Vietnam, several benefits. The procurement process takes where no private projects have been imple- less time. Overall preparation costs are lower, mented, the rules for BOT projects are still in the since the costs that would have been incurred by early stages of development. In China several unsuccessful bidders are eliminated. And unlike private projects are in operation, but the BOT in a competitive situation, in which all bidders policy continues to evolve. Laws permitting must respond to a common basic request for pro- water and road concessions are needed in most posals, the private sponsor has the opportunity countries, as are extensive legal changes to allow to show innovation in project design. privatization of state assets. Several conference Examples presented at the conference showed participants stressed the need for a legal struc- that the gap between competitive and noncom- ture that would increase confidence in the con- petitive contracting can be narrowed by over- tracting process among potential suppliers and laying on one the positive features of the other. eventual consumers and thus lower the costs of For example, a government could subject a sole- completing transactions. source bid to an open and competitive price The economic and social benefits of a project challenge before the award, while giving the ini- also depend to a great extent on how the contract tial bidder some preference based on its early is procured. While the choice between competi- design and development costs. The costs of pro- tive and noncompetitive procurement is often- ject preparation could be subsidized to attract a and quite rightly-emphasized, other features larger number of bidders, a practice used in the of the transaction can also substantially influ- United Kingdom's private sector initiative and ence the outcome. Early contracts in a country or likely to be adopted in the Philippines. In South sector are often negotiated directly with selected Australia authorities conducted a negotiation parties rather than offered for competitive bid. process with competing bidders that was akin to The Philippines, for example, used direct nego- that for sole-sourced contracts (box 1.7). What- tiations in its initiative to attract private ever the approach to contracting, preparatory investors to the power sector during the emer- work by the government is critical to success. gency period of blackouts. But in recent transac- Just as competitive and noncompetitive con- tions it has relied on competitive sourcing; tracting can share the presumed benefits of the several bidders have typically responded, other, they can also share each other's presumed resulting in substantial competition and a steady ills. Transparency of process, with a heavy lowering of the purchase price for power. emphasis on information disclosure, is critical, Another successful example of competitive regardless of whether a contract is procured com- procurement has been in Thailand, where bid- petitively. While a suspicion of political patron- ders were invited concurrently to bid on projects age is almost inevitable in directly negotiated to provide up to 4,000 megawatts of power. deals, a competitive process can also be tainted- Competition was extensive, and commitments or at least perceived to be so. There should be no to supply were obtained at the low end of the presumption that competitive bidding will be international range. Competitive bidding was fairly and transparently conducted. Witness the also effectively used in Indonesia for telecom- heavy controversy surrounding the award of a munications contracts. water treatment contract in Thailand and a set of The disadvantages of noncompetitive bid- telecommunications contracts in India. Lack of ding processes are well known: high prices and clarity on the criteria used in choosing the win- indifference to consumer needs often result. But ning bidder and a perception that the rules of the despite the obvious benefits of competitive bids, game have changed midway through the bid- many projects are still procured through direct ding process are typical sources of controversy. solicitation or in response to private sector pro- Three messages emerge from the experience posals. For example, in Malaysia, which has the in contracting for infrastructure provision. Making the Next Big Leap: Systemic Reformfor Private Infrastructure in East Asia 11 Competition can bring major gains in price. Box 1.7 Managing competition in contracting- Whether the contracting is competitive or not, South Austragia's experience in water suppli transparency is highly desirable on both effi- ciency and political grounds. And some of the The award of a water supply contract in South Australia positive features of direct negotiations can be shows how a competitive bid can incorporate some of the in.orporate into cornpettivebidding. presumed benefits of directly negotiated contracts. incorporated into competitve bidding.--- Prospective bidders were provided detailed tech- nical and financial information based on past oper- Using regulation to promote efficiency ation by the public sector, but they also were invited and expected to undertake their own due However carefully contract award is con- diligengce, including assessinggg demand. ducted, it generally must be followed by E The authorities announced: detaied criteria foir continual project oversight to ensure that con- choosing the- winning consortium and for con- tract terms are met and that unexpected effects ducting any renegotiations. Renegotiation can occur even in competitive .situations, and pre- are not interfering with societal concerns. Such s t c t b u e . ~~~~~~~~~~~~specifying the.criteria-to be used-ensures greater E ongoing oversight is referred to as regulation. As with contract award, the process-and thus *er receying proposals from four prequified the transparency and accountability-of regu- bidders, the authorities entered into a relatively- lation is at least as important as its technical Tnovel-and potentially delicate-set of parallel features. negotiations with the bidders. Theytook elaborate East Asia has limited experience with modem - precautions to prevent the abuse- of confidential. information, and they vaidted the assum ption regulatory practices, but conference participants underlyion each bidder' ppe limitin t agreed that the region's governments need to udpossibility of postcontractual renegptiations. adopt such practices. These practices are increas- * Te bidding process was completed in eighteen ingly based on exploiting the incentives of service months underthe supervision of highexerienced providers to behave in a socially desirable man- professionals, including international consultns. ner. This "incentive regulation" minimizes the Source South Austraa, Ministry for lndustry, Manufacring. Snal information required by the regulator to do its Business, and Regional Development; South Australia Water job. By contrast, rate-of-return regulation, now Corporation. rarely used, imposes high information require- ments. In this type of regulation prices are set so as to ensure that the provider receives a specified Regardless of the method of regulation, mea- rate of return, a system that creates a perverse sures are required to ensure the accountability incentive for the provider to increase capital costs and independence of regulators so that their while giving the regulator the difficult task of decisions will carry authority. If the relationship determining the appropriate level of investment. between the regulator, the legislature, and the Another, increasingly popular method of price executive is blurred, as it typically is, it will need regulation limits prices (or their rate of growth) to be clarified. One view holds that the regulator rather than rates of return. Under this "price cap" should be accountable to the legislature, with system providers have an incentive to minimize regulatory commissions staffed by members costs. with overlapping terms so that an entire com- A price cap system does require benchmark mission cannot be summarily dismissed. estimates of rates of return at the time the cap, or limit, is established. But once set, price caps need Dealing with broader societal concerns be adjusted only every five to seven years, lim- iting the information required for effective reg- Discussions in Jakarta emphasized the impor- ulation. Price caps are being used in power tance of dealing with societal concerns explicitly generation contracts throughout East Asia, and early, often with both public and private although an important contract for a national involvement. Doing so allows risks and oppor- sewerage system in Malaysia is being regulated tunities to be addressed efficiently. For example, on a rate-of-return basis. dealing with environmental and resettlement 12 Choicesfor Efficient Private Provision of Infrastructure in East Asia concerns during project development opens o 8 nlg e : rivate sect i re:ettlement opportunities for innovative, "win-win" solu- tions. Similarly, to ensure that the goals of Where truly volun*rresettlerent occurs-when land is expanded service coverage and affordable ser- purchased throughfair negtiations-e privates0ponsorsl. vices for the poor are met, they need to be clearly of the projetcan tke the lead in addressing the issues. But stated up front and reflected in the regulatory reinvoluresetement is necessa the relionship between, thet govermentne and the prwate sponsors istoften framework and pricing structures. tagonistic. Private spsors will be unwillingto commit sig- Resettlement is frequently an important con- niciat new investmentbecause ofthe:uncertainiesinlpro-m:l cern in infrastructure projects, particularly in jiec design. And timeidtiables. Governments tomayofferto transportation and hydroelectric projects, and it undertakethe resement ia even offer financial co-i can become a major source of project risk if not pensationhin the eventobf delays. But sc commitments are handled carefully. Governments in East Asia are niot a(lwascredible, at leatin, pati becasethe governmentt devising policies and procedures for resettling cacions 6ll be subetto inteatiscrutiny. those displaced by infrastructure projects.o iii More humane resettlernent atlower cost and inrlessit Projects involving international lending agen- Thepivateser can play aimprtnsuporting role, cies face increased pressure for effective design al4 though the govemmntmust be prepaedlt t0ake the,.. and implementation of resettlement plans. But lead.The government must uset up theconsultative proess even in projects with purely private investment, and the guidelines to ensure fair cornpensation-fr those to the risk of political opposition requires active be rettledand toprtectfteirlivel.ihBut one such government involvement to ensure that the con- gu i epidelinesiare in placete priepet sponsors a can cerns of those affected are fairly and equitably work alongsidegoement agens in inpemn9ng Te§ettdn enVP-dedgn' hdIng arid eveoprgnew sits andi addressed through consultation, choice of suit- offere peoe affected wor on tpjec and in able relocation sites, and adequate support spin -of fre e I s I - - (including compensation) to restore long-term Soe:etyinhivlue incomes (box 1.8). Dealing with environmental concerns simi- larly requires careful, thorough planning. Most objective, especially middle-income countries project sponsors tend to view environmental approaching universal access. This often implies concerns as a source of increased project cost and subsidizing access for some of the poor, poten- risk, both during project development and later tially jeopardizing the commercial viability of on, as unexpected liabilities arise due to changes service supply. Economists generally agree that in regulation and the discovery of sensitive envi- the best approach for achieving minimum access ronmental problems. But perceived risks can while safeguarding commercial viability is to often be turned to the advantage of both devel- provide an explicit subsidy for targeted house- opers and society when improved environmen- holds. A common practice under Argentine tal performance goes hand in hand with water contracts, for example, is to bill fully for increased operating efficiency-as it can in services, but to have households pay only part water, energy, and transportation projects of the bill and charge the government directly (chapter 5). To realize this potential for mutual for the subsidized portion. In Chile the subsidies benefit, regulators must be clear about the per- for rural electrification are built into contracts formance standards the project sponsors must that are then competitively bid. meet and allow them sufficient flexibility in Issues relating to sector regulation, contract- operations. ing, resettlement, the environment, and reaching In most countries many people, both poor the poor converge in the water supply sector. Few and nonpoor, lack access to electricity, tele- deals in water supply have been finalized in East phones, and piped water supply. Often they end Asia outside of Malaysia, but conference partici- up paying much higher prices for these services pants showed much interest in the sector. Because from alternative sources, such as for water from of the complexity of the issues in the water and vendors. Many societies have made ensuring sanitationsector, itisanimportantnew frontier for minimum access to basic services a policy public-private partnership in the region (box 1.9). Making the Next Big Leap: Systemic Reformfor Pivate Infrastructure in East Asia 13 Box 1.9 Water supply and sanitation-regulation, the environment, and the poor Because water is a basic necessity and clean water is required emments' reluctance to award monopoly distribution rights in to prevent the spread of disease, universal access to affordable such a sensitive sector. Some contracts have been awarded to water is a high priority everywhere. But throughout East Asia private operators-awater and sewerage contract in Manila, a water supply systems are under great stress as rapidly growing sewerage contract in Malaysia, a management contract for the urban populations place increasing demands on them. water distribution system in Macao, water sourcing and. treat- Perversely, in many systems subsidies have limited the expan- ment contracts in Malaysia and Thailand. SimBar contracts are sion of supply while failing to benefit the poor, many of whom under discussion in Chinese and Indonesian cities. But the lack access to the public system and buy water at high prices needs extend well beyond these early efforts. from private vendors. Sewerage systems are even less devel- Regulating the water and sanitation sector is a challenge, oped, and service prices are much too low to cover the sub- because large. investment requirements and high, environ- stantial investments required. As a consequence, poor mental standards imply a need for long-run:price increases. sanitation is a growing threat to public health and the environ- Balancing the-goals of expanding access, including to the poor,: ment in many countries. protecting the environment, and preventing abuse of monop- Private entry irto water and sanitation has been con- oly rights creates a policy challenge that can be met only strained by system inefficiencies, uneconomic pricing, and gov- through increased experience and public-private collaboration. Capital markets and domestic finance for infrastructure investment in East Asia reaches 30 private infrastructure percent in the next few years and more than 50 percent by early in the next century, it would still In most East Asian economies the bulk of finance amount to only 2-5 percent of GDP, a small frac- for private infrastructure has come from foreign tion of private domestic savings. Instead, the sources. Yet most of the revenues from infra- low domestic financing for private infrastruc- structure projects are in domestic currency, rais- ture stems from a combination of relatively ing the risk of currency devaluation and foreign immature domestic capital markets, especially exchange inconvertibility for foreign investors. bond markets, and domestic investors' cau- The risks for foreign finance of private infra- tiousness about such investments. Apparently, structure increase the importance of domestic domestic investors are more averse to the risks finance. But only about a quarter of the finance associated with the present phase of infrastruc- for private infrastructure in East Asia comes from domestic sources. Figure 1.5 East Asia has extraordinarily high savings ... Why has there been so little domestic financ- Gross domestic savings as a percentage of GDP, 1993-95 ing for private infrastructure? The low levels in 0 10 20 30 40 50 East Asia today are not without historical prece- Singapore dent. Much of the financing for some of the China infrastructure developed in North and South Malaysia America in the nineteenth century came from Thailand the capital markets of the United Kingdom Indonesia (Eichengreen 1996). But domestic savings in the Korea, Rep. of recipient countries were low. By contrast, East Developing EastAsia Asian economies have some of the highest sav- average ings rates ever recorded (figure 1.5). Total sav- -apangKon ings are running at 30-35 percent of gross _ domestic product (GDP), and private savings at Germany 25-30 percent. Moreover, a significant share of Brazl the savings is going into financial assets, with India bank credit, for example, comparable to levels in Mexico some industrial countries (figure 1.6). Argentina So the issue is clearly not a lack of domestic Philippines resources. Even if the private sector's share in Source. world Bank data. 14 Choicesfor Efficient Private Provision of Infrastructure in East Asia Figume 1.6 ... much of it lanneled into financial investent port, and telecommunications (table 1.2). For Totdraedit predbyiebankngsectoraspercentaoofGDP, 1995 example, PT Telkom, the Indonesian telecom- 0 50 100 150 200 250 300 munications company, went to the market with Japan an initial public offering in November 1995 and Hong Kong raised $1.69 billion, mainly onshore, on the Thailand Jakarta and Surabaya stock exchanges and later United States raised some $600 million through an onshore Malaysia private placement. The private Indonesian toll Germany ~~~~~~road company, Citra Marga Nusphala Persada, United Kingdorn Average for also has raised some $600 million on local stock developing East Asia markets. But with foreign investors accounting China acn Singapore for almost 80 percent of trading on the Jakarta Korea, Rep. of exchange, and about 50 percent in Bangkok, Philippines Kuala Lumpur, and Manila, the estimate of Mexico onshore finance includes a large share of foreign Indonesia financing. India Stock markets are likely to become an Brazil important source of finance for infrastructure Argentina companies in East Asia. Although the depth and Source: World Bank data. institutional framework of the region's ex- changes are less well developed than those of ture investment than are foreign investors, who mature exchanges, stock markets throughout the have greater opportunities for diversification. In region are growing and deepening fast. By one the coming years use of domestic equity markets estimate the Kuala Lumpur exchange saw a dou- is likely to grow rapidly, but long-term domes- bling in efficiency between 1992 and 1996, and tic debt finance will probably lag in most coun- the Jakarta exchange improved nearly as fast tries, taking off only when domestic contractual (World Bank 1997c). savings become significant, as has occurred to Although East Asia's stock markets are still some extent in Malaysia. (Contractual savings young, capitalization in several is comparable to have also been used in Singapore, but in a pre- or greater than that in rich countries-and is dominantly public sector context.) growing fast (figure 1.7). Stock market capital- ization in Hong Kong (China), Malaysia, and Equity markets Singapore was more than 200 percent of GDP in 1995-substantially greater than in the United Despite East Asia's gradual approach to privati- Kingdom and the United States. The exchanges zation of state-owned utilities, almost $11 billion in Thailand and the Philippines also had high was raised on foreign and domestic stock mar- levels of capitalization (though Thailand's has kets in 1989-95 (compared with $28 billion in since fallen back). Finance from stock markets Latin America), almost entirely for power, trans- will, of course, depend on the perceived riski- Table 1.2 Equity market financing of infrastructure privatization in East Asia and Latin America, 1989-95 (US$ billions) East Asia Latin America Sector Onshore Offshore Total Onshore Offshore Total Transportation 2.2 1.2 3.4 3.1 0.9 4.0 Telecommunications 1.7 2.2 3.9 4.3 11.4 15.7 Power 2.5 0.9 3.4 3.9 4.4 8.2 Other 0.1 0.1 0.2 0.1 0.0 0.1 Total 6.5 4.3 10.9 11.3 16.7 28.0 NDte: Data may not add to totals because of rounding. Source: World Bank, Intemnational Economics Department, Privatization Database. Making the Next Big Leap: Systemic Reformfor Private Infrastntcture in East Asia 15 Figure 1.7 Stock market capitalization in several East Figure 1.8 ... but bond markets are still relatively Asian economies is high and growing fast ... underdeveloped in most of the region Stock market capitalization as a percentage of GDP, 1990 and /995 Bond market capitalization as a percentage of GDP, 1990 and /994 0 50 100 150 200 250 300 0 20 40 60 80 100 120 Malaysia 1990 UnitedStates 1990 Hong Kong _ _ 1994 Singapore Germany _ United Kingdom Japan United States Thailand Singapore Philippines Malaysia Japan Philippines Korea, Rep. ofPhlpie Average for East Asia United Kingdom India Korea, Rep. of Mexico Indonesia Thailand Germany Hong Kong Brazil - China Argentina China Indonesia Source: Intemational Finance Corporation and World Bank data; Claessens and Glaessner forthcoming. Source: WoHd Bank i 995a. ness of projects. In mid-1997 Malaysian on local and international capital markets to investors showed signs of caution over some finance additional investments could emerge as infrastructure projects: a June 1997 rights issue a significant pattern. for the finance of the 2,400-megawatt Bakun Dam was reported to be 63 percent undersub- Debtfinance and bond markets scribed (Financial Times, June 12,1997). A relatively new development is the raising While there has been significant activity on East of funds through securities backed by pooled Asia's domestic equity markets (though much of infrastructure assets. Several Chinese projects it involving foreign investors), domestic debt issued such securities to raise financing on the finance of private infrastructure has been rela- Hong Kong (China) and the domestic Shenzhen tively limited. Does this reflect failure by the stock exchanges. For example, in 1996 the domestic financial system to efficiently interme- Guangdong Provincial Expressway Company diate private savings into profitable investment raised HK$477.9 million (US$62 million) opportunities? The answer is yes, but the prob- through an issue of B shares on the Shenzhen lem relates to the current phase of financial mar- exchange, backed by stakes in completed ket development rather than short-run policy. revenue-generating toll projects, including the Banks still dominate East Asian financial sys- Jujiang Bridge and Guangzhou-Foshan express- tems and account for the bulk of private savings way. The money raised was used to finance in financial instruments. Deposits are mainly additional investment. In late 1996 the Anhui short to medium term, limiting banks' ability to Expressway Company raised $100 million on make the long-term investments typical in infra- the Hong Kong (China) exchange to finance structure projects. East Asian banks also have three highway projects, with the company's bal- less capacity to support large-scale projects than ance sheet secured by the Hening Expressway, do the much larger and financially stronger already in operation (World Bank 1997a). This international banks. use of assets (originally financed by public or Financing infrastructure through long-term private equity or debt finance) to raise resources bonds is an attractive option in principle. Bond 16 Choicesfor Efficient Private Provision of Infrastructure in East Asia Box 1,10 Conractual isavn in oace for infra structiu Chil. Chile's independent petnsion:funids havtetEtE become ti0(theNtiiherlnds' is, unusua in Eiurope lin* having 1illy funded maorplayrsin omestc iftructure finai ncae, 4f0 is designedlto eventuly become part of men;ced inJanuay* 988, te Sydneya HaroiH rTunnel ended an orbitaf freeway neWorkthattkestrWaffIc around ther- up; as a disgWised financing itransaction of the New South port, througthe cit>y underthe habor and to the Nrh. yWales state Xgoyvernment. The freeway comprises MS Centa, which is privately Financeo ifor the ; tunnel was raised byj the Sydney i owned and was built first: M West, W h ich was fUndedW Haur Tunnel Cmpany, Which issued bonds that were largely by taxpayers NinNew ASout Wlest ais,now oper- * fully underwritten bythjeprivate sector. Responsibility forthe ating iand M5 East whichisa yesttobebuilt butould be eithrl boXnds trests tsquarelywiththe state government, bhower, public or pa. The owvners' OfM5 Cnta have already and revenues from tunnel tolsJgo to reducing the goverm- benefitedarom the building ofM5West and will bneiteveri men's liability for thetuinnel bonds. For this' reaso the reoce M5Ea ens. S; auditor-general of New Soth Wales (I1994)concluded that TrheA auditor-generl of NewSouth Wles 0(M1996) has for accwountig purposes, the tunnel is owned by the R6oads -pointedloutthateitfom the publicfundedWM5Wstcan- and Tra7ffAuthoity a government auortyTheftunnel tollt not be comp@e be aise of the adverseco nsquences for. does not coverthe interest on the bonds, andth6e defiiency th e owners of M5 Ctral. HeH conludesthtan urban toll is covered*by the toll on the Harbdur Bridge and, in the fir st Troadis notdesignedotoefficienmreetthe reasonableneds fewyeasbyte st:te gvernm ent.i Under the onginal con- ofthie motorist designedtoca*tur tollsad colde trad *e Sydney Habur Tfunnel Company,whichhtechni- athat phitetoroehi ftoradsispaie l callyowns the tunnel, isentited to asmall returntht s tied efficienitthan pubi ownership." to itsimaintenancefunction. Thereisnenoleffetivereturn froml Opminons difer wvidey on toll6 road. ivte toN roads. operation0 ofthe tunnel. are nsdrdmos aoa te e restiction ne * jg t: - Thepectgrewout fofderal governmnent restrictions not bep puton alteate trafficf and were.thereis less on state borrowing and the need tofreuce nst onl hi tWnetwork siat t th government has the Habour Bridglt spA the Jdevelopmentof tsome6 tocover. These conditionstend tbe met ontoill roadstcon- 1: innoaie long-trml hetfivneea cing techniques i nected tobibidges and tnnels. and helpedcreate a newmaiketfor instuionaluinvestment iitLin iprivate infrs tru cture.ttiitTiETt i:titdii0:4jf:j ittStf ii WtT 0 4j0T0 Sincethetunnel iseffiectivuelygs overnment owvned,the; The government is attracted to the idea of a state WksXgovernmentwillbenefitfrom anylincreasein traffic vol- private toll road because only private funding urnesibrought about by paeinvestmenti tin thie EasternI would allow the project to be built before the Dig stributor which conecs with ttunnel. 2000 Olympics, and the cost of constructing the road would have absorbed about 31 percent of the state's capital and maintenance budget for measures of work, budgets, and specific tasks. roads, a heavy burden to finance (box 2.7). The New South Wales system holds out the The main private rail project under way is the prospect of having the private sector bear much New Southern Railway, which will link Sydney's of the risk of managing the condition of the extensive rail system to the airport in time for the roads. 2000 Olympics. This will be a BOT project, but the An interesting test of government commitment state will still own the track. The private consor- to private sector involvement was the decision to tium will own the stations. Most of the users will build the Eastern Distributor, which connects the not be from the airport, but the airport traffic will center of Sydney to the airport, as a private toll pay a premium and will make the project eco- road. Construction of the Eastern Distributor nomic. The siting of the stations was designed to involves tunneling under the city, which means improve the value of government-owned land. that it is relatively easy to build toll booths without Preliminary scrutiny by the auditor-general sug- disrupting traffic flows. The project sponsors have gests that this project may be less disadvanta- agreed to make improvements to the roads con- geous to the government than earlier ones. necting to the city tunnel, which will improve toll revenue and traffic flow through the city to the air- Providingfederal incentivesforfinancing private port and through the Sydney Harbour Tunnel, infrastructure projects. The federal government which the government effectively owns. did more to encourage private infrastructure Organizing the Government for Efficient Private Participation in Infrastructure: Lessons from Australia 29 Box 2.7 Getting a better deal: The Eastern Distributor to the airport In August 1996 the govemment of New South Wales to be better structured than earlier toll road projects and pays announced that the Eastem Distributor linking Sydney to the more attention to network consequences. airport would be built as a private toll road. The deal appears Features of Eastern Distributor project Feature Contrast with preWous projects Govemment does not contribute to land or ancillary works. * GovemmentcontributedA$225 milliontolandacqui-- * The Road Transport Authorty (RTA) will be repaid for sition and associated wvorks for the M2 motorway. land acquisition costs. * Southem Cross Drive will be widened to six lanes and * RTA purchased land for M5 motorway: costwas con- General Holmes Drive to eight lanes at no cost to the verted into a land acquisition loan to be repaid by the govemment, wider roads will be available to all road owners of the MS. users, who need not use the northbound toll road. * Contractor will accept full risk of construction and traf- * Traffic usage of Harbour Tunnel is underwritten by the fic usage. government which provides a guarted revenue steam. Improvements to public transportation are not limited by the deal. * Toll free access is available for govemment-owned buses providing public transport. * Development of other road or public transportation options is not constrained by the project. • Preferred proposal acknowledges that Eastemr Distributor will be part of the principal north-south road corridor in this vicinity. * No renegotiaton will take place if altemative public * M2 contractcalls for renegotiation.- transport options are developed. 9 Bus services for local residents will be improved. Urban amenities .wiO be improved by tunnet. * Six-lane tunnel from Moore Park to north of William Street will reduce noise and visual impacts, removal of through traffic from streets will -improve environ- ment and amenity for local residents, and pedestrian black spot at Taylor Square will be eliminated. Tol WU be collected in one drection only, and improvements We be * Tolls are -collected in both directions on -the M2 and made to toll-free routes. MSrnotoways . m SoutrAustbal Ministby of Roads data. than simply cut back on the ability of the states to early years against other forms of income for borrow and cut their revenue grants. It intro- taxation purposes is a serious one. Australia has duced a range of incentives designed to over- strict rules governing the transferability of come aspects of the Taxation Act that made it losses between companies, which has meant difficult to finance private projects. Infrastructure that losses from a stand-alone project can be set bonds were introduced and development only against future income and not against cur- allowances were provided for select projects. The rent income in an associated company. Since federal government also took steps to compen- large infrastructure projects tend to incur losses sate state governments that sold state enterprises in the early years and large profits in the out that had previously been exempt from federal years, not being able to offset losses when they income tax but that lost their exemption when occur has made financing private infrastructure they were sold to the private sector. projects more difficult and expensive. The problem caused by the inability of a pri- Generalized transferability of tax losses would vate project to offset the losses created in the have been very expensive, however. Instead, the 30 Choicesfor Efficient Private Provision of Infrastructure in East Asia government allowed approved projects to issue some contracts were poorly structured. How- infrastructure bonds. The interest paid on these ever, as governments have developed a clearer bonds is nontaxable, which makes them attractive idea of what role the private sector should play, to tax-paying bodies and allows the bonds to pay their capacity to negotiate tighter and better con- a significantly lower rate than they otherwise tracts has increased. Consultants to government would. To prevent infrastructure bonds from have also played a pivotal role in building frame- becoming a general subsidy, the government does works and overseeing negotiations. not allow a project to deduct the interest payments as a business cost, as would normally be the case. Recognizing the different interests of This means that infrastructure bonds provide con- different government agencies siderable assistance to a project in the early years, when it is making losses, and offsets this assis- Many different government agencies, each with tance in the later years, when the project is mak- different interests, are involved in infrastructure ing profits and cannot deduct interest as an projects. Recognizing these interests and estab- expense. The net benefit to the project in present lishing clear-cut procedures for implementing value terms is positive. Infrastructure bonds have projects is critical. Both public utilities and pri- been widely used in the financing of toll roads. vate sponsors must deal with a multitude of government agencies. But the public utility is Learning lessonsfrom experience. As their expe- treated as an insider and is often an effective rience has grown, Australian state governments operator within the government. In contrast, a have developed clearer ideas about what role private sponsor is usually treated as an outsider the private sector can and should play in the pro- and lacks allies within the government. vision of infrastructure. Where these ideas have developed most clearly, so, too, has the commit- Thefinance department ment to put them into effect. There is now wide acceptance that the pri- The finance department seeks to minimize pub- vate sector can proved several important bene- lic liabilities. If public funds are to be used, the fits in the provision of infrastructure: finance department will want as little debt as - It can generate investment that would be possible raised and it will want to see a revenue delayed if funded publicly-or not provided stream to repay the debt. If the project is to be at all. This can have immense benefits if inad- funded by the private sector, the finance depart- equate power, water, roads, and sewerage are ment will not want the government to be drawn constraining growth. Private funding of into government funding through guarantees to infrastructure can free up government the project sponsors. resources for high priority social programs, In Australia, as private infrastructure projects such as public health and education, which have been subjected to greater scrutiny, state could never be financed privately, treasurers have begun to require that interest rate * It can produce large efficiency gains if a pri- margins properly reflect any government guar- vate plant is introduced into a public industry antees or commitments. This reflects both the that has not previously operated on commer- growing sophistication of financial markets, cial lines and that has poor staff relations. which have tended to see through disguised * It can help a public utility set prices that bet- financing arrangements and attribute liabilities ter reflect costs. Reaction to an increase in tar- back to the government when the public sector is iffs is often more muted if the utility is in fact carrying all the risk, and heightened pub- privately owned. lic sensitivity about tolls and contract details. There is recognition that governments must know exactly what they are trying to achieve by The industry department involving the private sector and that they must exercise discipline in achieving their goals. This The industry department seeks to maximize has not always been the case in Australia, where opportunities for local industry, whether the pro- Organizing the Governmentfor Efficient Private Participation in Infrastructure: Lessonsfrom Australia 31 ject is publicly or privately funded. It will expect Many projects cannot proceed unless the gov- a substantial proportion of the equipment used ernment provides the land or is willing to use its in the project to be manufactured locally and will powers for compulsory acquisition. But the want to see technology transfer and a commit- department responsible for compulsory land ment to export. Although the industry depart- acquisition will be reluctant to use its power to ment may be supportive of private projects, assist a private project. private sponsors may find it difficult to comply with all the industry requirements, particularly if The public utility the department requires a high level of offset business. The public utility will try to maintain its central role. If the regulatory function has traditionally The employment department resided with the utility or been heavily influ- enced by it, the utility will resist change, even if The employment department seeks to maximize its resistance endangers new private investment. opportunities for local employment. If skilled In many cases the public utility will be the most personnel are required, it will expect them to be difficult institution or agency to deal with, par- trained locally, not brought in from overseas. ticularly if the utility believes that the private sec- Most private sponsors can make their projects tor is being involved as a disguised financing attractive to the employment ministry by offer- vehicle to get a project built. If the government ing to train local residents to assume important also believes the project is a disguised financing positions created by the new project. One of the scheme, problems will inevitably arise, unless unexpected benefits in Australia of replacing the private sponsors of the project accept the role state-owned enterprises with private firms has the government assigns them. been the opening up of new career opportunities. Public utilities become concerned when change is proposed, and these concerns can make The environmental agencies change difficult. For example, if contractual rela- tions are to exist between the public utility and the The environmental agencies will want to mini- private project, the public utility will want to mize the detrimental impact of projects on the maintain maximum control, even if such control environment. Given the long life of most infra- raises the level of risk to the private project. The structure projects, most investors are interested in utility will often have powerful allies in this quest minimizing the risk of having to make expensive to retain control. It will suit the finance depart- upgrades to environmental standards partway ment, for example, to have all guarantees pro- through the life of a plant. vided by the utility rather than the government. The environmental agency can perform a Retention of such control by the utility can helpful role by ensuring that proposed projects weaken the private project if the financial stand- meet environmental requirements. The agency ing of the utility is unclear, however. can cause confusion if it is not clear at which level The workforce of the utility will also feel threat- (state, national, or international) responsibility ened if it suspects that the private project is for the environment lies, however. designed to benchmark more efficient levels of staffing. Workers and management of the public The land acquisition department utility can be a powerful political force, particu- larly if the utility has a large investment program. Land acquisition can be difficult, particularly if it In Australia in the 1980s, for example, the head of is left to the private sponsors to purchase required the government-owned telecommunications parcels of land. The nineteen toll road projects company often warned cabinet ministers of the currently out for private tender in Indonesia impact that a cutback in the agencies' borrowing require that the private contractor be responsible program would have on phone connections and for land acquisition. Whether this requirement investment in marginal seats held by the gov- hampers the projects remains to be seen. ernment in Parliament. 32 Choicesfor Efficient Private Provision of Infrastnrcture in East Asia Federal-state issues Negotiations over take-or-pay or power contracts should not be taken over entirely by In a federation each state or provincial govern- public utilities. The minister needs a team ment will want to bring investment and employ- around him or her whose experience is broader ment to its region and will be distrustful of than that of the utility. While the government's national guidelines. State and provincial gov- negotiating team needs to understand the ernments will use their ability to withhold plan- utility's interests, it also needs to be able to put ning approvals to leverage their interests. those interest into a broader context. Without coordination there is likely to be dupli- cation of approvals processes. If a project can be Resolving issues sited in any of a number of states, the project sponsor can use the resulting competition Handling the competing pressures of private among states to negotiate a better deal. State infrastructure projects requires that ministers be charges and taxes can be bid away in this committed to private sector participation and process, and duplication of approval processes put in place administrative arrangements that diminished. allow competing issues to be resolved. Federal-state relations can often be perplexing to private sponsors, who may be unsure about Coordinating government who has final authority and what the real issues are. Matters can become very confused when one Private infrastructure projects will stall unless the level of government assesses a project differently government establishes organizational structures from another and takes policy action accordingly. to prevent governnent processes from over- This happened recently in Australia when the whelming projects. Most countries try to deal previous federal government disallowed private with the complexity of the negotiations and the tol roads from qualifying for infrastructure large number of government agencies involved bonds. The new federal government restored by establishing central coordinating agencies. In their eligibility. Malaysia the coordinating agency is the Privati- Public utilities in East Asia are important zation Unit of the Economic Planning Unit in the bodies overseeing large and expanding invest- Prime Minister's Office; in Australia the agency is ment programs. In 1993 an estimated $70 billion the Office of Asset Sales in Canberra; in Indonesia was spent on investment in the region, most of it the state secretary coordinates the processes. The publicly funded. This is quite different from the coordinating agency in Malaysia is particularly situation in South America, where the public powerful, since it comprises the Technical Com- utilities performed poorly before the recent mittee and the Financial Committee, which eval- round of privatizations. In many of the more suc- uate and negotiate with the private firms (Yaacob cessful East Asian economies the public utilities and Naidu in this volume). and authorities are functioning with some credi- A properly functioning central agency can bility. Cooperation between the officials respon- be useful if it brings all the agencies together sible for key public utilities and the sponsors of and ensures that issues are resolved; if the cen- private infrastructure is therefore essential. tral agency is just another layer of authority Many public utilities and officials would like without the ability to deliver decisions from other to take advantage of the expanding revenue agencies, it will only add to frustration. An all- resulting from economic growth and to imple- powerful central agency can lead to another ment commercial pricing on their own. If range of problems if it runs roughshod over other policymakers are not going to fund public agencies without resolving legitimate concerns. If investment, they need to make this clear to the this is done, negotiations can be reopened only at public utilities by introducing a policy frame- great cost to all parties. work that defines the role of the private sector. The process will be most efficient if over time Without clear policy articulation there will be an agreed upon framework can evolve that ongoing confusion and resistance to change. enables the following key issues to be addressed: Organizing the Governmentfor Efficient Private Participation in Infrastruicture: Lessons from Atustralia 33 * The relationship between the private facility Both the private sponsors and the govern- and the public utility and distribution system. ment need to accept a measure of self-discipline; * The tax treatment afforded private projects. both sides should avoid springing unexpected While individual tax rulings may be neces- new demands on each other once either party is sary, each project should not have to negoti- locked into the project. The temptation for ate its tax treatment separately. If taxation either party to engage in "sequential ambush" arrangements are creating problems, they is real, but the long-run consequences heavily should be resolved for all infrastructure outweigh any gains that might be extracted in projects. the short run. The government must recognize * Arrangements for supporting local industry, that it will be seeking new private infrastructure which should be understood at the outset repeatedly and that a reputation for springing and left intact as the tender process proceeds. new demands on project sponsors or changing If local industry preference is part of the ten- the rules when it is very expensive to disengage der process, it should be transparent. will add to financing costs in the future, as spon- * Requirements for training, environment sors try to protect themselves against the poten- clearances, and immigration, which should tially higher cost of doing business. The private be understood at the outset. sponsor must recognize that a reputation for * Authority over and responsibility for the backing out of commitments at the last minute, project, particularly if there is significant failing to deliver on promises, or making new opposition from certain agencies. demands will make it very difficult to secure If senior ministers are firm, rules can impose new business in the region. The last minute structure and prevent particular agencies from demand for government guarantees to cover constantly reopening matters and trying to construction risk in the Sydney Harbour tunnel reverse earlier decisions. Establishing a rule that project was difficult for the government to han- tenders should be evaluated on the basis of dle since by then it had no way of withdrawing world pricing of inputs would simplify dealings from the project. Governments can protect with the industry department, for example. If themselves by not committing themselves pub- local industry preference is to be built into the licly to a project until they have reached agree- process, a fixed level of preference (say, 10 per- ment with the main project sponsors on key cent) can be prescribed. Formalizing this process issues. is preferable to having to make decisions about every potential domestic input. For rules to be Resolvingfederal-state disputes effective, however, senior ministers have to be able to make decisions on the rules, and the rules In some countries, particularly those with have to be accepted as fixed. strong state or provincial governments, unco- Even when rules are established, however, ordinated and possibly confrontational rela- issues will arise that cannot be determined on tionships between policymakers at various the basis of fixed rules. Some of these issues may levels of government may cause problems. be contentious. But decisionmaking will be sim- When state administrations are strong, the cen- plified by establishing rules in advance and tral government may feel that it is losing its leaving commercial judgments to the project ability to control the macroeconomy if many sponsors. Ideally, the sector or regulatory frame- major infrastructure projects remain outside its work that the government devises to oversee the control. To regain control, the central authority industry will answer most of the questions; as will often announce guidelines governing pro- time goes on, the process may require less and jects. In many cases this may make sense, since it less scrutiny. After the initial investment in the is efficient to have power, water, and transporta- detailed framework, the government may well tion conform to national guidelines rather than find that the process of selecting private infra- uncoordinated state ones. (The Australian expe- structure projects becomes more and more rience with six noncompatible state rail systems straightforward. is a case in point.) However, central guidelines 34 Choicesfor Efficient Private Provision of Infrastructure in East Asia can cause problems if the coordination of state With national agreement has come a will- and federal guidelines has not been thought ingness to coordinate responses to infrastruc- through. ture projects, particularly on enviromnental In countries such as China, where the rela- issues, where effort has been made to avoid tionship between the center and the provinces is duplicating environmental impact studies. still evolving, private sponsors of infrastructure Federal programs that provide for taxation projects often find themselves entangled in com- incentives, such as infrastructure bonds and plex and overlapping administrative arrange- investment allowances for eligible infrastruc- ments. Individual states and cities can have ture projects, have also encouraged the states to considerable power to raise revenue and fund coordinate their processes with federal processes particular projects, but the central authority in order to make infrastructure projects eligible usually has sufficient power over taxation or for federal incentives. As with most federal sys- exchange control to exert its authority if it tems, there is scope for national coordination, but wishes to do so. it is normally the federal government that has to Some promoters of private infrastructure pay to achieve it. have tried to minimize the difficulties that can If there is a lesson to be drawn from the occur by establishing direct commercial links Australian experience with federal-state issues, with cities and states (box 2.8). While such a strat- it is that the federal taxation power is very egy may work for certain projects, particularly important in building national responses. This those that are commercial and not dependent on lesson may have some relevance for countries multilateral or aid agencies, it can add another such as China, where national-provincial rela- element of risk to the project if the sponsor does tions are still evolving. The fact that Beijing is not fully understand the relationship with the building a national taxation base to replace the center. Without central government involvement income it received from public enterprises will and support there is also greater risk associated change the relationship between the center and with enforcing contract provisions. the provinces and may result in a steady increase Regardless of a project's ability to deal in Beijing's authority over the provinces. directly with a city or state, there may well be a need for the central authorities to control Obtaining the best deal behavior at the state level, especially when it comes to land acquisition and the provision of East Asian countries face tremendous opportu- state services to the project. The central author- nities for harnessing the private sector. Private ities may have to use their taxation powers and sector investment in infrastructure can remove controls on borrowing and foreign exchange to bottlenecks, improve economic growth, and prevent the project from being held hostage at reduce the social problems brought on by inad- the state level. equate water, sewerage, transportation, and In Australia experience has shown that in a power. The private sector is keen to invest and federal system in which the states have consid- will accept narrow margins if private firms are erable power, heavy-handedness is counter- forced to compete. To negotiate effectively with productive. The federal government needs clear private firms, however, government agencies instruments it can use to enforce its policies, but may need to acquire new skills. Multilateral at the end of the day there has to be a measure bodies and multicountry forums can help. of cooperation. In Australia this cooperation has come from regular formal high-level meetings Scrutinizing projects between state and federal leaders, who have managed to agree on a range of national priori- The potential gains from shrewd contract nego- ties they are willing to support. The Council of tiation are enormous in twenty- to thirty-year Australian governments, a body set up to deal take-or-pay contracts. These contracts are com- with federal-state issues of national importance, plex, legally dense documents the main purpose meets regularly. of which is to provide sufficient security to an Organizing the Government for Efficient Private Participation in Infrastructure: Lessons from Australia 35 BoX 2.8 Forging.links With cities: lTe ChinaWater Co:-- '. The China Water Company is a recently-formed developer. water facilities over a specified contract period. The project .and investor in water supply, wastewater treatrent. and is expectedto be completedwithin eighteen-months andwill water-related infrastruture. in China established by AIOC supply 150,000 cubic meters ofwater a day to the local pop- Ltd., an Australian institutional investor. AlDC's equity hold- ulation. The company has also identiffed a number of other ers are neithersuppliers nor operators in-the water industry. :potential projects. .but long-term investors from Hong Kong (China) and insti- Chinese cities cannot borrow, but their authorities can, tutional investors of the Australian and Singapore govern- although they usually do not have the standing to do so. The ments. The company has initial shareholder funds of $30 China Water Company identifies an income stream; negoti- million, shared equally between AIDC, Hong Kong Lanid, ates a contract with the water authority and the city! possi- and Hong Lim Investments, a subsidiary of the investment. bly involving a subsidy from the city. satisfies itself of the holding company of the Singapore government. Chinese security of the arrangements: and builds the facility. cities appear to see an advantage in dealing with long-terrn AIDC has found that avoiding aid agencies and multilat- investors rather than with operators or suppliers who are- erai lending institutions has made decisionmraking easier, and seen as often being more concerned with short-run retumrs. it has found the Chinese legal structure better than expected. AIDC is building a commercial business with individual The-company has scope to expand, as many Chinese cities- Chinese cities and does not deal with concessional lending :now have the income and wealth to finance water infra- institutions or multilateral bodies. The company uses appro- structure on a comrnmercial basis. It is estimated that to alle- priate local technology where possible and buys its water viate shortages China will need to build more than 230 new expertise on the market It has ertered into a joint venture water plants similar in size to the Shenyang project over the with the Shenyang Water Supply Generai Company, a gov- next five years. Beiing's restriction that the private sector emiment-owned water utility company in Shenyang city, the cannot own the water distnbution system meansthat China's capital of Liaoning-province. The $25 million joint,venture cities will be keen to.use private capital to fund water-treat- involves the construction, operation, and management of ment facilities to free up resources to imnprove distribution.. income flow so that financiers will lend to the investment. For example, a private toll road may project. Both the governments and the project be very bankable because of its ability to raise a sponsor and financiers will have expert advisers large revenue stream from motorists. But if it is review the contract. These advisers will be very connecting two toll-free public freeways, legiti- busy during negotiations (although the fact that mate questions can be raised as to whether the their compensation depends on the amount of project is earning an income stream from the new time spent suggests that in some cases negotia- investment or from the existing investment in the tions may be prolonged unnecessarily). two public freeways. In such situations closer While governments need advice on the com- analysis might suggest that the public sector join plexity of the contracts, they also need the exper- the two freeways. Even if the private project rep- tise to evaluate the broader ramifications of the resents a disguised financing arrangement and project. With toll roads consideration has to be the public sector benefits from commercial wind- given to how competitive forms of transporta- falls, all the costs to the public sector associated tion will interact. Future public investment in the with the private project should be considered. network, which will affect the revenue of the toll Governments sometimes feel more comfort- road, also needs to be reflected in the negotia- able dealing with a businessperson or company tions. A new private water treatment plant needs with whom they have dealt in the past. to be coordinated with future public investment Negotiations with such a person or company in distribution. A new private power generator can often be more straightforward and speedy requires investment in high-voltage and low- since there is a greater measure of trust and voltage distribution facilities to make best use of mutual understanding between the parties. the private project. Future investment by the Because they are perceived to have a lower level public sector made necessary by a private project of political risk, such projects can sometimes be should be reflected in the negotiations with the financed relatively more simply. In the long run, private sponsors, particularly if the private however, governments are likely to obtain bet- equity holders will benefit from future public ter terms if they develop a framework within 36 Choicesfor Efficient Private Provision of Infrastructure in East Asia which a wide range of companies can bid on an auditor-general's powers over private infra- arm's-length basis. structure is still being debated in Australia, and Governments are at a disadvantage when a some balance will need to be struck between private promoter devises a project and then pro- protecting commercially sensitive documents of ceeds to market it to the authorities, since the private companies and taxpayers' right to know government is forced to depend on the exper- what is being done in their name. tise of the promoter to evaluate the project. Where proposed projects have been announced Establishing a regulatory authority by the government and have not been subject to competitive tendering-as in the Sydney What happens if performance turns out to be Harbour Tunnel project-or crucial financial radically different from what the financial mod- issues have been developed in a post-tender eling suggested? If the project generates more arrangement, the government faces increased revenue than expected-because of greater pro- risks. Despite these drawbacks the Malaysian ductivity or lower costs-there will be political authorities have deliberately avoided competi- pressure to recoup some of the windfall gains for tive tendering. The government selects private consumers. If rates of return are lower than companies with which it negotiates, and the pri- expected, the project owners will want to revisit vate sector is encouraged to propose particular the pricing arrangements, something that gov- projects for privatization. Contracts in Malaysia ernments usually resist. have never been regarded as immutable, how- In industrial economies governments estab- ever, and the government can renegotiate lish independent regulators to deal with such aspects that are unsatisfactory (Yaacob and situations. This would be done either by review- Naidu in this volume). ing rates of return or by reviewing CPI - X formulas at periodic intervals to keep a balance Reviewing projects: The role of the auditor between the interests of the consumers and the private investors. In Australia formalized review of the govern- As East Asian economies develop and the ment's contracts with the private sector has been private sector plays a larger role in the provision left largely to the State Auditor-General's Office, of infrastructure, the need will grow to require which audits projects and makes the findings the review of tariffs in order to avoid abuse of known to state parliaments. State auditors- market power. Arbitrary government discretion general are statutory officeholders, and although to adjust tariffs after contracts have been signed they are appointed by executive government would make private infrastructure projects their authority comes from Parliament. It is from more difficult to finance on a project finance the auditors-general in New South Wales and basis. Establishing a review process with Victoria that the public knows so much about the accepted guidelines and methods of operation Sydney Harbour Tunnel, the tollways, the water could reduce uncertainty and facilitate new pri- treatment works, and the costs involved in the vate investment. In many jurisdictions the sale of Loy Yang B. authorities retain the right to reopen contracts Partly as a result of the work of the state that prove to have undesirable consequences. In auditor-general, the current government in New Malaysia, for example, the authorities have South Wales announced a formal policy entitled made it clear that contracts are not immutable, "Guidelines on Private Sector Participation in and contracts have been renegotiated. Such a Infrastructure Provision." The guidelines cover system works in Malaysia because there is close the calling of tenders and the methods of select- communication between the government and ing proposals. private investors and because investors have The auditor-general does not have the power been allowed to earn attractive rates of return. In to scrutinize all documents, particularly docu- the power sector independent power producers ments held by the private sector, many of which earn rates of return of 18-19 percent, and con- are commercially sensitive. The extent of the cession contracts for road projects are designed Organizing the Government for Efficient Private Participation in Infrastructure: Lessons from Australia 37 -Bx 2. Fromoting co,lipmtition anid investment in a with a third-party access code As part of the drive to buid a competitive national market for Provision is also made: for review of the reference tariff. el-.ectricitand gas, state and federalleaders in ,Australia agreed every five years in order to allow questions of excess or inad- in m'id-1995 to create the Gas Reform Task Force. The task- equate profis to be addressed. Not all issues would be subject force has set about developing a national code for third-party to review, however. Structural issues would be set in stoneto access to all pipelines. It covers:both tranmission and distribu- give certainty to the project, but marketvariable issues, such as. -i-n systems. Federal and .state representatives, regulatory demand, would be reviewed. This provision also enables the Agencies, the gas industry. and:major consumers have all been: CPI - X formula to be reconsidered every five years. . . - involved. ' . . ' - -; ' - ' - . ; ' ; . . - '; aThe model strikes a reasonable balace between the need The code wil determine an access reference tariff, which for certainty and the difficulies associated with locing up the ref- wiil be based on afair rate of returnrton assets. This will require; erence price for at leasttwentyyears. The code reduces riskand financial modeling and careful: valuation of assets, Efort has is welcomed by investors in the gas industry and new investors, been made to provide incentives for discounts and to avoid seeking to compete by building. new pipelines. The code will passing on costs if the pipeline is not fully utilized. The natural increase competion, but it will rnotget in te way of theoriginal monopoly elements of the gas industry are to be structurally negotiaions that underpinned the financing of the pipeline. since. separated, and the reference triff will, be adjusted by a It will apply only to third-party users,aller the foundation users CPI - X formula.; and suppliers have signed cont-actsthatmake the pipelineviable, to provide investors with a return of 14-15 per- existing investors and new entrants while pro- cent. However, East Asian governments may moting competition and efficiency. find it attractive to formalize informal review Victoria has had great success with a pric- processes as contracts take on greater weight ing model based on splitting off the generators and they seek to strike even more competitive from the distribution function and forcing the deals with private investors. generators to compete on pricing in a central In Australia the current negotiations over a pool. Elements of such an approach could be third-party access code for national gas usefully introduced elsewhere. Malaysia has pipelines illustrate how regulatory arrange- taken steps in this direction by selling off a ments that open up new markets and provide share in Tenaga Nasional, previously the for a fair rate of return on assets and periodic monopoly supplier of electricity in Malaysia. review can reduce uncertainty, encourage com- Five independent power producers have been petition, and make private investment more allowed to supply electricity to Tenaga, with a attractive (box 2.9). separate regulatory agency set up to ensure The first private project can act as a catalyst fair pricing, prevent anticompetitive behavior, to regulatory change. The sale of Loy Yang B check prudent investment, and ensure safety broke the mold in Victoria, and although it did in the industry. As well as corporatizing the not fit into any competitive model, it did force old monopoly supplier and making it more the government to think through the implica- responsive to market forces, the changes have tions of a lone private supplier in a vertically brought new entities into the system that over integrated, publicly owned electricity industry. time will serve as benchmarks against which Commencement of the Paiton Power Gen- efficiency can be measured. Pressure will con- erating Complex in Indonesia is likely to lead to tinue to build to make tariffs competitive. As similar pressures. Already other private electric- the system evolves and the independent power ity projects are progressing on the basis of the producers become more significant, this pres- Paiton contract, saving money and effort by sim- sure is likely to lead to further regulatory plifying the negotiating process. The fact that reform. Malaysia may be influenced by the Paiton debt is now rated and trading in New windfall that Victoria gained from selling York as investment-grade paper represents a assets and decide that it, too, wants to reap major step forward. As all parties gain experi- some of the benefits that can come from con- ence, new regulatory arrangements will need to tinuing to deregulate its system and selling off be put in place to bring greater certainty to both generation and distribution assets. 38 Choicesfor Efficient Private Provision of Infrastrncture in East Asia Improving public sector technical and passed on to other areas and so that experience negotiating skills gained in one country in the region can be trans- ferred to other countries. Advisers with a broad Public servants often lack technical and negoti- understanding of policy are essential to comple- ating skills. The auditor-general of New South ment the lawyers and other advisers. Outside Wales (1996) has highlighted the question of the consultants to the Victorian government, includ- capacity of the public sector to negotiate accept- ing Troughton Swier and Associates and Credit able arrangements with the private sector: Suisse First Boston, have been at the heart of electricity reform there. Advisers can be trained The public sector typically does not or hired, and advisers and officials could rotate have the prospect of commercial fail- among East Asian countries. ure that helps to motivate the private sector. And it has not trained its public Recognizing the advantages of a framework service to develop and assess what are often conceptually difficult arrange- The Australian experience reveals that a frame- ments. Moreover, the government does work that sets out how private infrastructure not reward its senior officers in the projects will operate strengthens the hand of same way to the same extent as does public sector negotiators, particularly if the the private sector. It would thus be sur- framework promotes competition among the prising if the government's senior private sector bidders. Understanding the oper- executive had the necessary skills to ating environment reduces uncertainty, which negotiate a balanced deal with the pri- will enable the government to negotiate nar- vate sector. And if senior executives in rower margins with private promoters. If the the government sector have these government structures its framework to pro- skills, they must be tempted to seek mote competition, it can gain an additional employment with the private sector advantage by forcing private sector sponsors which actually pays for these skills. and investors to bid against each other to further compress margins without exposing the gov- Contract negotiations are normally based on errnent or the community to additional liabili- financial modeling, which attempts to deter- ties or costs. mine the rate of return generated by particular There is currently no shortage of private tariff structures. The task for the government equity willing to invest in infrastructure projects and project negotiating teams is to arrive at a in East Asia. Large infrastructure funds inter- rate of return and a tariff that look reasonable to ested in long-term investment are located in both parties and are acceptable to the financiers. Hong Kong (China) and elsewhere, and U.S. The financial modeling used by the parties is utilities are keen to invest in East Asian infra- central to the negotiations, and it is essential that structure projects as a way of lifting their over- the government be in a position to build its own all earnings rate, the domestic part of which is model rather than use a noncustomized model or held down by regulation in the United States. depend on the model prepared by the project International companies that supply equipment sponsor. Having the capacity to build a financial for infrastructure projects, particularly power model and assess models built by others requires projects, are also keen to become equity part- skills that all governments should possess. ners, and energy suppliers want to participate in It is clear that the public sector in Australia exchange for long-term contracts. National util- has been learning from its mistakes and has been ity companies, such as Electricite de France, are developing new skills. It is also clear, however, also keen to invest as part of a national strategy. that to a large extent different infrastructure sec- All these companies recognize that East Asia is tors have failed to learn from the mistakes of the fastest-growing area in the world, that other sectors. More can be done so that experi- growth prospects are poor in Europe and else- ence gained in one area of government is quickly where, and that the margins on their tradi- Organizing the Governmentfor Efficient Private Participation in Infrastrtctutre: Lessonsfrom Australia 39 Table 2.1 Proceeds from the sale of the distribution businesses and generators in Victoria (millions ofAustralian dollars) United Energy Limited Solaris Power Eastem Energy Powercorp Australio Ctipower Limited Yalloum HazehMood Sale date August 1995 October 1995 November 1995 November 1995 November 1995 March 1996 August 1996 Book value 944 490 971 1,204 693 1,537 700 Gross proceeds 1,553 950 2,080 2,150 1,575 2,428 2,350 Note: United Energy Limied, Solabs Pawer, Eastem Energy, PowercorpAustralia, and Citipower Limied are distrbution businesses. Yalloum and Hazelwood are power stations. Source: Victoria, Treasury Department data. tional businesses are low. All have come to the nesses were sold without guarantees, with the conclusion that infrastructure investment in understanding that the exclusivity of their fran- East Asia is one way of pursuing their corpo- chise was not watertight and that franchise cus- rate goals and increasing earnings. These com- tomers who could not choose their suppliers panies are also attracted to spreading their would be protected by a CPI - X regime that investments across countries to minimize risk would set maximum uniform retail tariffs. By so that the investment interest is not concen- 2001 all customers would be able to choose trated in particular countries but is spread whom they purchased electricity from, and they across the region. would be able to choose from a list of indepen- At the same time Asian capital markets are dent retailers that would include retailers from developing rapidly, and there is growing scope other states. Choice would be phased in, with for countries to finance private projects domes- the largest consumers having the opportunity to tically without recourse to foreign capital. A choose first. developing domestic capital market is very In reality, each distribution area was rela- important because it enables long-term invest- tively secure, but the distributors would have to ment and savings to be channeled into private compete for their larger customers and could not infrastructure and allows the projects to be treat their smaller customers too casually. What financed in domestic currency, thereby remov- made the distribution businesses attractive to ing exchange rate risk from what are essentially the bidders was the fact that despite the uncer- domestic investments. The rapid development tainty, the new arrangements provided the of Australian capital markets since they were opportunity to introduce new technology and to deregulated in the 1980s has been very impor- retain the gains that might come from produc- tant in helping to finance private infrastructure. tivity improvements and cost reductions. What Given the strategic concerns motivating was offered provided enough security and busi- many potential investors, governments have ness opportunity to make the distribution busi- scope to extract premiums. In Victoria the state ness attractive assets. The generators were sold government created a framework that provided without guarantees, with only the prospect of for the separation of the generators from the dis- selling electricity in a wholesale market in which tributors, but it also provided for the sale of the generators in other states with excess capacity regionally based distribution businesses and the would compete. generators. The five distributors and two gener- A wider range of equity holders were ators were sold sequentially during the twelve involved in the various consortia, including months before August 1996. The tendering U.S. and U.K. power utilities and Australian process raised A$950 million-A$2.4 billion for superannuation funds. One of the reasons such each business, for a total of A$13.1 billion from high prices were realized was that funds man- the five distribution businesses and two genera- agers believed that the electricity industry in tors (table 2.1). At the time of the tendering Victoria was an attractive place to invest. This process, these assets had a book value of about was the turning point and underscores why the A$6.5 billion. sale process was so different from the sale The bidders were prepared to accept consid- process for Loy Yang B. Loy Yang B needed gov- erable commercial risk once they felt the policy ermnent guarantees and took an extended structure was secure. The distribution busi- period of intense negotiations. The five distrib- 40 Choicesfor Efficient Private Provision of Infrastrncture in East Asia utors and two generators were sold within ing advice and, if asked, assisting in the selection twelve months without guarantees. The differ- process itself. This role might be helpful in coun- ence was the framework and the fact that the tries that are not accustomed to managing large distributors had a wider range of commercial international tendering processes on an arm's- opportunities because they sold directly to cus- length basis. Participation by a multilateral tomers, unlike Loy Yang B whose output was lending institution might spread the flow of sold on a take-or-pay basis to the wholesale information and help bring the expectations of pool. The fact that a national electricity grid and all parties into line. a competitive market for electricity will be func- The Asia-Pacific Economic Cooperation tioning within the next few years has also added (APEC) Energy Working Group, which com- new commercial opportunities (see box 2.10 for prises the United States, Japan, Canada, an example of a sale under a competitive and Australia, and the developing economies of East stable market framework). The net result of Asia, has been active building regional coopera- these sales was that the state budgetary position tion on energy matters. APEC brings a useful was transformed and the state gained new bud- perspective to such issues as trade liberalization, getary flexibility. standards, and infrastructure. It provides the East Asian countries could conclude from this leaders of the United States, Japan, and China that they, too, could extract competitive prices with the opportunity to develop a common from the private sector if they established frame- sense of purpose in a region in which the three works that provide less than exclusive franchises powers have much at stake in building a creative but allow direct sales to customers and genuine and practical relationship. commercial opportunities. In exchange the pri- APEC energy ministers met in Sydney for vate sector would accept mechanisms to protect the first time in August 1996, when they customers from unfair trading. There need be no endorsed a work program that will strengthen government guarantees if in the process of estab- regional cooperation by, among other things, lishing the framework, the financial position of facilitating the seconding of regulators and the various public utilities could be adequately other trained personnel among member econ- scrutinized. If assets were also sold, East Asian omies. APEC also has the potential to speed governments could also find theirbudgetaryposi- development of sectoral and regulatory frame- tion improved, with greater scope to channel works for energy. Its main strength, however, is resources into high-priority areas. that it is the only vehicle through which a num- ber of important multilateral issues, including Recognizing the role of multilateralfinancial environmental issues, standardization of energy institutions equipment, and security of energy supply, can be hammered out. Multilateral financial institutions have tradi- Environmental issues in East Asia need to be tionally played an important role in the provi- addressed on a multilateral basis. Without sion of infrastructure in East Asia, providing agreement among nations, individual countries finance, soft loans, and technical assistance. may feel free to water down enviromnental con- Today the financing task has become so large trols in a bid to gain a competitive advantage. that multilateral financial institutions can play With the environmental consequences of one no more than a small role in financing. They can, country's standards likely to affect other coun- however, play an important role in strengthen- tries, there needs to be a venue in which these ing government institutions and their officials issues can be resolved. There may, in fact, be the by providing training and by funding expert making of an agreement under which various advice. In this way, governments can deal more countries would provide assistance with new effectively with project sponsors to everyone's cleaner technology and cleaner coal that would advantage. benefit all concerned. APEC has the potential to Multilateral institutions can also assist some build the confidence and mutual understanding countries with the tendering process by provid- necessary to make such agreements possible. Organizing the Governmentfor Efficient Private Participation in Infrastructure: Lessonsfrom Australia 41 Box 2.10 Fetching top dollar when a competitive and stable market framework is established: The sale of Hazelwood Power Station Hazelwood Power Corporation operates an integrated brown be uncompetitive and would have to dose once ViKtoria's elec- coal mine and a 1 ,600-megawatt power station located in the tricity market was deregulated. In fact, the old State Electricity La Trobe Valley. The corporation was sold August 4, 1996, for Commission of Victoria was set to close Hazewood. A$2.35 billion. It had a book value of about A$700 million, rev- Hazelwood's main attration is that it should be able to oper- enue of A$255 million in 1995-96, and eamings before inter- ate as a low-cost base load facility selling into New South Wales est, tax, and depreciation of A$ 115 million. Revenues were and South Australia once the national grid is established. expected to dedine over the next few years, pending the full However, itwillface fierce competition from New South Wales operation of the national market for electricity. and Victorian suppliers, who collectively have excess capacity.- The corporation was bought by the Hazelwood Power The sale underlined that the market will pay a 'high pre- Partnership, a consortium comprising Britain's largest elec- mium for a commercial opportunity once a competitive and tricity producer, National Power (52 percent), -U.S. power stable market framework is established. The high price was companies Destec (20 percent) and PacificCorp (19.9 per- achieved despite the govermment's refusal to allow a major cent), and the Commonwealth Bank and its funds arm equity holder in the Yallourn power station, U.Ksbased (8 percent). Powergen, and a memberof one of the iosirg bidders to have The high price paid astounded the market. Hazelwood is a degree of influence over Hazelwood's management. a thirty-year-old plant, which many observers believed would Powergen withdrew from the consortium. Source: Vctora. Treasury Department data; Australian financial Review, August 5, 1996. The question of the security of energy supply lus for private involvement in infrastructure is at the heart of many investment decisions, and came from the need to invest despite tight bud- coordination of electricity generating specifica- get constraints, and investments in transporta- tions has the potential to save more than A$10 tion, water, and power projects were little more billion, according to APEC. The fact that coun- than disguised financing transactions designed tries such as Indonesia and Australia, with their to get around budget funding problems. This large energy resources, belong to APEC pro- phase also saw drawn out negotiations and the vides scope for further progress on this issue. cancellation of projects. Although the private projects expanded supply, there was a feeling Conclusion that governments could have negotiated better deals. Involving the private sector in the provision of In Australia transactions have been left largely infrastructure opens up a wide range of oppor- in the hands of state governments. Progress has tunities. With private sector funds governments been fastest in those sectors inwhich governments can make essential infrastructure investments have tried to carve out a legitimate role for the pri- even if they have, limited scope to borrow or vate sector. In the state of Victoria, for example, the raise revenue. But to attract private sector inter- breaking up and privatization of transmission, est and ensure that the state gets good value out generation, and distribution assets has trans- of the private sector, governments have to formed that state's budget position and has develop sophisticated processes and acquire created a much more competitive and responsive sophisticated skills. Private investment in infra- industry. structure forces governments to identify and for- Transportation has experienced a less radical malize arrangements that previously could be transformation, and doubts over the desirability left unspecified when the system was entirely of private toll roads remain. But states have publidy owned. Learning to develop new sys- improved their ability to extract competitive bids tems is not straightforward, and governments from the private sector. State auditors-general frequently make mistakes along the way. But have brought public scrutiny to a number of pro- governments learn from their mistakes. jects, strengthening the hand of government and The Australian experience is similar to that of narrowing margins. States have improved their many countries in East Asia. Initially, the stimu- ability to work closely with a number of poten- 42 Choicesfor Efficient Private Provision of lnfrastncture in East Asia tial contractors and have developed techniques exchange for commercial opportunity if they to extract better deals. The fact that equity hold- believe the policy framework is stable. Gov- ers in a number of listed toll roads have done ernments can reap large returns by develop- well has encouraged a range of new institutional ing a detailed framework that sets out clearly investors, which has further strengthened the the role of the private sector. hand of governments. * If governments achieve the right balance Private water projects have developed between security of return and commercial steadily, and they, too, have benefited from risk, private sponsors will accept competi- public scrutiny and the growing number of tion without government guarantees. private infrastructure funds. It is likely that the * There is a role for regulatory oversight, private sector will provide an important share which can encourage competition, reduce of new investment in water treatment in the uncertainty, and encourage new investment future, although there currently appears to be Regulatory oversight is particularly impor- little interest in selling concessions or exclu- tant in the power industry. sive franchises. * Even if the major objective in involving the Officials are still digesting the full implica- private sector in infrastructure is to increase tions of the recent experience, although some budget flexibility, governments can still measure of consensus has occurred. Many now negotiate narrower margins by negotiating recognize the benefits of setting up a competi- with several project sponsors and increasing tive framework and forcing private investors to public scrutiny of negotiated deals. bid against one another. There also appears to be agreement that compeition and private owner- Note ship in the power industry can free up budget resources and improve efficiency. Better deals Don Russell is global asset adviser at Sanford C. be secured in transportation and water, Bernstein, New York. He was formerly Australian an now be the m attrtion of wate ambassador to the United States and has held sev- although for many the main attraction of private eral senior civil service positions in the Australian investment remains budget flexibility,. government. Private infrastructure promotes efficiency because it allows private investors to design and organize investment to minimize ongoing costs. References Private investors are less likely to overengineer plants or invest where risk is too high. Benefits New South Wales, Auditor-General. 1994. "Road on.this score are likely to be particularly impor- Transport Authority: Audit of Infrastructure on where the desg o be panhas a larg Projects." New South Wales, Australia. tant where the design of the plant has a large . 1996. "Financing Infrastructure: Private Profits bearing on the cost of ongoing operations and from Public Losses." Paper presented to the Public maintenance. Accounts Committee, Parliament of New South What implications for East Asia can be Wales, July 31. drawn from the Australian experience? Victoria, Auditor-General. 1994. Annual Report. Victoria, • An innovative and flexible domestic financial Australia. World Bank. 1995. "Infrastructure Development in East market is important. Most private infrastruc- Asia and Pacific: Toward a New Public-Private ture projects are domestic and need to be Partnership." East Asia and Pacific, Office of the financed in domestic currencies. Only when Vice President, Washington, D.C. institutional investors are attracted to pro- jects can govermnents negotiate narrower margins from private sponsors. Expanding private infrastructure and a developing domestic capital market seem to go together. * Private investor interest in infrastructure is high, and private sponsors of projects will accept considerable commercial risk in CHAPTER 3 Contracting for Private Provision of Infrastructure: The Malaysian Experience Yahya Yaacob and G. Naidu U ntil just over a decade ago the provision tion in the economy led to a huge increase in the of infrastructure in Malaysia was almost size of the public sector relative to the economy: entirely the public sector's responsibil- the public sector grew from about 29 percent of ity. Infrastructure services were considered far gross national product (GNP) in the 1970s to a too important to be left to the private sector. And peak of about 58 percent in 1981. Public enter- the Malaysian government, like many others, prises proliferated. presumed that the technology and economics of With the large government,presence in the infrastructure precluded any substantial role for economy, the public sector deficit grew, leading the private sector. Because of natural monopo- to a sharp increase in domestic and external bor- lies, economies of scale, and externalities in the rowing. External debt more than quadrupled production and distribution of infrastructure between 1980 and 1985. Compounding this, the services, infrastructure was considered more international recession in the 1980s dampened suitable for public provision than for private. Malaysia's export earnings. The looming eco- In the mid-1980s the Malaysian government nomic crisis culminated in a negative growth initiated a program of economic liberalization rate in 1985, the first since independence in 1957. and deregulation that included a comprehensive By the late 1970s it was already apparent that privatization policy. The policy entailed down- government revenues could not keep pace with sizing the public sector while expanding oppor- the growing expenditures. It was these circum- tunities for the private sector. In infrastructure stances that prompted the government's policy the opportunities for private sector participation changes. in areas previously the exclusive domain of the The shift in strategy from public-sector-led government have expanded considerably-not growth to private-sector-financed development only through the sale of equity in state enter- began in 1983, when the prime minister prises but also through privately financed devel- announced a national policy relating to the opment of new services and facilities. concept of "Malaysia Incorporated." This con- cept sees the country as a corporate entity in A shift toward private provision of which the government provides the enabling infrastructure environment-infrastructure, deregulation, lib- eralization, and macroeconomic management- The privatization policy had its origins in the and the private sector serves as the main engine macroeconomic problems Malaysia faced in the of growth. This policy marked the beginning of early to mid-1980s. Many of these problems Malaysia's ambitious program of privatization. were, rightly or wrongly, attributed to the gov- The government set out its rationale for privati- erinent's increasing involvement in the econ- zation in Guidelines on Privatisation (Malaysia omy, largely in pursuit of the objectives of the 1985). Implementation of the policy is guided by New Economic Policy. This extensive interven- the Privatisation Masterplan, adopted in 1991 43 44 Choicesfor Efficient Private Provision of Infrastrmcture in East Asia (Malaysia 1991a). The government's commit- in Malaysia need government sanction in the ment to expanding the private sector's role in form of a contractual arrangement with the the economy is reiterated explicitly in its Second government. Contracting between the public Outline Perspective Plan (Malaysia 1991b). The and private sectors in Malaysia for infrastruc- Seventh Malaysian Plan (1996-2000) confirms ture provision, operation, and maintenance has that privatization will be an important means of taken various forms, the main ones being leases achieving the government's development and concession contracts (appendix table A.1). objectives (Malaysia 1996). Infrastructure is at the forefront of the privatization program. Leasing Over the past decade the liberalization and privatization programs have dramatically Leasing is commonly used in privatizing state changed the conditions under which infra- infrastructure companies. Under a lease agree- structure services are provided in Malaysia. ment a public authority or agency transfers a Private sector provision of infrastructure is state enterprise's physical assets to a private extensive, encompassing ports, roads, power firm for a specified period, and the private and telecommunications services, urban infra- company is required to purchase outright any structure, water supply, sewerage, and even moveable assets of the state enterprise, such as hydroelectric generation (appendix table A.1). vehicles. The private operator is allowed to The privatization of state infrastructure compa- recoup its lease payments-which usually take nies and the opening of many segments of the the form of an initial payment and annual pay- sector to private participation have resulted in ments-and operating costs through user fees an important change in the respective roles of for the infrastructure services it provides. the public and private sectors in infrastructure Since ownership of the physical assets remains development. with the government, the private operator This shift is clearly evident in the financing assumes only operational risks. At the expira- of infrastructure development. Until the Fourth tion of the contract the physical assets revert to Malaysia Plan (1981-85) investment in infra- the government. structure in Malaysia was entirely financed by In Malaysia leasing has been used most the public sector. That is no longer the case. The often in privatizing ports. The facilities at growth in private financing of infrastructure Malaysia's premier terminal, Klang Port, have has been so dramatic since the mid-1980s that been leased to three port operating companies, during 1996-2000, coinciding with the Seventh and four other ports are also being run by pri- Malaysia Plan, the private sector is actually set vate companies under leases. Under two other to spearhead infrastructure development in the lease agreements the corporatized railway country. During the Plan period the private sec- company is operating the country's rail ser- tor is expected to invest 68.3 billion ringgit vices and Malaysian Airports Berhad is operat- (RM), three and a half times the RM 19.2 billion ing its airports. that the public sector plans to spend on infra- structure (table 3.1). Including the resources Concessions that the private sector is expected to spend on the power industry would further increase the By far the largest number of contracts used in share of private financing in infrastructure the privatization of infrastructure in Malaysia development during the Plan period. have taken the form of concession agreements. Concessions incorporate all the features of a Contracts for private provision of lease contract, but from the outset the private infrastructure company has the additional responsibility of financing the construction of the project. Thus, The liberalization of entry into infrastructure unlike leases, which apply to existing assets, sectors has not meant free entry: private firms concessions are used for the development and that want to develop or operate infrastructure operation of new infrastructure. In a typical Contractingfor Private Provision of Infrastrmcture: The Malaysian Experience 45 Table 3.1 Public and private financing for infrastructure development in Malaysia, 1991-2000 (ringgit millions) Sixth Malaysia Plan (1991-95) Seventh Malaysia Private sector Public sector Public sector Plon (1996-2000) investmenta Sector allocation expenditure Public sector allocation (1996-2000) Transport 1 2,881.6 11,594.7 15,484.2 Roadsb 8,451.0 7,572.6 9,838.8 17,505.0 Rail 1,802.6 1,735.4 3,370.0 10,600.0 Ports 434.0 410.9 486.8 4,241.7 Airports 1,833.0 1,780.6 1,266.0 5,956.0 Urban transport 361.0 95.2 522.6 Utilities 2,876.3 2,796.7 3,687.3 Watersupply 2,749.5 2,671.9 3,575.3 2,571.7 Sewerage 126.8 124.8 112.0 1,759.4 Communications 76.1 71.0 58.6 Telecommunications and postal services 45.0 39.9 25.5 25,660.0 Meteorological services 31.1 31.1 33.1 Total 15,834.0 14,462.4 19,230.1 68,293.8 a. Privatized projects. b. Excludes local roads in regional development areas, some local authorities, and agncultural roads, which have been allocated RM 700 million. Source: Malaysia 1996. concession agreement the private firm under- power purchase agreement between the firms takes to finance the construction of an infra- and Tenaga Nasional Berhad, the integrated structure facility and to operate it for an agreed power utility. The reason for this arrangement on period. Consequently, in a concession agree- was that, from the very beginning, the govern- ment the private provider in theory assumes ment did not want to bear any of the project both the operational and the investment risks. risks. The power purchase agreements are The Malaysian government has used con- therefore the substantive contractual instru- cession contracts for the construction and oper- ment in the development of private power gen- ation of sixteen major urban and interurban eration in Malaysia. road schemes, build-operate-transfer (BOT) projects involving a total investment of more Otherforms of contracting than RM 17 billion. Three light rail transit pro- jects in the capital city of Kuala Lumpur are Three other contractual arrangements deserve being developed under concession contracts as mention. The first is a contract between the gov- build-operate-own-transfer (BOOT) schemes. ernment and a private provider that essentially Concession contracts have also been used for combines a lease and a concession agreement, the development of new ports in Malaysia, the used in privatizations in which the private com- Lumut Maritime Terminal, and the Pelabuhan pany both takes over existing assets and is Tanjung Pelepas. required to develop new facilities. The new ter- A variation of the concession is the contrac- minal at Klang Port, Klang Multi Terminal, is tual arrangement under which the independent one example of such an arrangement. Another power producer projects in Malaysia have been is the privatization agreement between the gov- developed. In mostcountries suchprojects have ermnent and the private operator of Johor Port involved both a BOT or BOOT concession (Seaport Terminal Sdn. Berhad), which consists agreement between the government and the of a lease for operating the existing facilities and independent power producer and a power pur- a concession agreement to build a new port, chase agreement between the producer and the Pelabuhan Tanjung Pelepas. (often integrated) national energy corporation. Management contracts are another avenue In Malaysia, however, private power genera- for involving the private sector in infrastruc- tion was brought about through the issuance of ture. Under a management contract the private licenses by the Electricity Supply Department contractor is responsible only for the operation to the independent power producer firms and a and management of the government-owned 46 Choicesfor Efficient Private Provision of Infrastructutre in East Asia facility. This type of contract is rarely used in The substantive contracting procedure is the Malaysia's infrastructure sector. The govern- same regardless of how the private contractor is ment has signed a few management contracts in chosen: the water sector and a management contract for * The private company (or companies in the case Penang Bridge that obligates the private firm to of a restricted tender) is required to undertake invest RM 500 million in improvements and a detailed feasibility study at its own expense repairs. and to prepare a detailed proposal. In some infrastructure industries the govern- * Two committees established by the Privati- ment issues licenses to private firms to provide zation Unit, the Technical Committee and the services formerly provided exclusively by a Financial Committee, evaluate the detailed government department or state enterprise. proposal and undertake negotiations with Privatized ports, for instance, operate under a the private firm. The committees then pre- license issued by the government, as do Tenaga pare a joint recommendation and submit it to Nasional Berhad and Telekom Malaysia. These the Economic Planning Unit. licenses are time-bound and range from twenty- * The Economic Planning Unit submits the rec- one years for Tenaga Nasional Berhad and ommendation to the Cabinet, which either Telekom Malaysia to thirty for most of the pri- accepts or rejects it. vatized ports. Licenses issued to private compa- * If accepted in principle by the Cabinet, the nies to provide telecommunications services are privatization proposal goes through a round not time-bound. Although licenses are not in a of detailed negotiations between the private strict sense contracts, like leases and concessions company and the relevant ministry. they too cannot be had on demand. They also * Upon completion of the negotiations, the pri- impose implicit contractual obligations on the vatization proposal is again submitted for licensees, and failure to fulfill those obligations approval by the Cabinet, which even at this can result in termination of the licenses. point may reject it. i If the Cabinet accepts the draft agreement (a Contracting procedures lease or concession), the ministry and the pri- vate company enter into a contract. The procedures used in contracting depend on who initiates the privatization proposal. In Projects initiated by the private sector Malaysia a privatization project in infrastructure can be initiated by either the public or the private A unique aspect of Malaysia's privatization pol- sector. The procedures for awarding contracts in icy is that it allows-even encourages-the pri- these two cases are similar though not identical. vate sector to initiate or propose projects for privatization. In such cases the contracting Projects initiated by the public sector process is initiated by the private firm's submis- sion of an unsolicited proposal to the Economic A privatization proposal initiated by the public Planning Unit. If the initial evaluation finds sector can be implemented in one of two ways. merit in the proposal, the unit gives the firm a The government can choose or nominate a pri- letter of intent and the status of "preferred con- vate company to undertake the project. Or, if the cessionaire." This process is tantamount to first government has already undertaken a privati- come, first served, because it very nearly accords zation feasibility study, it can direct the Privati- the company that submits a privatization pro- zation Unit of the Economic Planning Unit to posal exclusive right to undertake the project. offer the project for direct negotiation with a But the company must still prepare and submit selected private company or to call for a a detailed project proposal, including a feasibil- restricted tender. The choice of approach and of ity study, for evaluation by the Technical and the private contractor (even in the case of a Financial Committees. The project then goes restricted tender) is made at the highest politi- through a process similar to that for a proposal cal level. initiated by the public sector. Contractingfor Private Provision of Infrastnrcture: The Malaysian Experience 47 Basicfeatures of the contracting process errnent support to be provided. The other arti- cles in a typical concession or lease contract per- Regardless of how a privatization project is initi- tain to termination of the contract and dispute ated, the contracting process will always include settlement mechanisms. certain basic features. Evaluation and negotiating mechanism. The Length of negotiations. The larger the project Technical and Financial Committees are the and the more technically complex it is, the principal government bodies for evaluating pri- longer it takes to negotiate the contract. Most vatization proposals and negotiating contracts negotiations for infrastructure privatization in in Malaysia. Their formation has centralized the Malaysia, however, are concluded within six evaluation process, facilitating the entire con- months, and lease contracts take much less time tracting process. The effectiveness of the com- to conclude than do concessions. (Economic mittees depends on the expertise and skills of Planning Unit officials are of the view that con- their members. The members of the Technical tracting through open, competitive bidding Committee are drawn from the ministries and would take much longer than the sole-source government agencies where the expertise negotiated or restricted tender processes now needed to evaluate a particular proposal is avail- used in Malaysia.) Because of the experience able. Thus for a road project the Technical gained by the evaluating agencies and, equally Committee would include, besides officials from important, by the private sector bidders, con- the Privatization Unit, officials from the tracting now is said to take only half as long as Infrastructure Section of the Economic Planning when the privatization program began. Unit and engineers from the Public Works Department, the Highway Planning Unit of the Critical negotiating points. The most important Ministry of Works, the Malaysia Highway negotiating points in contracting for infrastruc- Authority, and the Department of the ture projects relate to technical specifications, Environment. For an independent power pro- length of contract period, level of user fees (tolls, ducer proposal the committee would include port fees, power purchase price), service quality officials from the Energy Section of the standards, and government support (support Economic Planning Unit and the Electricity loans, traffic volume supplements for toll roads, Supply Department. In addition to representa- external risk supplements, government assis- tives from the Privatization Unit, the Financial tance in land acquisition). At the beginning of the Committee's membership includes staff from contracting process the distance between the the Treasury, the Accountant General's Office, government's position and the private firm's is and the Attorney General's Office. usually quite large. It is during the negotiations The two committees are also authorized to between the private firm and the Technical and begin the negotiating with the private sector. Financial Committees that compromises are Over time this task has been eased as technical made and agreement is reached. The initial dif- benchmarks are established on the basis of ear- ferences on nearly all the vital parts of the con- lier projects and as the committees gain experi- tract are now beginning to narrow, largely ence in assessing the technical and financial because both the government (and its agencies) parameters in the private sector proposal. The and the private sector have become familiar with committees do not have the final word in nego- the range of technical and financial elements. tiations. Contracts are fine-tuned at the Cabinet level and even during final negotiations with the Scope of contract. A typical contract begins ministry. with a section containing the provisions of the concession agreement. Other important articles Open bidding or negotiated contracting? set out the design details for the project, the con- struction schedule, the toll rates or other user The description of the contracting procedures fees, the schedule of fee increases, and any gov- above should make it evident that contracting 48 Choicesfor Efficient Private Provision of Infrastructure in East Asia for infrastructure privatization projects in inevitably been sacrificed. Although this may Malaysia does not occur through transparent well be true, Malaysia's approach to contracting and competitive bidding. In fact, in the infra- includes features that should offset at least some structure privatization over the past decade only of the potential efficiency losses. one contract has been awarded through com- petitive bidding (a small independent power Negotiating process producer project in the state of Sabah). In nearly all other infrastructure privatization-whether The negotiating mechanism, especially the through divestiture, leases, or concessions- Technical and Financial Committees and the contracting has been through a sole-source Privatization Unit, appears to function in a way negotiated process. In a very few cases, where that ensures that private firms cannot dictate the the project was identified by the government, terms of contracts. Both committees have the contracts were awarded through a restricted ten- requisite skills and expertise to undertake effec- der offer. Examples include the Kuantan Port tive and meaningful negotiations with private privatization and the East Coast Highway, for firms, and it is generally agreed that they give which three firms were invited to submit their best effort to obtain the best possible terms tenders. for the government and the public. That the In both sole-source negotiated contracting bureaucracy is a formidable negotiator is con- and restricted tender offers, the private com- firmed by many of the private firms now pany has generally been selected by the coun- involved in the infrastructure sector. try's political leader and the basis of selection There are numerous examples of the bureau- therefore cannot be discerned. Despite the fre- cracy's effectiveness in negotiations. In many quent criticism that the award of contracts in the cases toll rate proposals have been scaled down infrastructure sector has lacked transparency during negotiations and lease and concession and the accusations of political favoritism, the periods have been shortened. The most recent Malaysian government has rarely deemed it example is the reduction in the sale price of elec- necessary to explain or justify its choice of con- tricity from the Bakun Dam concession. tracting mechanism or of the firm to which a One factor that favors the bureaucracy in its contract has been awarded. negotiations with private firms is its information There are three possible explanations of why advantage. Work by government research the government has avoided competitive bid- departments, submissions by other private ding. The first is a belief that awarding contracts companies for the same project, proposals for through open, competitive bidding involves similar projects, and other sources of information higher transaction costs than negotiated con- produce a huge database that the government tracting. A second possible explanation is a can use to assess and evaluate privatization pro- belief that open, competitive bidding for con- posals. There have been so many road privatiza- tracts may make it difficult to achieve the New tion projects, for example, that government Economic Policy objectives. A third possibility is departments and agencies are sufficiently well that the government has avoided open, com- informed to undertake effective negotiations on petitive bidding because it is time-consuming. all substantive issues of a road privatization Negotiated deals apparently can be completed proposal. in half the time required for a competitive bid- In addition to the bureaucratic scrutiny, there ding process. are at least two other levels of review at which contracts can be modified to take into account Contracting and efficiency efficiency considerations and consumer inter- ests. The negotiations are subject to scrutiny at It could be argued that because contracts for the highest political level of the Cabinet, and infrastructure projects in Malaysia have not contracts undergo final negotiation at the min- been competitively awarded, some of the poten- istry level. Both processes help ensure that pro- tial efficiency gains from privatization have jects are efficient. Contractingfor Private Provision of Infrastntcture: The Malaysian Experience 49 Specification of evaluation criteria The first independent power producer project was developed under a take-or-pay power pur- For all infrastructure sectors open to private chase agreement providing little incentive for sector participation in Malaysia, basic technical efficiency. For the next four such projects the and financial standards and design parameters agreement did not include take-or-pay provi- have been specified. And regardless of which sions, so that the most efficient power producer approach has been used to award a contract, would be the first allowed to supply the grid. these standards must be met by the private Changes have also been made in the pricing supplier. For roads, for example, privatization mechanism to force power producers to proposals must contain a set of technical para- increase efficiency. The independent power pro- meters that meet the standards for design, ducer pass-through in the pricing formula was construction technology, pavement design, and discontinued, and the automatic rate revision the like that are set by the Public Works Depart- clauses have been removed from the licenses ment and the Highway Authority. For the finan- granted to privatized utility companies. cial evaluation, proposals must provide project cost estimates, traffic and revenue projections, a The role of consumers financial analysis, and a financial plan. These technical and financial criteria provide some Whatever the mechanism by which the contract assurance that the projects approved are was awarded, privatization projects have increas- efficient. ingly had to stand up to scrutiny by Malaysian consumers. On many occasions the public has Allocation of risks expressed dissatisfaction over the levels of tol rates, telephone rates, electricity rates, and fees In the early years of infrastructure privatization for sewerage services, forcing the government to in Malaysia some of the commercial risks of pro- renegotiate with the concessionaires. jects were borne by the government. But many of these risks have since been shifted to the pri- Factors in the success of contracting in vate operators. Similarly, forms of government Malaysia support once provided to private operators are no longer as readily available. Even if contracting in Malaysia cannot be said to The experience with road projects illustrates guarantee efficient infrastructure provision, the shift of the burden to the private sector. To there is no doubt that, unlike many other coun- enhance the viability of road projects, the gov- tries, Malaysia has succeeded in attracting sig- ermnent in the past gave private operators assis- nificant private resources to its infrastructure tance in the form of support loans, traffic volume sector. In addition to the projects already com- guarantees, and external risk guarantees and pleted and under way, many proposals are under bore the full cost of land acquisition. But since consideration for the privatization of existing 1995 the government has begun to transfer more ports, the development of new port terminals, of the risks in road projects to the private sector, the privatization of roads, and the development including the cost of land acquisition. (However, of independent power producer projects. the government still gives advances or interest- What explains the government's success in free loans to concession companies to alleviate contracting with private firms for the supply of the burden of financing in the early years of the infrastructure services? There are three main fac- concession.) The transfer of the cost of land tors. First, the government has a substantial and acquisition to the concession companies means credible commitment to the privatization of that they must now be more precise in their infrastructure. Second, the government has con- design work, resulting in less waste in land sistently shown a genuine interest in making intake and thus greater efflciency. privatization projects succeed even if that means In the electricity sector too there are signs renegotiating with the private operators. And that efficiency is now a greater consideration. third, the straightforward institutional structure 50 Choicesfor Efficient Private Provision of Infrastructure in East Asia for infrastructure privatization and the harness- the flexible manner in which privatization con- ing of expertise and skills at the Economic tracts are implemented in the country: Planning Unit to evaluate and negotiate project * Public protests over the imposition of tolls by proposals have facilitated contracting. the private developer of an urban road pro- There is strong commitment to the privatiza- ject in Kuala Lumpur led the government to tion policy among the country's political leader- renegotiate the contract so as to reduce the ship. Prime Minister Mahathir's personal tolls and delay their imposition. interest in the privatization program lends con- * In the Kelang Container Terminal privatiza- siderable credibility to the policy. The political tion agreement the lease contract gave the stability and the overwhelming strength of the company exclusive rights to provide con- ruling coalition party also help assure the pri- tainer handling services at Klang Port. Soon vate sector that the privatization policy and the after the agreement was signed the govern- economic liberalization program will be sus- ment realized that granting these exclusive tained. The Guidelines on Privatisation, Privatis- rights had been a grave error. When the ation Masterplan, and Second Outline Perspective remaining facilities at Klang Port were leased Plan all confirm the government's commitment to a new port operating company that was to privatization. The high-level commitment also allowed to develop its own container creates an environment conducive to contract- berths, the government persuaded Kelang ing by limiting the government's ability to Container Terminal to drop its exclusive behave opportunistically. rights. In return the government allowed the The bureaucracy's attitude toward the pri- company to expand its terminal from three vate sector has become increasingly positive container berths to four. since the government's adoption of the Malay- * At the beginning of 1996 PLUS, the concession sia Incorporated concept. The public sector is company for the North-South Expressway, now encouraged to view the private sector as a was entitled under the concession contract to partner in development and to work to ensure raise its toll rates. But the government per- the success of privatization projects. One out- suaded the company to delay the toll hikes come of this approach relates to the provision and reduce the increase and began negotiat- of information to private firms to assist their ing with PLUS the compensation for this project preparation. Feasibility studies under- change to the contract. taken by the government or its agencies are * As a result of much public dissatisfaction now readily made available to the private firms with the way the national sewerage project selected to bid for a project, and departments was being implemented under a concession are encouraged to support the firms' project contract with Indah Water Konsortium, the preparation. government commenced renegotiation of the The public sector's commitment to making contract. privatization projects succeed is reflected in the * In 1994 the minister responsible for telecom- government's flexible approach to implement- munications issued a number of new ing contracts, best illustrated by projects that licenses. In early 1996, however, the new need to be renegotiated. Contracts have often minister of energy, telecommunications, and been modified by mutual agreement because of post thought that too many licenses had been unanticipated events-sometimes to protect issued and encouraged consolidation of the government or consumer interests and some- industry through mergers among the firms. times at the request of the private firm. There The matter is now being left entirely to the have been at least four major renegotiations in private sector. recent years, and the expeditious settlement of These examples suggest that contract rene- the issues reflects both the government's com- gotiations have been common in Malaysia. But mitment to projects' success and the private sec- they have been neither time-consuming nor tor's belief that the government is renegotiating costly. The government's flexibility has con- in good faith. The following examples illustrate tributed to this. In addition, private infrastruc- Contractingfor Private Provision of Infrastructure: The Malaysian Experience 51 ture firms have been extrerr ely cooperative, in tor in the Perspective of Economic Liberalization, part because they depend on the goodwill of the New Delhi. Economic Planning Unit, Prime Mini- govermment for future projects. Renegotiation is ster's Department, Kuala Lumpur. also eased by the operational auditor system, in Ibrahim, Abdul Khalid bin. 1987. "Privatisation and the New Econornic Policy." Paper presented at the which one auditor comes from the government National Conference on Privatisation: Towards the and the other from the private company. This Formulation of a Masterplan, Institute of Strategic system minimizes disputes over requests for and International Studies, Kuala Lumpur. renegotiation. Perbadanan Nasional Berhad, Kuala Lumpur. Also important in Malaysia's success in con- Jomo, K.S., Christopher Adam, and William Cavendish. 1995. "Policy." In K.S. Jomo, ed., tracting out the provision of infrastructure to Privatising Malaysia: Rents, Rhetoric, Realities. private firms is the simple institutional structure Boulder, Colo.: Westview. created to deal with infrastructure privatization. Kennedy, Laurel. 1995. "Telecommunications." In K.S. The Privatization Unit and the Technical and Jomo, ed., Privatising Malaysia: Rents, Rhetoric, Financial Committees constitute an effective Realities. Boulder, Colo.: Westview. and inexpensive contracting mechanism, and Lee, Cassey. 1995. "Regulatory Reform in the Infrastructure Sector: The Malaysian Experience." the procedures for gaining approval for privati- Paper presented at the Regional Workshop on zation projects are fairly straightforward. The Managing Regulatory Policies and Reforms in East Privatization Unit acts as a one-stop agency, Asia, World Bank and the Institute of Strategic and although approval is also needed from the International Studies, Kuala Lumpur, July. Cabinet and the relevant ministries. But the University of Malaya, Kuala Lumpur. tripe-laeredappovalsystm des nt apear Malaysia, Economic Planning Unit, Prime Minister's triple-layered approval system does not appear Department. 1985. Guidelines on Privatisation. Kuala to be overly cumbersome or complex. Contract Lumpur: National Printing Department. disputes are to be settled by arbitration in accor- . 1988. "National Ports Plan." Vol. 1, "Overview." dance with the arbitration rules of the United Prepared by PRC Engineering, Inc., in association Nations Commission on International Trade with Sepakat Setia Perunding Sdn. Berhad and Law. There is no provision for legal resolution of Aseambankers Malaysia Berhad, Kuala Lumpur. .1991a. Privatisation Masterplan. Kuala Lumpur. disputes. National Printing Department. Also contributing to the rapid pace of infra- . 1991b. The Second Outline Perspective Plan, structure privatization in Malaysia is the rate of 1991-2000. Kuala Lumpur: National Printing return that the govermnent allows private firms Department. to earn from investments in the sector. Inde- . 1996. Seventh Malaysia Plan (1996-2000). Kuala pendent poerpodcrstpiayLumpur: National Printing Department. pendent power producers typically earn returns Malaysian Economic Association. 1991. "Bintulu Port of about 18-19 percent, and concession contracts Privatization Study." Vol. 1. Kuala Lumpur. for road projects are generally tailored to give Naidu, G. 1992. "Private Provision of Physical investors a return of 14-15 percent. Infrastructure: The Malaysian Experience." Economic Development Institute Working Paper. Note World Bank, Washington, D.C. .1995. "Infrastructure." In K.S. Jomo, ed., Privatising Malaysia: Rents, Rhetoric, Realities. Yahya Yaacob is secretary general of the Ministry of Boulder, Colo.: Westview. Works, Malaysia, and G. Naidu is an associate profes- Naidu, G., and Cassey Lee. 1997. "Malaysia: The Trans- sor at the University of Malaya. ition to Privatization." In Ashoka Mody, ed., Infrastructure Strategies in East Asia: The Untold Story. References Washington, D.C.: Economic Development Institute, World Bank. Aida, Boey Abdullah. 1996. "Malaysia: Towards Vision Ng, Chee Yuen, and Toh Kin Woon. 1992. 2020-The Privatization and Road Development "Privatization in the Asian-Pacific Region." Asian Strategy." Economic Planning Unit, Prime Pacific Economic Literature 6(2). Minister's Department, Kuala Lumpur. Puthucheary, Mavis. 1987. "An Assessment of the Hitam, Samsudin bin. 1995. "Transport Infrastructure Privatization Guidelines with Reference to Objective for Economic Development: The Case for Setting." Paper presented at the National Con- Malaysia." Paper presented at the Asian Conference ference on Privatisation: Towards the Formulation on Emerging Role of the State in the Transport Sec- of a Masterplan, Institute of Strategic and 52 Choicesfor Efficient Private Provision of Infrastructure in East Asia International Studies, Kuala Lumpur. University of an Update on the Malaysian Privatization Master Malaya, Kuala Lumpur. Plan." Paper presented at the National Privatization Salleh, Ismail Muhd. 1991. "Privatization: The Summit: Privatization-The Next Steps, Kuala Malaysian Experience." In Hisashi Yokoyama and Lumpur. Economic Planning Unit, Prime Minister's Mokhtar Tamin, eds., The Malaysian Economy in Department, Kuala Lumpur. Transition. Tokyo: Institute of Developing Economies. Sulaiman, Ali Abul Hassan bin. 1993. "Financing Salleh, Ismail Muhd, and Saha Dhevan Meyanathan. Infrastructure Projects: Issues and Recent Policy 1993. Malaysia: Growth, Equity, and Structural Developments." Paper presented at the Regional Transformation. Lessons of East Asia Series. Conference on Financing Infrastructure Projects in Washington, D.C.: World Bank. South-East Asia, Kuala Lumpur. Economic Planning Salleh, Ismail Muhd, and H. Osman-Rani. 1991. "The Unit, Prime Minister's Department, Kuala Lumpur. Growth of the Public Sector in Malaysia." Institute . 1994. "Infrastructure Development for Econo- of Strategic and International Studies, Kuala mic Growth: The Case of Malaysia." Paper present- Lumpur. ed at the World Infrastructure Forum, Jakarta. Shawal, Abdul Hamid. 1996. "Malaysia Privatization Economic Planning Unit, Prime Minister's Depart- Experience-Past Success, Future Challenges, and ment, Kuala Lumpur. Contractingfor Private Provision of Infrastructure: The Malaysian Experience 53 Appendbt Table A. I Infrastructure privatization and contracting in Malaysia Sector and project Method of privatization Type of controct Ports Klang Port Kelang Container Terminal Sale of equity (1986) Lease (21 + 30 years) Kelang Port Management Sale of equity (1992) Lease (30 + 30 years) Klang Multi Terminal Sale of equity and BOT (1994) Lease (30 years) and concession (33 years) Johor Port Sale of equity (1995) Lease (30 + 30 years) Bintulu Port Corporatization (1993) Lease Penang Port Corporatization (1994) Lease Lumut Maritime Terminal BOOT (1993) Concession Pelabuhan Tanjung Pelepas BOOT (1995) Concession Kuantan Port Sale of equitya Lease Roads North Klang Straits Bypass BOT (1984) Concession (25 years) jIn. Kuching/Kepong Interchange BOT (1985) Concession (16 years) KL Interchange BOT (1987) Concession (30 years) North-South Expressway BOT (1988) Concession (30 years) Second Link to Singapore BOT (1993) Concession (30 years) Penang Bridge Management contract (1993) Management contract (25 years) Butterworth-Kulim Expressway BOT (1994) Concession (32 years) Seremban-Port Dickson Highway BOT (1994) Concession (30 years) Shah AJam Expressway BOT (1994) Concession (29 years) North-South Expressway Central Link BOT (1994) Concession (25 years) KL-Karak Highway BOT (1994) Concession (27 years) New North Klang Straits Bypass BOT (1995) Concession (25 years) Cheras-Kajang Highway BOT (1995) Concession (30 years) Elevated Highway over Sg. Klang and Sg. Ampang BOT (1996) Concession (33 years) Damansara-Puchong-Putra Jaya Highway BOT (1996) Concession (33 years) New Pantai Highway BOT (1996) Concession (30 years) Sungai Besi Road BOT (1996) Concession (30 years) Water supply Labuan Water Supply BOT (1987) Concession lpoh Water Supply BOT (1989) Concession Larut Matang Water Supply BOT (1989) Concession Semenyih Dam Management contract (1987) Management contract Tube well maintenance, Labuan Management contract (1988) Managemnent contract Johor Water Authority Corporatization (1994) Lease Pulau Pinang Water Authority Corporatization (1987) Lease Power Tenaga Nasional Berhad Sale of equity (1992) License (21 years) Independent power producers YTL-Paka and Pasir Gudang BOT (I 995)b Power purchase agreement (21 years) SEV-Lumut BOT (I 996-97)b Power purchase agreement (21 years) GSP-Sepang BOT (I 994-96)b Power purchase agreement (21 years) PDP-Port Dickson BOT (I 995)b Power purchase agreement (21 years) PSP-Powertek, Malacca BOT (I 995)b Power purchase agreement (21 years) Telecommunications Telekom Malaysia Berhad Sale of equity (1990) License (21 years) Ten private telecommunications operators License Others KTM Berhad (Malayan Railway) Corporatization (1992) Lease Malaysian Airports Berhad Corporatization (1992) Lease National sewerage system BOT (1992) Concession (28 years) Light rail transit system I (phase I) BOOT (1993) Concession (60 + 60 years) Light rail transit system I (phase 2) BOOT (1994) Concession (60 + 60 years) Light rail transit system 11 BOOT (1994) Concession (60 + 60 years) Note: BOT is build-operate-transfer; BOOT is build-operate-own-transfer. a. Transaction was pending in 1996. b. Date of commissioning. Source. Naidu 1995 (updated by author). CHAPTER 4 Regulating Private Involvement in Infrastructure: The Chilean Experience Alejandro Jadresic E xpanding infrastructure is a main chal- initiative. Such reforms have significantly lenge for the Chilean economy. Rapid eco- changed the structure and operations of the nomic growth, which has averaged 7.4 infrastructure sector. percent annually over the past decade, is requir- ing massive investment in energy, telecommu- From state to markets: A historic overview nications, roads, railroads, ports, airports, water supply, and irrigation. In the next six years the Until the 1970s the state was the main player in economy is expected to grow at about 6.0 per- Chilean infrastructure. Through government cent annually and total investment require- institutions and state-owned companies, it was ments in infrastructure are estimated at more the role of the state to plan, finance, build, and than $18 billion (table 4.1). operate most of the country's infrastructure. In order to meet such needs without endan- Then in the late 1970s government reforms gering the budget and diverting resources from began to reverse the roles. Privatization of the pressing social needs, Chile has implemented a power and transportation sectors is now nearly policy that allows the private sector to take the complete, and private investment is flowing into lead in infrastructure investment. Private com- infrastructure construction. panies should meet almost all new investment requirements in telecommunications and energy Major state involvement and a major share in the remaining sectors. In the next six years private investment in infrastruc- Before the Second World War the state was heav- ture should account for about $13 billion, or more ily involved in building roads, ports, railroads, than 70 percent of required investment. airlines, irrigation works, and waterworks. Private participation in infrastructure implies After the war state involvement strengthened as more than capital investment. Chilean policy- a result of policies that explicitly promoted gov- makers also rely on the private sector to plan, ernment intervention in developing basic infra- build, and operate infrastructure, and to manage structure. State-owned companies were created the commercial risks associated with infrastruc- for electricity, oil, telecommunications, ship- ture projects. The Chilean economy benefits not ping, and urban transportation. Private compa- only from the financial resources provided by nies in such sectors were transferred to private investors but also from their managerial government ownership. State monopolies and technical skills. became the norm. Major reforms have been introduced in the By the early 1970s it had become the govern- Chilean economy in order to involve the private ment's responsibility to operate and develop sector in infrastructure, and reforms are still new infrastructure, relying on the national bud- taking place, since the government is commit- get or income earned by state-owned companies. ted to creating new opportunities for private The government set the prices charged to cus- 54 Regulating Private Involvement in Infrastructure: The Chilean Experience 55 tomers at levels that were insufficient for self- Table 4.1 Estimated infrastructure investment financing but that reduced inflationary pressures requirements in Chile, 1995-2000 on the economy. Capital shortages became com- (US$ millions) mon in the infrastructure sector, and national Sector Investment requirements investment plans could not be completed. Highways 4,250 Financial deficits worsened in state companies in Urban roads 2,000 Water supply 950 which social objectives had fostered the hiring of Sanitation 1,480 excess personnel. Community facilities 810 Customers had no choice but to accept con- Railroads 470 ditions imposed by the sole state supplier. Irrigation 370 Protectionist policies had progressively been Subways 520 imposed, severely limiting any opportunity for Aiworts 100 Rain water and river management 1 95 new investors to enter the market. Barriers to Power industry 3,000 entry also existed in such sectors as fuel distrib- Gas industry 1,500 Telecommunications 2,500 ution, air transportation, and shipping, where Total investment requirements 18,595 privately owned companies remained as impor- Source: Chile, Ministry of Public Works data. tant players. frameworks. Administrative actions were taken The shift to private provision to split up large enterprises or transform them into private corporations. In the late 1970s the government introduced rad- Starting in the late 1970s and continuing ical reforms in the Chilean economy. The guid- through the 1980s, many companies were priva- ing principles of such reforms were to reduce the tized in the infrastructure sectors, including the intervention of the state in the economy, pro- gas distribution company, the telephone com- mote private initiative, open markets to interna- pany (Compafia de Telefonos de Chile, or CTC) tional trade and foreign investment, stimulate and two other telecommunications companies, domestic competition, and lift restrictions limit- five power generation companies, eleven power ing access of new actors in the infrastructure distribution companies, and an airline (table market. State-owned companies were required 4.2). The story of privatization of the electricity to finance their operations and investment plans and telecommunication sectors is told in case out of earnings. Prices were deregulated when studies later in this chapter. competition was feasible or set at levels that Different sale schemes were used in the pri- would cover costs when state monopolies were vatization process. In the first phase, through the service providers. State-owned companies 1985, entire companies were sold. This made for were forced to reduce costs and to fire excess a faster sale to a single bidder. However, only a personnel. Stringent budgetary limits were few investors could qualify as potential bidders, imposed, constraining not only internal opera- given the amounts of capital required; at this tions but also investment plans. stage institutional and foreign investment was Once these new economic rules were in place not yet important. As a consequence, property and state-owned companies had balanced their was concentrated in a few hands. It was also budgets, the decision was made to privatize argued that the prices paid were too low. those activities that could be run on a commer- To overcome these problems, the next phase cial basis. The government realized that only the of privatization considered a greater diffusion of private sector could provide the funds required property. Very often some shares were kept to resume investment in expansion of domestic aside for purchase by employees or for civil ser- infrastructure. In many cases privatization had vants with the help of long-term credit schemes. to be preceded by legal reforms in order to trans- The state also granted soft loans to individuals fer to the government regulatory and planning to buy a limited number of shares, which was activities previously performed by state compa- called popular capitalism. During this period nies and to establish competitive regulatory controlling shares were auctioned only in the 56 Choicesfor Efficient Private Provision of Infrastnrcture in East Asia Table 4.2 Infrastructure companies privatized in Chile, Table 4.3 Infrastructure companies privatized in Chile in 1976-90 the 1990s Company Yeara Sector Company Yeara Sector Gasco 1977 Gas distribution Edelnor 1994 Power generation and transmission Frontel 1980 Power distribution Fepasa 1994 Railroads Saesa 1980 Power distribution Empremar 1995 Shipping Chilmetro 1986 Power distribution Colbun 1996 Power generation Emec 1986 Power distribution Ferronor 1996 Railroads Emel 1986 Power distribution Tocopilla 1996 Power generation Pilmaiquen 1986 Power generation Telex - Chile 1986 Telecommunications a. Refers to the year private capital gained control of the company. Source: Based on prvate communication of Rosella Cominetti (Economic Chilgener 1987 Power generation Commission for Latin America). Chilquinta 1987 Power distributon CTC 1987 Telecommunications Emelat 1987 Power distribution companies has been transferred to the private Pullinque 1987 Power generab'on sector, with special safeguards to ensure the Edelmag 1988 Power generation and distribubon entry of new players and greater competition. Endesa 1988 Power generaton Entel 1988 Telecommunications The state shipping company was sold during Elecda 1989 Power distribution this period, and privatization of the railroad sys- Emelas 1989 Power distribution tem was initiated in order to stimulate invest- Lan Chile 1989 Airtransport ment and modernization (table 4.3). Investment Pehuenche 1989 Power generation during the 1980s in the state-owned railroad had a. Refers to the year private capital gained control of the company. been very low, leading to infrastructure deterio- Source: SAez 1993. ration and a decline in railroad use. After a 1992 law allowed the railway company to create a few cases where massive investment was partnership with the private sector, a controlling required to boost company development. share of the rail freight business was privatized, Domestic pension funds played a crucial role forming two companies: Fepasa, covering the in the privatization of state-owned companies, at southern and central part of the country (1995), a time when few large domestic or foreign and Ferronor, covering the north (1996). In the investors were willing to invest in what was seen passenger business, in both suburban and as a bold liberal experiment in a developing interurban services, conditions are being created country with high political risks and unproven to promote private sector participation. A sys- regulatory norms. The private pension fund sys- tem is being defined that will allow private com- tem had been created in the early 1980s as a panies to bid for a concession granting them the replacement for the almost bankrupt social secu- right to run passenger services on a commercial rity system. The new system introduced individ- basis. In some cases in which the social rate of ual accounts managed by private companies in a return is satisfactory but the commercial return competitive environment regulated by the state. is not, a one-time lump-sum subsidy may be Workers were required to deposit a set share of considered. their earnings in these accounts, with benefits A concessions law has been approved in based on the accumulated value of the accounts order to promote private investment in roads, at the time of retirement. Using these forced sav- tunnels, and other transportation infrastructure. ings, the new pension funds acquired large Concession arrangements allow major projects shares in privatized companies, particularly in to be developed and financed by private con- the power and telecommunications sectors. To sortia that recover their investments by charging this day they remain a major supplier of funds user fees. This system is described in the road for the ambitious investment programs that and transportation case study later in this these companies are undertaking in Chile and in chapter. neighboring countries. The next round of privatization will affect During the 1990s privatization of the power ports, water supply, and sanitation. For these sector was completed and that of the trans- sectors the government has proposed legal portation sector was begun. Control of all power reforms allowing all new investment to come Regutlating Private Involvement in Infrastructure: The Chilean Experience 57 from the private sector. In the case of ports, state- The positive business climate and existence owned regional companies will privatize opera- of clear rules have been important not only for tions. In the case of water supply, privatization privatizing state-owned companies but also for of 65 percent of the shares of state-owned com- maintaining the flow of investment. In fact, pri- panies is being considered. Progress to date in vatized Chilean infrastructure companies have delineating public and private roles in the water become major investors in other sectors in Chile supply and sanitation sector is described in a and in neighboring countries. After privatiza- case study later in this chapter. tion the asset value of Chile's infrastructure companies has grown at a rapid pace, much Guiding principles faster than the overall rate of economic growth (table 4.4). Private participation in Chilean infrastructure Favorable business conditions have also sectors is guided by four basic principles, been important to attract investors from Chile embodied in existing laws and in government and abroad for the concession system that is policies and initiatives: promote private invest- being applied to develop road infrastructure. ment, strengthen competition, protect the envi- Low political risks and high credit ratings in ronment, and satisfy basic social needs. The international financial markets have facilitated balancing of these objectives requires a sound private participation in long-term projects (see regulatory system. case study on roads and transportation). Promoting private investment Strengthening competition Shortage of infrastructure can become a bottle- Promoting fair competition is a general policy neck for development, requiring allocation of principle for all infrastructure sectors in Chile, massive resources to new projects. But funds are since it is the best way of ensuring efficient required to meet pressing investment needs in operation and better services to consumers. social areas such as education, health, and hous- Chile was a pioneer in deregulating its power ing, where it is difficult to attract private capital. and telecommunications industries within a In fact, at present 70 percent of the state's budget competitive framework. There are no restric- is allocated to social areas. There is no choice but tions on investors wishing to enter the market to rely on private capital for infrastructure expan- nor on customers, who may choose among dif- sion. In addition, private participation works as a ferent suppliers. As a result, capacity shortage mechanism to promote efficiency in constructing has been completely eliminated, the most mod- and operating infrastructure: the profit motive ern technology is being used, prices have gone makes cost reduction a high priority. down, and companies are still earning fair Chile has been very successful in promoting returns (see case studies on electricity and private investment in infrastructure. A key telecommunications). incentive has been the persistence of a favorable It is important to stress that no state guaran- investment climate in the economy as a whole. tees or privileges are involved in telecommuni- A stable political system, a well-developed cations or power projects. Companies develop financial sector, openness to trade and foreign projects at their own risk, estimating demand, investment, and capable government institu- setting prices, and negotiating with financial tions have contributed to this climate. In addi- institutions. Price regulation applies only to tion, regulatory norms established for the main small customers for services in markets where sectors have applied clear and stable rules. The there are natural monopolies, such as telephone duties and rights of private operators are services and electricity distribution. defined in sectoral laws, which clearly distin- A similar policy has recently been adopted to guish the regulatory role of the state and the develop the natural gas industry, supplied by managerial role of both private and state-owned pipelines from Argentina. An open and compet- companies. itive framework is allowing rapid development 58 Choicesfor Efficient Private Provision of Infrastnucture in East Asia Table 4.4 Asset value of selected privatized companies in Chile, 1987-96 CompoNiia de Tel6fonos de Chile Entel Chilgener Assets Increase Assets Increase Assets Increose Year (US$ millions) (percent) (US$ millions) (percent) (pesos millions) (percent) 1987 507 - 139 - n.a. n.a. 1988 754 48.7 154 10.8 n.a. n.a. 1989 975 29.3 209 35.7 n.a. n.a. 1990 1,379 41.4 259 23.9 n.a. n.a. 1991 1,688 22.4 301 16.2 408,515 n.a. 1992 2,124 25.8 362 20.3 460,326 12.7 1993 2,481 16.8 394 8.8 605,245 31.5 1994 3,065 23.5 533 35.3 643,063 6.2 1995 3,658 19.3 644 20.8 669,895 4.2 1996a - - - - 781,484 16.7 - Not available. n.a. Not applicable. a. As of September 30, 1996. Source: CTC; Melo and Serra 1996; Chilgener Estrategia, November 25 and December 16, 1996. of this industry, with no involvement by the Protecting the environment national governments in project selection or financing. Equal access is guaranteed to all cus- Environmental protection has become a major tomers requiring gas transportation services political priority in recent years. New norms and provided by pipeline owners, and there are no legislation have been approved to provide clear constraints on investors wanting to build and rules to investors and ensure that all infrastruc- operate new gas pipelines. ture projects are developed in a sustainable New legislation is being introduced to create manner. Preventing environmental damage is a fair and competitive environment in the port the reigning principle. and water supply and sanitation sectors that will A clearly defined review process, with fixed allow private companies to provide most of the deadlines for final authorization, has recently investment required with adequate safeguards been established, including detailed regula- for consumers. In the case of ports, the large tions. It requires environmental impact assess- state-owned company Emporchi will be divided ment studies for most large projects, indicating into ten separate, autonomous companies, any mitigation measures required. Many large which will be allowed to compete among them- projects undertaken in recent years have per- selves and to attract private capital for infra- formed such studies on a voluntary basis even structure expansion. In the case of water and when not required to do so by law. Environ- sanitation, new legislation will allow privatiz- mental studies are reviewed by an ad hoc tech- ation of state-owned enterprises, within a nical committee composed of representatives regulatory framework that promotes efficient from public institutions involved. The National operation and marginal cost pricing (see case Commission for the Environment (Conama) or study on water supply). its regional offices, depending on the project's In the case of roads and other transportation coverage, makes the final decision about the pro- infrastructure, the state has kept a key planning ject's environmental feasibility. Third parties role but grants concessions to private parties that are affected by the projects may file com- allowing them to build and operate infrastruc- ments during the review process. ture and charge user fees. This newly introduced Some infrastructure projects need to meet concession system ensures a competitive, trans- specific environmental and safety standards, parent, and open bidding process that allows the such as emissions standards for air and liquid best projects to be chosen. The only state guar- pollutants, quality norms for construction mate- antee is one safeguarding minimum earnings rials, and route design constraints for roads and from user charges (see case study on roads and pipes. Such standards are usually based on transportation). international experience. Regutlating Private Involvement in Infrastructure: The Chilean Experience 59 Satisfying basic social needs cations and transportation markets, including urban and intercity traffic, railroads, airlines, and It is a government objective to provide basic shipping. The National Energy Commission social infrastructure to all Chileans. Yet existing oversees oil, coal, gas, and electricity markets. policy recognizes that it may be unprofitable for Technical and economic regulation is carried private investors to serve isolated areas or low- out by specialized institutions. There are superin- income groups. To overcome these limitations tendencias for water supply and for electricity and the government provides funds for projects that fuels, subsecretarias for transport markets and meet minimum social and economic targets. telecommunications, and direcciones generales for Most infrastructure projects that the govern- irrigation, roads, and air transportation. In addi- ment will finance in the next few years would tion, there is a fiscalia (prosecutors' office) and very likely not be developed by the private sec- antitrust commissions that monitor competition tor because of low profitability or because it is throughout the economy, including the infra- difficult to charge users. structure markets. The National Commission for Mechanisms have been introduced to maxi- the Environment is responsible for environmen- mize provision of basic social infrastructure by tal policy and regulation. private investors. Direct subsidies are the pre- The performance of government institu- ferred measure. For instance, government funds tions helps to explain the positive role that the are supplied in a competitive way to private private sector has played in Chilean infrastruc- electric and telecommunications utilities that ture. However, further modernization may be serve rural areas and to ships that serve isolated needed to ensure that regulatory duties are per- islands. In the case of water supply and sanita- formed more efficiently in the future. For that tion, the state provides a direct subsidy to poorer reason the government is promoting adminis- families so they can pay the regulated tariffs trative and legal reforms in order to strengthen charged by the companies, which are set at cost. technical capabilities and enhance the power About 20 percent of Chilean families receive this and autonomy of regulatory agencies. Recruit- benefit. Mechanisms like these allow poor fami- ment of highly qualified staff at the regulatory lies to satisfy their basic needs without obliging agencies is a main concern. Attractive job the state to build or operate infrastructure. The opportunities and good salaries in the private state has only to provide efficient market incen- sector make it difficult to attract top profes- tives to private investors. sionals needed in the public sector. A number of incentives are being considered, including Ensuring capable state regulation improved salary schemes for regulators and use of external consultants for highly special- Private participation does not imply state with- ized tasks. Another concern has been to give drawal from the infrastructure sector. On the regulatory agencies greater legal authority to contrary, it requires active and effective involve- ensure enforcement of regulatory norms. ment of state entities to ensure that private actors Likewise, arbitration mechanisms are being operate in line with social goals. To do this, state considered for resolution of disputes between entities must rely on highly qualified personnel agencies and companies that would minimize who understand and can implement the regula- the need for court litigation. tory framework. Several state entities are involved in Chilean infrastructure. Ministries Private participation in four infrastructure dictate government policy and are responsible sectors: Case studies for the overall performance of specific sectors. The Ministry of Public Works oversees trans- Case studies of the electricity, telecommuni- portation infrastructure (roads, ports, airports), cations, water supply and sanitation, and water supply, sanitation, and irrigation. The roads and transportation sectors describe the Ministry of Transport and Telecommunications process of privatization and the different is responsible for the operation of telecommuni- mechanisms used. 60 Choices for Efficient Private Provision of Infrastructtre in East Asia The electricity sector: Wholesale divestiture every four years for distribution charges; mandatory interconnection and rights of way In its early stages the development of the for electricity transmission over third-party sys- Chilean electricity sector was driven almost tems; and a coordination mechanism for load exclusively by private initiative, but this sce- dispatching. nario changed after the Second World War. In The next step was to prepare the companies 1943 the state-owned company National Electric for privatization. Chilectra was divided into Company (Endesa) was created by the indus- two distribution companies (Chilectra and trial promotion agency (Corfo) in order to carry Chilquinta) and one generating company out the national electrification plan. Endesa (Chilgener). Regional distribution activities undertook several tasks. It planned the exten- and a few smaller generation plants were sep- sion of electricity to cover the whole country, arated from Endesa to become individual studied the availability of hydroelectric incorporated companies. The largest genera- resources, trained the people required for the tion facilities and the transmission lines sector's development, built hydro- and thermo- remained the property of Endesa. electric generating units in different regions of Although care was taken to divide existing Chile, extended trunk lines and started inter- companies, the electricity sector remained quite connecting them, and expanded urban and rural concentrated. Much of the regulatory effort in distribution systems. Endesa was a privileged recent years has been directed to facilitating the state company and could count on having entry and operation of new actors in this market. highly qualified personnel and plentiful This might not have been necessary had Chile, resources. like some countries that have undertaken priva- Some private companies coexisted with tization recently, been more careful to create a Endesa but they progressively lost ground. The competitive set of companies before divesting to most important was Chilectra, which produced private investors. and distributed electricity in Santiago and In the second half of the 1980s the main power Valparaiso and their suburbs. In 1970 Chilectra companies were privatized, including Endesa. was nationalized, so by the mid-1970s the state Open sales of small share packages on the stock controlled 90 percent of generation capacity, 100 exchange were the basic mechanism. The major percent of high-tension transmission lines, and buyers were the private pension funds, although. 80 percent of distribution systems. shares were also offered to employees and civil The first step in reforming the electricity sec- servants. Shares in electric companies still con- tor was taken in 1978 with the creation of the stitute about half of pension fund investment in National Energy Commission (CNE). The com- private stocks. mission would operate independent of state- The privatization process generated a posi- owned companies and would promulgate tive interaction between the power and financial policies, development plans, and regulations for markets. Shares and other financial instruments the electricity and other energy sectors. The CNE offered by the electric companies became very would lead the reform process in these sectors. attractive in the financial market. The real value A new electricity law was approved in 1982, of electric companies' shares increased almost establishing an innovative decentralized model one thousand times between 1984 and 1994 and for developing the electricity sector, which so far rose from about 2 percent of the total value of had operated as a vertically integrated, state- shares traded in the early 1980s to more than 45 owned monopoly. The new approach involved percent in the early 1990s (table 4.5). the separation of generation, transmission, and The electric companies also initiated vigor- distribution activities; free entry and competi- ous investment and expansion efforts both in tion in electricity generation; a concession sys- Chile and abroad. Over the past ten years elec- tem for distribution; a marginal cost pricing tricity consumption has grown about 8 percent scheme for small customers, which is reviewed annually, while total annual investment is every six months for generation charges and approaching $800 million. Prices have started to Regutlating Private Involvement in Infrastnucture: The Chilean Experience 61 Table 4.5 Chilean electric company shares traded, 1980-94 Table 4.6 Chilectra's electricity losses, 1983-92 Value of Total value of Electric (as percentage of production) electricity company shores traded company shores Year Losses shores troded (1993 pesos as percentage 1983 22.4 Year (1993 pesos millions) millions) of total 1984 19.3 1980 3,801 201,669 0.02 1985 20.4 1981 1,255 125,816 0.01 1986 20.9 1982 1,148 59,062 0.02 1987 19.8 l ?83 1,366 29,6227 0.05 1988 18.8 19e'4 788 23,926 0.03 1989 16.1 i985 5,740 34,107 0.17 1990 13.6 1986 63,242 192,409 0.33 1991 13.3 1987 92,540 309,841 0.30 1992 12.0 1988 93,643 373,108 0.25 Source: Chilectra n,d. 1989 146,617 468,091 0.31 1990 186,764 394,293 0.47 1991 403,271 904,104 0.45 tive manner to companies willing to extend the 1992 334,595 884,273 0.38 1993 547,397 1,191,148 0.46 electricity network in rural areas. f994 765,019 2,088,827 0.37 A related development that is having a posi- Source: Predes 1995. tive effect on the electricity industry is the con- struction of pipelines across the Andes to bring fall as competition in power generation has natural gas from Argentina for combined cycle become stronger and productivity in distribu- thermoelectric plants and industrial and resi- tion companies has increased (table 4.6). At the dential uses. The idea of building a gas pipeline same time the electric companies have become is very old but has long met resistance for polit- major investors in neighboring countries that ical, economic, and technical reasons. In 1990 the have started to deregulate their own electric Chilean and Argentine governments called for companies, making use of experience gained international bids by private consortia inter- operating in deregulated markets. Chilean com- ested in building such a project but had to can- panies now control between a fourth and a third cel when they realized that they had no objective of installed capacity and distribution in both way of selecting a winner. The two governments Argentina and Peru and are starting to invest in later decided to open the market fully and let Bolivia, Brazil, and Colombia. private investors take the initiative. This liberal The modernization process has received fur- trade agreement granted no exclusivity rights or ther impetus during the 1990s. The last remain- state guarantees, allowed buyers and sellers to ing state-owned power companies have been set the terms of the gas supply contracts, and sold with safeguards ensuring that they would required open access conditions for gas trans- not be acquired by either of Chile's main private portation. These conditions set the stage for suc- generation companies and that they would cess. Fierce competition developed between two undertake investment plans to consolidate their consortia until one of them was able to sign competitive position in the market. New norms enough supply contracts with buyers; this con- are also being introduced to improve the regula- sortium will start transporting gas in 1997. The tory framework, strengthen competition, and second consortium's project was suspended, but ensure that new projects protect the environ- new private projects to build pipelines across the ment. These norms cover the quality of service Andes and distribute gas in Chile are being to be provided by regulated utilities, the fees to developed. be paid by power generating companies using third-party transmission facilities, and environ- Telecommunications: Gradual privatization mental impact assessment studies required before building new projects. Mechanisms have Telephone service was introduced in Chile as been designed to promote investment by private early as 1880, only four years after its invention. distribution companies in rural electrification In 1927 the main company was acquired by the projects: state funds are provided in a competi- Intemational Telephone and Telegraph Corpora- 62 Choicesfor Efficient Private Provision of Infrastructure in East Asia tion (IIT), an American corporation, and was The principles of the new regulatory frame- incorporated in 1930 as Compafifa de Telefonos work were established in the General Law of de Chile (CTC). CTC soon acquired other, Telecommunications, approved in 1982 and mod- smaller companies and became a virtual monop- ified in 1987. The law granted equal rights to pri- oly, serving more than 90 percent of the market. vate and state-owned companies, within a In 1964 the government created a state- concession system that allows a company (the owned company, Entel, to provide national and concessionaire) to operate providing that it fol- international long-distance services and to rep- lows a set of well-defined regulations. Prices were resent the country in international agencies such freed from regulation except for services that the as Intelsat. In 1971 the government took over the Antitrust Commission allowed to be provided management of CTC and in 1974 bought it from under monopoly conditions. Free entry to the ITT. Chile's telecommunications sector was then market was allowed for new companies. Service dominated by a state-owned duopoly, with local and interconnection obligations were imposed on services provided by CTC and long-distance ser- telephone companies. Cross-subsidies were elim- vices by Entel. Telephone rates were based on inated and a long-run marginal cost pricing long-term average costs, and a 10 percent profit scheme was introduced for telephone services, rate was allowed. In practice, however, rates with a market profit rate determined by the cap- were kept low for political reasons and rate ital asset pricing model. Prices were to be recal- increases frequently failed to keep pace with culated every five years, with an index inflation. There were cross-subsidies in favor of mechanism to be used for the interim (box 4.1). local service. Investment was modest and unsat- Privatization of CTC started in 1987, when isfied demand grew. minority shares were sold to company employ- Reform started in 1977 with the creation of ees and to pension funds and a request for bids the Subsecretaria de Telecomunicaciones (Subtel), was issued for a 30 percent controlling share with an independent body. Its role was to design a requirement for continuing investment. An policies and technical norms and perform reg- Australian conglomerate, the Bond Corporation, ulatory duties, including the granting of con- won the bid and then sold its share in 1990 to a cessions and calculation of tariffs for regulated Spanish company, Telef6nica de Espafia, which services. remains the controlling investor with 44 percent of shares. In 1989 the state sold its remaining Box i4.1 Calculatingrla lcl telephone irai shares in CTC. The private pension funds became important minority shareholders. oaulate regulated cal telephonet The privatization of Entel was conducted arem egroupedinto a fw areas accord;Inglto demographicT parameters.: Art ideal sateo-he-art, efficient oMFpany slightly differently. Between 1986 and 1990 all tservingeachoftihese areas.is defined, usullyoni the basis f b shares were sold either on the stock exchange or proposai fromthe comWpanies,wich are chekd by the to company employees. The pension funds were xereuator In this simulation of a competit enronment the main buyers. Telef6nica de Espafia acquired pri Ofces are cUla onhe basis of mar. ina costs derived 20 percent of the company, but after it took con- 6fromioestntland operationcosts required forf eIrvice trol of CTC the Antitrust Commission forced it (:g:E WeXnarl90rlirlOhetwittitfive-yearirnandfire_4fTi-^n'(etiS: W-ve ar epansionin lineith five-yeard;emandforecasts. The price to divest its share in Entel. Divestiture was com- ailehargedepe.ndingion the number and duration Of callsE | pleted in 1993. Today Entel is controlled by a ;Tlmhe harge Sper un;it omewdvanes accoringto thecallvof- partnership formed by the Chilean company ;-ume. inipeak a onpeak perpiods teday Iftesecharges Chilquinta and the Italian company STET/ dnot yield fteWlowed profit erate bcseofecnies n Telecom, each holding 19.5 percent of shares, ofV;P scaleg they are adjusted uw but in sXucha way as tpog with the pension funds and other groups as h.minimize e resucling rtioninsocial re, minority investors. As a private company, Entel wg;ith the s3e. ord.process esulting n iareducion Tel thceased to represent Chile in international o-mpanies have contnued toinvest intheexpansion telecommunications agencies. .of local service coverageli 0 ;0$t0^00--l l:Further reforms were introduced in the 1990s. The law was modified to fully open the Regulating Private Involvement in Infrastrucitre: The Chilean Experience 63 market for long-distance services and introduce mance. State agencies must match the efficiency a multicarrier system allowing any customer to and productivity improvements of the private choose among suppliers for each call. Rates have sector. One of the main changes being considered been freed from regulation and new companies is the creation of a superintendency of telecom- have entered the market, making it one of the munications, which would be in charge of mon- most competitive in the world. itoring company compliance with regulations In addition, a state fund financed by the bud- and imposing appropriate sanctions, tasks cur- get has been created to promote expansion of the rently performed by Subtel. Subtel would retain telecommunications network to rural areas. responsibility for the political aspects of the Rural communities prepare and propose pro- telecommunications sector, including the design jects with government help. The proiects are of laws and regulations, the granting of conces- usually attractive from a social perspective but sions, and the calculation of regulated rates. not from a commercial one. The fund provides an investment subsidy to make the projects prof- Water supply and sanitation: Private investment, itable, and private companies compete to government regulation receive it. Proposed projects are evaluated by a central council according to their social value. Water supply and sanitation services in Chile This program is giving hundreds of communi- have traditionally been provided by the state. ties nationwide access to telephone services. For many years this task was in the hands of the The deregulation and privatization of Ministry of Public Works, through its Direc- telecommunications have had very positive torate for Sanitary Works, and of several munic- results for the Chilean economy. Investment ipal and state companies or agencies serving has expanded significantly. The number of tele- individual cities. There were also a few small phone lines has more than tripled in eight private companies that struggled to survive years, and unsatisfied demand has almost dis- with low, government-set tariffs. appeared (table 4.7). New technologies and ser- Reform was first attempted in 1977 with the vices have been introduced, and the network creation of the National Sanitary Works Service has been fully digitized. Companies have (Sendos), which integrated all state institutions diversified their services in both regulated and involved in water supply and sanitation, includ- nonregulated businesses, including cellular ing the Directorate for Sanitary Works and the telephones, cable TV, and private telephone municipal companies. Sendos was an autono- services. Seven companies offer long-distance mous organization within the Ministry of Public services (formerly monopolized by Entel), Works that covered the whole country through demand has grown sixfold in the past eight eleven regional departments. Sanitation services years, and prices have fallen dramatically. in the two main cities in the country were left in Competition is also developing at the local the hands of two state-owned companies: Emos level as new companies have taken on overlap- in Santiago and Esval in Valparaiso. The role of ping concessions and ambitious expansion pro- Sendos was to plan, build, and operate water jects. Future plans include technologies such as supply and sewerage systems, as well as to set personal communication systems, which will quality standards and monitor compliance; the compete directly with cellular phones in the Ministry of the Economy set tariffs. This scheme short run and possibly with local service in the allowed greater coordination among state units long run, as prices fall as a result of economies but had its problems, stemming mainly from of scale and better technology. Sendos's dual role as operator and regulator. Subtel, the state regulator, has played an More far-reaching reform was introduced in important role in deregulating the telecommuni- 1989, when the regulatory role of the state was cations sector. It has defined policies and moni- separated from the operational role of compa- tored compliance with existing norms. Today nies, whether state-owned or private. New laws one of Subtel's main objectives is to modernize provided the framework for efficient develop- itself in order to improve its regulatory perfor- ment of water supply and sewerage services 64 Choicesfor Efficient Private Provision of Infrastructutre in East Asia Table 4.7 Chilean telephone service after deregulation, 1987-95 Lines in service Telephone density Quantity Annual increase Lines per Annual increase Waiting lise Year (thousands) (percent) 100 inhabitants (percent) (thousands) 1987 581 - 4.65 - 232 1988 631 8.6 4.93 6.0 236 1989 689 9.2 5.40 9.5 284 1990 864 25.4 6.56 21.5 308 1991 1,056 22.2 8.02 22.3 241 1992 1,279 21.1 9.56 19.2 314 1993 1,516 18.5 11.10 16.1 198 1994 1,657 9.3 11.97 7.8 117 1995 1,894 14.3 13.42 12.1 52 - Not avaiable. a. For CTC, the largest company. Source: Melo and Serra 1996, based on data from Subtel and company annual reports. using a concession system, which imposed sev- sewerage treatment plants, and introduce new eral regulations on concessionaires. They were technologies and managerial skills, much greater allowed to finance operations and investment private capital participation is required. There- required for expansion with tariffs set every five fore, the decision has been made to privatize years according to marginal cost criteria. A sys- Emos, Esval, and the regional state-owned com- tem of direct subsidies for low-income con- panies. A bill was sent to Congress to allow the sumers was introduced to offset the impact of government to sell up to 65 percent of these com- higher tariffs and was essential in allowing tar- panies' shares to private investors. By retaining a iffs to be based on costs. Service obligations and 35 percent share, the state will keep some veto quality norms were imposed on all companies. power over major corporate decisions. Compliance with these laws and regulations At the same time, the government has pro- was ensured by a system of fines and sanctions. posed legal reforms that will strengthen the Each of Sendos's eleven regional depart- regulatory powers and capabilities of the super- ments was transformed into a state-owned intendency. Private control of natural monopo- incorporated company with the same rights and lies in the water and sanitation sector will duties as Emos, Esval, and the few remaining require stronger regulatory authority. Specific private or municipal companies. Regulatory norms have been considered to improve the duties were assigned to the Superintendency of method for calculating tariffs and to restrict hor- Sanitary Services, a newly created body, which izontal integration of water companies. was given the right to grant concessions to com- mercial companies interested in providing water Roads and transportation infrastructure: and sewerage services, calculate tariffs, impose The concession system sanctions, and regulate and monitor compliance with technical and quality norms. Its head is The traditional source of financing for construc- appointed by the president and has a great deal tion and maintenance of roads has been the state of autonomy. funds allocated to the budget of the Ministry of The new regulatory model has allowed corn- Public Works. Tolls for use of intercity roads and panies to increase investment in sanitation sys- taxes on transportation fuels have been charged tems based on earnings, expand water supply for many years, but the resulting income has not and sewerage coverage, and achieve higher necessarily been used to extend the transport profitability (table 4.8). network. Not surprising, supply has fallen short The current administration has decided to of demand, and the road deficit has increased. promote further reforms in this sector. In order to The investment shortfall became more severe in achieve 100 percent coverage for water supply the 1970s and the 1980s, since restricting infra- and sewerage, undertake major investment in structure investment was a preferred method for Regulating Private Involvement in Infrastructure: The Chilean Experience 65 fighting inflation in Chile as in many other Latin Table 4.8 Performance of the Chilean water and American countries. It has been estimated that sanitation sector following reform during the 1980s only 30 percent of road invest- Investment in sanitation, 1965-95 ment needs were met. Road traffic has increased investment almost fourfold in the past twenty-five years, Period (I995 US$ millions) while the road network has remained nearly 1965-70 71 unchanged. 1971-73 65 In the early 1990s the government realized 19970-95 15 that the road deficit could become a major bottleneck to economic development. Chile's Urban residents with water and sewerage services, export-led growth model needed an efficient selected years, 1965-95 transport network, since road transit was grow- Urban Water servce Sewerage service ing at 9-10 percent annually, and new transport population coverage coverage capacity would be required to handle new trade Year (millions) (percent) (percent) following trade agreements to be signed with 1965 5.85 53.5 25.4 neighboring countries. It was estimated that the 1970 6.67 66.5 31.1 1975 7.62 77.4 43.5 annual losses due to the road deficit amounted 1980 8.89 91.4 67.4 to nearly $1.5 billion, stemming mainly from 1985 9.66 95.2 75.1 congestion, pollution, accidents, and load losses 1990 11.40 97.4 81.8 due to inadequate transport infrastricture. The 1995 11.99 98.6 89.2 government also significantly increased invest- ment in roads, but it became clear that the state companies, 1988-95 would be unable to meet all investment require- companies, bilitya ments. In order to satisfy the medium-term need Year Proftabili4' for new roads, 1,200 kilometers of roads would 1988 -1.36 1989 -0.76 need to be paved every year, far more than the 1990 -0.82 500 kilometers paved by the government in a 1991 -0.13 good year. 1992 0.94 1993 3.56 The solution was to involve the private sector 1994 5.19 in obtaining additional funds and also to intro- 1995 6.30 duce new managerial practices and technologies. a. Profits after taxes as percentage of total assets. The concessions law approved in 1991 estab- Source: Chile, Superntendency of Sanitary Services data. fished the framework that would apply for pri- vate companies willing to invest in constructing, requested toll level, the tariff structure, the con- operating, and maintaining roads and other cession period, the subsidy requested or pay- transportation infrastructure. The concession ments committed to the state, the score on the system involves mainly projects defined by the technical evaluation, and environmental consid- state. Concessions are granted through a bidding erations. The selected bidder must create a cor- process, with potential investors submitting poration devoted exclusively to the project offers that must satisfy specific conditions stated defined by the bid. in the terms of reference. The process is trans- The concessionaire is required to build or parent and competitive and does not involve improve, operate, and maintain the roads dur- bilateral negotiations. The concession system is ing a concession period lasting no more than flexible and can be applied to roads, ports, and fifty years in exchange for toll income. The other transportation infrastructure. The law government usually offers a minimum income allows private pension funds and insurance guarantee based on traffic assumptions. This companies to invest in the concession projects. guarantee, which is normally accepted by the Bids for road concessions are analyzed from winning companies, has two main goals: to help both a technical and an economic perspective. the private investor obtain financing and to Selection is based on such criteria as the show the state's commitment to the project. The 66 Choicesfor Efficient Private Provision of Infrastructure in East Asia Table 4.9 Road and tansportation projects offered for concession in Chile, 1993-99 (US$ millions) Amount to be awarded Projects Investment 1993 1994 1995 1996 1997 1998 1999 Route 5' 1,690 0 0 160 710 820 0 0 Urban concessions 870 0 0 10 250 290 100 220 Interurban concessions 1,533 42 30 381 140 440 500 0 Total 4,093 42 30 551 1,100 1,550 600 220 a. Route S is the country's main highway. It is part of the Panamerican Highway System stretching from Alaska to Patagonia. Source: Chile, Ministry of Public Works 1996. financial backing is important, since the conces- ence with the concession system has so far been sion grants only the right to exploit the infra- very positive. The private sector, both in Chile structure for a given period; the state remains and abroad, is highly motivated to invest in the owner of the road works from the beginning roads and other transportation infrastructure of the project. The income guaranteed by the that the economy badly needs in order to keep state usually covers maintenance costs and growing. The system allows reduction of the about 70 percent of operating and capital costs. road deficit while freeing government resources But if profitability exceeds a previously estab- for other uses, including the construction of lished level (usually 15 percent), the conces- roads that are socially desirable but do not meet sionaire has to share the additional income minimum commercial conditions to be offered equally with the state. A conciliation mecha- as concessions. nism is available in case of conflicts arising Several factors help to explain the positive between the investor and the state during the response from private investors to concession concession period. projects, even if the expected profitability is not Private investors may also propose new pro- high. Internationally, the country is assessed as jects. If a project is accepted, the company that one with low political risk and institutional and proposed it receives a bonus in its bid and may macroeconomic stability. The Ministry of Public receive a full or partial refund of the development Works has carefully overseen thorough prepara- costs associated with the project. Many projects tion of the required studies and undertaken have been proposed, several have been accepted broad promotional efforts. Investors also cannot (including two airport terminals and urban and have failed to notice the steadily increasing interurban roads), and some are being built. demand for this type of infrastructure, which The Ministry of Public Works has created a can be expected to keep pace with the economy's Concessions Division to regulate the concession sustained growth. system. This division defines projects to be offered, manages the bidding process, and Conclusion supervises project construction and operation. Regulations governing the concession system Chile has come a long way in deregulating and and the bidding process have evolved over privatizing its infrastructure sectors. The pri- time. The government has introduced modifi- vate sector is now involved not only in financ- cations to solve problems as they have arisen, ing investment projects but also in planning, taking into account international experience. building, and operating new infrastructure The first concessions were awarded in 1993. facilities. Such participation is guided by Two projects have been finished so far-one tun- general principles, including promoting invest- nel and one road-several more are being built, ment, ensuring fair competition, protecting the and others will soon be tendered. The estimated environment, and satisfying basic social needs, value of projects to be awarded in 1993-99 and by capable regulation. exceeds $4 billion (table 4.9). The current situation owes its success to the Although it is too soon to evaluate the long- design of major reforms that have been intro- term operational outcome, the Chilean experi- duced over the past twenty years. Generally Regulating Private Involvement in Infrastructure: The Chilean Experience 67 speaking, sectoral reforms have started with the studies, for the fieldwork he performed, and for his creation of a regulatory institution to lead the useful comments. process and of a legal and regulatory frame- work. The next step has been the privatization of References state-owned companies in the case of electricity Acevedo, Roberto, and Juan Err,zuriz. 1994. and telecommunications and the granting of "Infraestructura: oportunidad u obstaculo para el concessions to let the private sector undertake desarrollo" (Infrastructure: opportunity or obstacle new projects in the case of roads. This sequenc- for development). In Felipe Larrain, ed., Chile hacia ing strategy has proved to be effective. Private el 2000: Ideas para el desarrollo (Chile in the year 2000: investment requires clear and stable rules estab- Ideas for development). Santiago de Chile: Centro lished by law and a regulatory body indepen- de Estudios P(iblicos. Ale, Jorge, and others. 1990. "Estado empresario y pri- dent from potential state-owned competitors. vatizaci6n en Chile" (Entrepreneurial state and pri- Accelerating the process by starting privatiza- vatization in Chile). Cuademos Universitarios, Serie tion without a proper regulatory framework Investigaciones 2. Universidad Nacional Andres does not seem to pay off, since high risk will Bello, Facultad de Ciencias Econ6micas y drive away potential investors, and it is difficult Administrativas, Santiago de Chile. to modify regulations once property rights have Chile, Ministry of Public Works. 1996. "Programa gen- eral de concesiones" (General concession program). been awarded. Coordinaci6n General de Concesiones, Santiago de Private participation in infrastructure has Chile. had strongly positive effects on the Chilean Chile, Superintendency of Sanitary Services. 1996. economy. Massive private investment has been "Memoria anual 1995" (1995 annual report). taking place in energy and telecommunications Santiago de Chile. Chilectra. n.d. "Chilectra highlights." Chilectra networks and is starting to flow into the road, Metropolitana (company publication). water supply, and other infrastructure sectors. Diaz, G.-H., Gonzalo Adolfo, and Mario A. L6pez M. Such investment is allowing the economy to 1996. "Representaci6n y proyecci6n tarifaria de maintain high growth rates and the government empresas y otras consideraciones en tomo a la legis- to use its resources for social objectives. Users laci6n de servios sanitarios" (Companies' tariff pre- benefited from more and better services at sentations and projections and other issues in water and sanitation services legislation). Universidad de reasonable prices. Companies have increased Chile, Departmento de Ingeneria, Santiago de Chile. their productivity, earned fair returns, and Fischer, Ronald D. 1995. "Economia de las concesiones diversified their operations in Chile and abroad. viales en Chile" (Economics of road concessions in Private participation in infrastructure has Chile). Universidad de Chile, Departamento de posed ew chalengesfor the Chilean govern- Ingenieria Industrial, Centro de Economia Aplicada, posed new challenges Santiago de Chile. ment. It has been moving away from managerial Galal, Ahmed, and others. 1994. Welfare Consequences of activities and has had to develop new regulatory Selling Public Enterprises: An Empirical Analysis. New skills. Just as private companies are modernizing York: Oxford University Press. and becoming more competitive, the state is Jadresic, Alejandro. 1993a. "Desregulaci6n econ6mica: reshaping itself to incorporate the human avances y tareas pendientes" (Economic deregula- resoursand technology required to ensure effi- tion: progress and impending tasks). In Eugenio resources and technology requlred to ensure effi- Lahera, ed., C6mo mejorar la gesti6n publica (How to cient private development in infrastructure. improve public management). Santiago de Chile: Consequently, it is promoting administrative Cieplan/Flasco Foro 90. and legal reforms that will strengthen its finan- . 1993b. "La transformaci6n de la producci6n, el cial and technical capabilities as well as the crecimiento y la competitividad intemacional en la power and autonomy of its regulatory agencies. experiencia chilena" (Production transformation, power growth and international competitiveness in the Chilean experience). In Studies and Reports of the Note Economic Commission for for Latin America 84. Santiago de Chile. Alejandro Jadresic is minister president of the National Melo, Jose Ricardo, and Pablo Serra. 1996. Energy Commission, Chile. He wishes to thank Gaston "Competencia y regulaci6n en telecomunicaciones: Held for his valuable help, especially with the case La experiencia chilena" (Competition and regulation 68 Choicesfor Efficient Private Provision of Infrastructure in East Asia in telecommunications: The Chilean experience). ization experience in Chile: Lan Chile, Entel and Universidad de Chile, Departamento de Ciencias CTC). Working paper 2. Universidad Adolfo Ibaniez, Ffsicas y Matemdticas, Santiago de Chile. Instituto de Economfa Politica. Paredes, Ricardo. 1995. "El sector electrico y el mercado Saez, Raul E. 1993. "Las privatizaciones de empresas de capitales en Chile" (The electric sector and capital en Chile" (Privatization of companies in Chile). In markets in Chile). Paper LC/R 1496. Santiago de Oscar Mufnoz, ed., Despues de las las privatizaciones: Chile: Economic Conmmission for Latin America. Hacia un estado regulador (After privatization: Rojas Pinaud, Alejandro. 1994. "Experiencias de priva- Toward a regulatory state). Santiago de Chile: tizaciones en Chile: Lan Chile, Entel y CTC" (Privat- Cieplan. CHAPTER 5 Managing Environmental and Resettlement Risks and Opportunities in Infrastructure Bradford S. Gentry G overnments struggle to attract private project and to help them capture the opportu- investors to infrastructure projects and nities to address key issues through private to addresstheproblems createdbyunre- involvement? Before addressing this question, solved environmental or resettlement issues. governments must recognize that their role has Private investors are acutely aware of the finan- changed, but not been eliminated or dimin- cial risks to infrastructure projects posed by ished in importance, and that affected commu- environmental and resettlement concerns. nities need to be incorporated into the risk Examples of how these problems can affect pri- mitigation process. vate investment in Asian infrastructure abound Governments should then follow five basic in the power, water, and transportation sectors.' steps for managing environmental and resettle- Tlhe risks associated with environmental and ment risks and opportunities: resettlement issues reduce the attractiveness of * Identify risks and opportunities through infrastructure projects. But these problems can environmental assessments (including reset- also create opportunities for governments to tlement issues) and investor due diligence. improve local environmental and social condi- * Assess the relative financial importance of tions cost effectively and for private investors to particular risks and opportunities. make money. Privately financed water supply * Take advantage of opportunities and miti- and treatment plants can improve water safety, gate substantial risks through design of the and longer-term prospects of populations af- project, the environmental legal framework, fected by resettlement can be improved, for and the resettlement plan. example. * Allocate the residual risks to the parties best East Asian governments must consider two able to manage them (sponsors, governments, fundamental sets of questions as they strive to development banks, private financiers). reduce deterrents to private investment. First, * Implement risk mitigation steps in a timely why are private investors concerned about and effective manner. environmental and resettlement risks? What Environmental and resettlement risks can be legal, operational, and political risks do envi- managed and opportunities captured. They ronmental and resettlement issues pose to must, however, be treated not as a special cate- infrastructure projects? How do the impacts of gory of problems but as key objectives. those risks vary across different types of infra- structure projects depending on their location, Environmental and resettlement risks as design, construction, operation, secondary deterrents to private investment impacts, and political sensitivity? Second, what steps can governments take to make pri- The goal of any private investor is to find deals vate investors more comfortable with the level that offer predictable and acceptable returns. of environmental or resettlement risk facing a In the infrastructure sector this search is 69 70 Choicesfor Efficient Private Provision of Infrastructure in East Asia $Box 5. PubiN c oppositilon6t otheBik: B lanhydroelecitri crectkinMalaycompi cates financding e $5. billion:Bakun hydlroelectricpowerprojecthas lo'ng DiffeSrnces in federal and state pre ndureme that beenT oposedl yenvironental and other nongovem- transfer had tffeectof delminatingplints'i right to:partIci- k A mental izatins (N£0s. The dam is desined to0pro,- i ate intihelEb process. The courtruledthtEkran, te devel- -vide 2,400 2:1 tmegawatts t ofpower ;tto,fpeninsularn Ma.ysia p of the proe Iha to compywith etionai a before througha65'0-kilometerlong unidersea cablefrom the state' it could buildt 'thdamN The decision has. beJen apaled to a; of Sarawak on the island of, orneo. dat,e d odeep in the jun- hghr court. l 6gle, te dam woUld reportedly a-lodd anarea the see o The project IS proceedig (the plaintiffs' request that an S3ingapopre and force moE than 9,000local tribes pople to mjun stopngwre ssud s d iedy h Apals relocate. Cou~~~~~~~~~~~~i Art). BUt' the searh for finacig (a lagato hicis~ Alhtough tffie Sarak igoverniffen offered tioiprvyide reportedlyto be seture db floating shares in the dam'soer-9M ;new hm or moet $20 #milion iAn compn s ti on to tin:a company) hasbeen mademoredfficduitdfiy tes suit, and those beingov three a the peole tobe roted filed d[financiala believe thatte legal issues mut be resolved suit, challenging the goernmment's approv the environ- before finan ng can ltak place. in addition16 AB,B ton- mental impact assessment (EIA) for the projec. Strudcton cont r for the dam, hasffi been e subject of a In its. ruling the High Courtfound thatMthehntionalt gIo- petitiondrive by more than anhundred N s d th emin ernrrt hadviolated the Naional- Environmental Quality Ac pmembers of the European PariamenRt seeking itswit drawlI by tranferring responsibility foroapproving the ElAtothe ate -from the proect.0 Friend ofthe Eart ha also said tat it will authorl;0i;ties in Sr0awak (a shareiolder in the p oroc step iu its lobbyi ofi itors 6in ABB and Ekran. complicated by the long timeframes over Types of environmental and resettlement which returns are earned and the "public" risks nature (and hence political sensitivity) of the services provided. The level of risk inherent in The environmental and resettlement risks facing such long-term, sensitive investments leads any project fall into three main categories: legal, financiers to address as many significant risks operational, and political. at the outset as they can. Environmental and resettlement issues can Legal risks create enormous uncertainty for investors. They can increase completion risk through Legal risks arise when a project is not in com- delays, failure to obtain necessary authoriza- pliance with all applicable procedures and tions, and cancellation in the face of public standards, including both local laws and the opposition. They can increase project risk by contractual requirements of investors. If the increasing construction or operating costs, project does not meet local requirements, it reducing future revenue streams, or decreas- may be subject to delays, enforcement, law- ing the value of collateral. In extreme cases suits, closure, or cancellation. If the project they can pose direct risks to financiers through does not meet both local and investor require- liability or the commercial impact of interna- ments, its chances of attracting international tional protests. financial support are substantially diminished. Public opposition to infrastructure projects National environmental requirements are because of environmental and resettlement con- often extensive, with regulations setting envi- cerns is now finding its way into the courts in ronmental assessment procedures, project siting East Asia, further increasing uncertainty for approval processes, environmental standards investors. In June 1996 the Kuala Lumpur High for project operation, and liability for environ- Court ruled that the government's approval of mental damage. National resettlement require- the environmental impact assessment for the ments in East Asia tend to be less developed Bakun hydroelectric project in Sarawak was ille- than elsewhere, and many countries in the gal (box 5.1). Delays to the project would cost region lack adequate laws on compensation for almost $4 million a day, according to the chair- the taking of private lands or fail to enforce man of the project company. them. Only one country in the region (China) Managing Environmental and Resettlement Risks and Opportunities in Infrastructure 71 Box 5.2 The World Bank's pollution prevention and Box 5.3 World Bank criteria for resettlement plans abatement handbook The Word Bank's directive on involuntary resettlerent In 1995 the World Bank released a draft handbook on the (Operational Directive4.30)applies to Bank supportof infra- environmental performnance of the industrial projects it sup- structure projects that use public emninent domain powers ports WNorId Bank 1995). Commonly referenced by public to acquire land, whether private investors are involved or and private intemational financiers, the handbook includes not. It includes the.following list of.factors to be addressed suggested emission limits for different types of projects. The by govemrnments: limits for thermal power stations, for example, cover air * Organizational responsibilities.; emissions, liquid effluent, and solid waste. Recommended Valuation of and compensation for lost assets. monitoring and reporting systems are also included, Identification of vulnerable groups. * Resettlement finance and budgeting. * Communityparticipation. has a legal framework for addressing the * Land tenure, acquisition. and transfer broader social issues created by involuntary * Integration withhostpoputions. * Training, employment, and credit. resettlement. SocioeCOic surV - The search for support from multilateral - * Sheiter irscture. and services. development banks brings with it the need to Legal frarnework. meet additional environmental and resettlement * Environmnrital prection and managerment. requirements, such as those implemented by the * A3teiative sites and selection, World Bank (Operational Directives 4.01 on * Implementation schedule and monitoring. environmental assessment, 4.20 on indigenous peoples, and 4.30 on involuntary resettlement). These requirements have been adopted, in large Even more important is the growing number part, to address the criticisms leveled by envi- of commercial bankers and underwriters who ronmental NGOs and others over the develop- look beyond local law to international standards ment banks' historical lack of sensitivity to on environmental and resettlement issues. The environmental and resettlement issues. starting point for a commercial banker's analy- In some cases these standards parallel local sis is determining whether a project is in com- requirements; in many cases they go beyond pliance with local law, whether or not the law is national laws. Included are guidelines for envi- ever enforced in practice. In countries in which ronmental and resettlement review procedures, enforcement is lacking, pressure from the finan- minimum environmental performance stan- cial community to improve compliance repre- dards (box 5.2), areas to be addressed in reset- sents a new and powerful inducement to meet tlement action plans (box 5.3), and public notice local requirements at the outset of a project. and consultation. Many bankers, particularly those from indus- Although some countries have raised sover- trial countries, then consider compliance with eignty objections to the existence of international international standards, which is necessary standards, their use is on the rise. The U.S. when development bank support is sought. Export-Import Bank and the Overseas Private Even where such support in not sought, how- Investment Corporation (OPIC) have adopted ever, compliance with international standards is environmental procedures and standards similar increasingly viewed as a useful defense in the to those of the World Bank. In 1995 OPIC took face of international protests over a private steps to cancel the political risk insurance it had investor's involvement in a particular project issued to Freeport-McMoRan because of the (see box 5.15). scope of the environmental impacts from the company's Irian Jaya copper and gold mine. Operational risks Other national export credit agencies are under increasing pressure to follow the lead of the U.S. Operational risks reflect the technical and man- Export-Import Bank and apply similar standards agerial capacity of the project team to meet the to their export assistance programs. necessary standards. The level of risk depends 72 Choicesfor Efficient Private Provision of Infrastructure in East Asia Box 5.4 Environmentalprotestsdelay construction !Box 5.5 Resetdement issues delay transportprojdects of ligt railinBangkoki i in Guangzhou, China Environmen:al potests haveadded to the delays and Gcoss Guangzhou, southem Chin's: rmost prosperous city has !Wting the lready complicated iieffois to build: three fmass attracted considerablepriate interest in transportation pro- tatinsit lines to help e ease Bnoks chronic trcprobems. jects, although resettlement issues Nhaveben! a continuing Tw of the lines have been;sponsored by Thai developers source of 6controversy. Rettlement tcompensation was (Tn anayonand Bangkok Land), and onehas been spQnsored i raised Was pirt of the ciytys effoirts torehachagreement with y la HO Kong 6(hina)firm(Hlopewell Holdings).:; Hopewel*lHolding, a KHong Kon (China) firm, for the l East Infresponse to publicpressre tomeove underground South-WAeA Rig Road a1toll road projetd thathas b een toreduce noise and visual impact, the Thai government stalled by disagements overinvestmientcosts. Srignificant haswimposed numerouconditons on thepxj ectis,dncIud- delays have beenhexperiencedoiver the resettlement of i ing thtecommissioning of additional environmentall studies more than 140,000 residentsaffedbMetro subwa line. and the increased use of undergrund routews The furthest number one. galg iprojct Taayong, hasi had to move its main idepot to a new lotion asS a result of envirormental protests. Difculties Einresongenvironmentalissuesandfrequent local or international opposition and press coy- changes:in:Thai govenmemnt policy on transport projects have substantialy increased the diffikuties facndg private erage. The intensity of the opposition depends investors inn these pro ect, not only on the characteristics of the project but also on the way it is handled. Problems can be exacerbated if the government and the sponsors on the ability of the facility to meet applicable do not demonstrate a willingness to understand standards at the commencement of operations and address local and international concerns, at (Has it been properly designed? Does the equip- least to some degree. This is particularly true for ment work as planned? Was the resettlement resettlement issues. plan properly implemented?) and the ability of Public opposition can increase both comple- the operator to provide reliable performance tion and project risks by delaying a project, rais- over time (Are trained personnel and manage- ing project costs as a result of required design ment systems in place? Are the required actions changes, increasing the possibility that the gov- being taken?). Operating risks are usually less ernment will cancel the project, reducing the worrisome to investors than legal or political number of potential investors, impairing the risks, because operating companies tend to be operator's ability to maintain or collect adequate experienced, the level of risk can be assessed by user fees, and, in extreme cases, placing project technical consultants, and contractual protec- facilities and personnel at physical risk. tions and insurance can be secured. Examples of some of these effects can be found in transport projects in Bangkok, Thailand, and Political risks Guangzhou, China (boxes 5.4 and 5.5). Changes in the law, particularly in rules Political risks, which include the risk of opposi- affecting a project's financial performance, are tion to the project and the risk of major changes also a major concern to investors. Sometimes to the laws governing project construction or referred to as "creeping nationalization," this operation, are usually the most worrisome to risk involves unanticipated changes by the gov- private investors in long-term infrastructure ernnent to the rules governing the project that projects. Public opposition is the most unpre- reduce the expected return to investors. Of dictable risk. Most of the other environmental greatest concern are reductions in the level of and resettlement issues can be efficiently fees charged to users. Protests over expressway addressed by project sponsors and the govern- tolls in Indonesia and Malaysia and sewerage ment if they are well managed and sufficient fees in Malaysia have complicated private sec- resources are marshaled. tor involvement and lowered returns to Environmental and resettlement issues are investors (box 5.6). Unexpected tightening of among the most likely to generate significant the environmental standards or widening of the Managing Environmental and Resettlement Risks and Opportunities in Infrastructure 73 Box 5.6 Protests over sewerage fees force rollback in Malayshta Since it was awarded the national. sewerage concession in Protests over the new sewerage charges began almost 1993. Indah Water Konsortium (Mk) 3has faced a storm of immediately. Commercial users of water found themselves protest over the fees it charges. The result has been confrconted with substantial -bills ,for sewerage services,, govemment-ordered reductions and substantial disruptions in regardless of the quantty or qualityof th-eir efuent. No cor- getting the business up and running, both of Which have fiueled responding reductions in local rates were made, and no continuing protests over the lack of improvement in services. immnediate improvemerts in service. were apparent to the Before the concession was awarded, sewera services ubUc. were the responsibility of 144 separate local autho ies,and. In response t.tohe. protests,te ore reced' fees were induded in the general local rates. Operatioa per- - o-merd alfees ereofirsthreeyer encessn, in formance was poor and underinvestment in infrastr was effect phasing inthe new.charges. Athfug ths reduction qu-w. a serious problem. As the government struged to find an- -ted some of e pbc opposition, fee ad srviissues have answer to the growing concern over sewage poluion, coinueto dog NM niae May I the com pany placed proposedanational concession. The concession wasapproved fUll-page ads in all major newspapeis-announcng a-complete bythe legislature, andar nwregulatoryframneworkwas estab- '. review of s ope rtons,' induing the possibiity of furthr... lished for WK's fees. reuions in fees. . ... .. scope of resettlement efforts may have similar Plant design determines the environmental effects by raising project costs. impacts of facility operations as well as the num- ber of people to be relocated. Air pollution control Effects of environmental and resettlement issues are most pressing for coal-fired power sta- risks on different types of infrastructure tions, given the concerns over the impact of dust projects on local health; the effects of acid gases on local health, buildings, and ecosystems; and the impact The environmental and resettlement risks fac- ing an investment depend on the following fac- tors, which vary from sector to sector, project to o 5.7 G me al o ,eet re ,i project, and location to location: the sites cho- a dsin isul ni-; sen for both main and ancillary facilities; the .,One ofthe or unresolved issues facing *te EDSA Light design, including expected emissions and other a T it Projiect in Mana (IRT 3)i th edo impacts; construction; operation of the com- AIe70sqterthsitonw adtis t :be built. A POrW n! ofhese Ja%endardfomr pleted facilities; secondary impacts, including - pisto aeri of aits and e , , , . cwal:.~~~~p.rerpi,sps thrc*ghi :a: series!o law. itsnard ev`tn-- opening up new areas to development; and noticesv. E lothqt er e sidngothe st political sensitivity over the type of service pro- bean in a: I9 Md hd i:notbeen resolved by 199.6 Pat, vided or project undertaken. The nature and ofe delaystemsfmhdi of findingn t acceptable.. intensity of environmental and resettlement sites for resetlemet Trhe siepreferrei d bytfoemment issues varies across types of infrastructure is twntfive kiometers fm ithedepot site,and relative- projects (table 5.1). ..inexpenIe. The other possible site is'six .ilom.ts fro . Site selection raises a host of difficult issues, heb dep sie, a &id particularly for hydropower, highway, rail (box ou - t pp.Ridntha, repo''- 5.7), and ancidlary thermal power facilities, e-s ch to e p - including fuel source, fuel transportation, and '' didnm t it,eao norms.n pa.l" power transmission. The need to resettle resi- the gemefi tW'ia a c nive s dents is a major factor in most of these cases. .- isuuVNeyofesur titudeson Flooding of wilderness areas for hydropower a.wider oe m s faciities destroys forests and biodiversity. b i rese p o aeb Cultural, religious, or archaeological sites and e. i igthep -ma wildlife areas may also be affected. All of these e a mplo_ment nfDtul e e _ issues raise significant legal, operational, and f- Wes r an f a p political risks. 74 Choicesfor Efficient Private Provision of Infrastructure in East Asia Table 5.1 Relative importance of environmental risks to various types of infrastructure projects Thermal power Hydropower Renewable power Drinking water Seweroge Highway Rail Site selection Main facility / /5/ / / // /V./ Ancillary facilities .44' // /1 / .4 / / Plont design Air /1/ 5/ Water / /V,/ v// /5/ / / Waste 5/ // Noise / / /4 Health and safety 5/ / / / ' .44 /// Construction Air / / / / / /5 /5 Water S // Waste / / / / Noise V r S / 5 5. /5 Operations Management 5/5/ /5/ ( /,// 5/ / / Health and safety 5/ /5 / / / / 5/ Emergencies / /V /(/ /5 5/ /4 Secondary impacts / /./ / /5/ / Political sensitivity .4 /VV v ./4 ./4 /5 55 Note: Intensity of rsk is indicated by number of checks. of carbon dioxide on global warming (box 5.8). The political sensitivity of different types of Water quality issues are critical to the operations projects is critical and affects all aspects of project of water and hydroelectric facilities. The need to preparation and implementation. For projects dispose of sewage sludge creates major waste that have come under the public spotlight- issues for sewerage systems. Noise is a major fac- locally or internationally-new hurdles to pro- tor in transportation projects and presents at least ject completion are erected (table 5.2). some risk to most other projects as well. Construction generates significant environ- A cooperative approach to environmental mental impacts, which are usually temporary and resettlement issues and manageable by qualified contractors. These risks are thus largely operational risks. During All of these environmental and resettlement operations the quality of management's imple- issues can be managed once government accepts mentation of the environmental and resettlement that increased private involvement in infra- programs is key to the success of the project. structure means that its role has only changed, Failure to implement a well-designed operations rather than been eliminated or even diminished or resettlement plan increases the risks to private in importance, and that public involvement is investors. Emergencies-such as release of toxic critical. While governments no longer have pri- materials-are a particular concern in drinking mary funding or operating responsibility, they water systems, where operational risks are usu- set targets and frameworks for private involve- ally the principal concern. Secondary impacts ment at the outset and have an ongoing respon- range from the ancillary development spurred sibility to monitor performance and apply by the opening of highways into new areas to the frameworks in a predictable and consistent increases in consumption of resources that often manner over the life of the project. This changed accompany expanded access to power or roads. role affects both project design and regulatory These impacts generally increase legal risks in oversight activities. Effectively meeting these the structuring of the project or political risks new responsibilities means that the government over its life. and the private operator have to build a long- Managing Environmental and Resettlement Risks and Opportunities in Infrastructure 75 Box 5.8 Japan and China work together to develop cleaner coal A unique set of reiationships is emerging between China and Japan has many reasons to try to help China reduce the Japan as they struggle through the environmental and eco- environmental impacts :of its expanding power: sector. nomic implications of the rapid expansion of coal-fired power Concern that acid rain from China is damaging Japanese stations in China. forests is,gr.owing. Japan is a leading exporter of air pollution The intemal debate over increased coal use is intensify- control equipment, and the Chinese market is potentially ing in China. In March 1996 the federal cabinet released a huge. Japanese cOmpanies are also seeking to participate: in, reporttotheNationalPeople'sCongressstatingthatthecoal the growth of privaie sector involvement in Chinese infra- sector must 'accelerate production to meet the country's structure-and other-projects. increasing energy demands." In April 1996 the Chinese The resul thas been a number of cleaner coal' initiatives Ministry of Public Health :and the State Science and in ChinasponsoredbytheJapanese government. As parto.f Technology Commission reported that pollution was now a is 'green aid" progrim, the Japanese Ministry of leading cause of illness and death in many Chinese cities and International Tradeand 1ndustry has been deronstrating the that air pollution, much of it caused by the, burning of coal, use of lower-priced flue gas desulferization equipment in a was of particular concern. Similar results from earlier studies small nu-mber of Chinese power plants.'In l96 theJapa nese: led a Standing Committee of the National People's Congress:.C Overseas Economic Cooperation Fund announicedthat it. to call for much tighter controls on sulfur dioxide emissions was focusing.its:new special loan program to China on envi-. in the fall of 1995. The govemment was thus faced with the ronmental projects, including cleaner coal.usage, and formal need to both increase coal production and reduce air pollu- . agreement among China. Japan. and Germanywas expected tion, something it could achieve only by investing in air onthecosponsoringofafeasibilitystidyforacolliquefac- ipollution controls. tion plant (expected to cost $500$.600 million). Table 5.2 Politically sensitive issues that can affect infrastructure projects Issue 7yes of projects particularly aftcted Resettlement of large numbers of people, particularly indigenous peoples Hydropower fadlities, highways, and rail lines. or squatters (box 5.1). Imposition of new or significantly increased user fees on 'public' services Water supply or wastewater treatment, roads, and electricity. (box 5.6). Destruction of large areas of tropical forest or other sensitive habitats Hydropower facilities. (box 5. 14). Emission of large quantities of air pollutants affecting local, regional, and Coal-fired power stations. global environmental conditions (box 5.9). term working relationship based on clearly structure projects, the public must be involved defined roles. While each has its own areas of in the risk mitigation process early and often. exclusive responsibility-with the government Such involvement can provide early warning responsible for regulation and the operator concerning project features that might lead to responsible for technical performance-joint opposition and help establish ongoing relation- action will be necessary on many issues, includ- ships with the community, which would allow ing major resettlement issues. Since it is the sponsor to monitor and respond to new impossible to anticipate and provide for all issues as they develop. contingencies that may arise over the course of Public involvement is a sensitive, compli- a twenty-year concession, the parties must cated, and uncertain process. In some countries develop a strong working relationship based on public criticism of government-supported pro- respect and understanding of each other's goals. jects is actively discouraged; in others there has Lessons from experience in developing such been little experience in soliciting public input. working relationships are now beginning to Identifying and reaching the various groups to emerge from earlier privatization efforts, such as be consulted can be difficult. Deciding how that in Buenos Aires (box 5.10). much public involvement is enough and what Since public opposition is often the most changes should be made to project design unpredictable and worrisome risk facing infra- requires judgment. 76 Choicesfor Efficient Private Provision of Infrastructure in East Asia Box S5.904 Publicdopposition to coal-fired power plants Box 5.,10 Developing a god working jreW t ionship in. suspends construtionlin Thalland Buenos Aires: Aguas A*ntinas and ETOSS Duingp the i 990s a number of calc-fired power plants Aspets of the 1.993 rvaiation of th'eBuenos Aireswer beame the subject of environmental protests in Thailitid syse demontrte the pr of c larydefied rol e One ofthe earliest w,as the MaeMoh station, in northern ad long-trm workng relaionhipos. Oear standa*d of per-. 7Thailand.in October 992 adverse weter conditions and fborance were: esiablished and. a prdcing strItureV tht amalfunctaionat theplantreawted an air pollution event thatl t iencourages efficient operation was adopted. A reguoao.y c6aused ndrtedsotf residentslto requireitreatientfort res-t bod y EnteTrirtio de Obrasly Sers Sanitai(E3ETO Si piratory problems.;As ka result the Electrici tGeneration wW as creatt overseethiveso concessionaire, Authority f Thailand had to ct Wb pouci atfhe Plant,( Aas Aretinasand avanet of procedures are. bei.g .used ... reduing its lready sti ained totl :generating capacity b to; reso ivedispes blnt heties 4ore important, 31 percent hoevr astecneso oso,ec at sbming In early 1996 constctU6ion of an expermenta power to understaidthie.iother's igodsand methoids of operaion satio ssuspnedyhegovemmeitfolwingg prots more d t swor the wde b local residents. Designed prImariy to burn muiclpa Isolid issues that arise tihrughg diy ptions la tr"kreor,i waste, the plat had also plained to use c or u to 40 being establsh ththel dtrs As Ag , cca percent f its eIiel in its early years. -akes available tsa on liel6t seek inu rmtecmayo regiAWonaenvirprn- Although project sponsors may fear that ernet pl . MN tm l rs informing the public may delay or even derail a freg.lat-. c e, it pies te pres 0 Wtha bwsis frW project, experience has shown that effective pub- coring to resolve p t he lic outreach minimizes the risk of significant public opposition and saves time and money goals for the infrastructure investment, it should over the life of the project. In Calcutta, India, for undertake the initial analysis during prepara- example, an outreach program involving pri- tion of terms of reference. In the case of an unso- vate investors successfully developed a resettle- licited bid, the sponsor should do so. Once the ment plan (box 5.11). Some multinational concession has been awarded, the process companies view public involvement as the should continue jointly between the govern- means of obtaining the "social license to oper- ment and the sponsors, with the involvement of ate," which they regard as just as necessary as financiers before closing. The project operator any legally required permits. should then carry the effort forward, with input Addressing environmental and resettlement from the government and the affected public. issues is a continuing process that involves both One of the first steps will be the commission- private and public parties. A five-step process ing and execution of some form of environmen- consisting of identifying, assessing, minimizing, tal impact assessment, often accompanied by or allocating, and implementing can be adopted. incorporating resettlement issues (box 5.12). Activities in any one of these areas are affected Such reviews are almost always required under by activities in the others and usually proceed in national law and by development banks. Where parallel. private developers are involved, they are usually responsible for preparing the environmental Identifying potential environmental and impact assessment. Failure to conduct an ade- resettlement risks and opportunities quate assessment provides project opponents with a powerful device with which to delay the The process of identifying environmental and project, as demonstrated by experiences in resettlement risks and opportunities must begin Malaysia, the United States, and Europe. at the earliest stages of project development, and Once the envirornental impact assessment it must continue throughout the life of the pro- has been conducted, other types of risk of con- ject. As new parties become involved in the cern to private investors can be identified. For transaction, they should be brought into the legal risks all applicable requirements must be process. Once the government has identified its identified and their likelihood of being met Managing Environmental and Resettlement Risks and Opportunities in Infrastructure 77 Box 5.1 I Working cooperatively on resettlement Box 5.12 Checklist of potential issues for an issues in Calcutta environmental analysis The original plan for construction of a 500-megawatt ther- The International Finance Corporatioris guidance to staff on mal power plant on the outskirts of Calcutta required mov- environmental analysis and review identifies the folowing ing 200 families (800 people) frorm, the site of the generating areas: station and railway line. Representatives of the affected fam- * Agrochemical usage. ilies as well as of local, regional, and national govemment * International vvaterways. bodies worked with the Rehabilitation Committee to fadli- * Biological diversity. tate the planning and implementation process. As a result of * Involuntary resettlement. their efforts the project was redesigned s,othat only I OO fam- * coastal and marine resource management ilies had to be moved. The lntemational Finance Corp- Land settlement. oration provided financial and other support to the project, * Culural properties. construction of which began in 1993. * Natural hazards. * Dams and reservoirs. assessed. Performing such an assessment * Occupatinalhealhandsafety * Environmental guidelines. requires both legal and technical skills and 1 * Portand harbors. usually handled by local and international law a* Hrdous and toxic materials. firms working closely with engineering consul- * Tropicalforests. - tants. In many countries it is difficult to find local Indigenous peoples. lawyers familiar with both environmental %;Watersheds. requirements and the needs of private investors. * Induced developrnent/soiocuttural aspects. As both local and international law firms gain - Wetands. experience with these issues, however, these dif- Maor hazards. W \ldlands. ficulties are diminishing. The sponsor's advisers usually take the lead on these issues, subject to confirmatory analysis by the lenders' advisers. Public outreach is an extremely important Identifying operational risks requires assess- part of this effort. Ideally, such efforts begin with ment of the technical and managerial capacity of the environmental impact assessment. The basic the project to meet the required standards. The features of an outreach program include the sponsor's personnel, working closely with its following: suppliers, will prepare a plan for doing so. Their * Identifying affected groups (both local and plan is then reviewed by the government's tech- international) through contacts with govern- nical consultants and then by technical consul- ment, community, environmental, religious, tants retained by the lenders. Many engineering business, and other organizations. firms are qualified to review these plans, * Providing notice of the proposed project, although the different cost pressures facing the including a project description, through media design and operation of privately financed facil- bulletins, local project offices, interested orga- ities may make assessments difficult for con- nizations, and community meetings. sulting engineers whose only experience is on * Offering opportunities for concerned citizens public sector projects. to submit comrnments on the project through The methods for identifying political written remarks, surveys, individual inter- risks-particularly the likelihood of significant views, focus groups, and public meetings. public opposition-are the least well defined, * Analyzing and developing responses to the because the issues themselves are less clear. The comments received, by making changes to first step is for international sponsors and the project or explaining why requested lenders to engage in a broad effort to try to changes will not be made. understand the country and its politics, goals, * Disseminating the responses to the affected and needs. Sponsors then work with govern- groups through media bulletins, local project ment officials to identify the risks facing a par- offices, interested organizations, community ticular project. meetings, and revised project descriptions. 78 Choicesfor Efficient Private Provision of Infrastructure in East Asia Engaging in an ongoing process of providing attention to their overall infrastructure goals and information and receiving public input on the range of methods for meeting them, the envi- the project, through local project offices, ronmental regulatory framework adopted for mailings, community meetings, and citizen the project, and the plan to be developed and fol- advisory boards. lowed for addressing any involuntary resettle- ment issues. Assessing the significance of particular risks Infrastructure goals and alternative methods for After environmental and resettlement risks and meeting them. Government infrastructure plan- opportunities are identified, their significance to ning has historically focused on large, high cap- the project needs to be determined. First, a rough ital cost facilities, often designed without order of magnitude must be estimated for the substantial attention to environmental or social financial implications of each risk or opportu- impacts. As governments seek to increase the nity. In some cases this is a relatively easy task; private sector role in such projects, they often in other cases assigning a financial value is com- use these prior infrastructure planning efforts plicated. For example, it is difficult to determine and assumptions as the basis for bids and other the cost of the delays incurred as a result of dis- private involvement. turbances at sites with local historical or reli- By relying on earlier planning efforts, gov- gious significance. Measuring and valuing these ernments often miss out on opportunities to impacts can be difficult. Doing so is necessary, apply private sector resources and creativity to however, to give both government sponsors and the cost-effective attainment of environmental private investors a basis for deciding whether or and development goals. This is true for two not to proceed with the transaction. major reasons. First, only relatively recently Second, the available estimates must be com- have environmental and resettlement issues pared with the value of the deal as a whole or the begun to have a major impact on infrastructure ultimate costs to users. Although the cost of mit- planning efforts. Second, while the private sec- igating a risk or capturing an opportunity may tor can often meet many of the government's seem large in absolute terms, it may represent an infrastructure goals more cost effectively and insignificant amount in the context of the over- more reliably, its ability to do so is severely con- all deal. Calculating possible impacts on user strained if it is limited to working within the fees or investors' return allows sponsors and the confines of early public sector plans. government to decide whether or not to go for- To capture opportunities for improving envi- ward and to focus their efforts on those risks and ronmental or social conditions through private opportunities with the greatest potential impact involvement, governments need to take two on the deal. steps. First, they should assign higher priority to a wider range of environmental and resettle- Minimizing risks during project design ment goals. These targets can then be included in the optimization process for developing alter- The most effective time for governments and pri- native approaches to meeting infrastructure vate investors to consider environmental and needs. Clean water is already a priority for most resettlement issues is at the earliest stages of pro- countries in East Asia. Greater priority should ject design. By including environmental and reset- be given to increasing the efficiency of power tlement goals from the beginning, governments use and controlling dust and acid gas emissions can bring private sector creativity to the design of from thermal power stations. Opportunities for cost-effective solutions. Private investors are most ancillary environmental benefits for highway comfortable when clear investment targets are projects should be valued more highly. In cases presented and significant risks can be eliminated of involuntary resettlement, alternatives that through careful project development. minimize the numbers of people moved or max- In order to make the most of the project imize the social gains to those affected should be design phase, governments must pay special weighted more heavily. Managing Environmental and Resettlement Risks and Opportunities in Infrastructure 79 If governments set environmental and social targets, private investors will respond with meth- Box 5.13 Adoptng a deman side management . . . ~~approach to energy,efficiercy Jn Thailand:-ii; ods and prices for meeting them, providing gov- a t e ernments with a measure of the cost of achieving In 1991 Thaland became the first' sian coutryto adopt a these targets. Broader consideration of environ- utility-sponsored demand side management (DSM)' energy mental and resettlement goals will also help effidency program. A 1995 review4ofthe potenialforinvest- mental and resettlement goals will also help~ ment in Thailrd's energy ,effiaen industy by the Inter-. reduce the potential for local and international national Institute for Energy Conservation documents the public opposition. In turn, this will expand the wisdom of this initiative.- pool of potential international funding sources. On average Thai investments in increased energy effi- Second, governments need to be willing and ciency cost less than haf the ptice of new-generating capac- able to consider a wider range of methods for ity for the same level of megawatts. An4achievable DSM meeting their goals. The clearer governments can potential of at least 2,000 megawatts over the next decade be about goals and the more leeway they can give h b entified25 percent of planned system ean- the private sector to design methods for meeting sion As much as $2.3 billion in-capital costs could be saved t t mifan aggressive programrto capture 2,000 megawatts of peak tliem, the more likely the private sector is to come --deadwsinpc.-Frgnorzo -;xt6e demand was in place. Foreign operators:with: extensive; up with cost-effective solutions. Choosing among experience with DSM prograams in other markets (especially a range of options, however, requires a broader the United States) can readily bring ths knowledge to bear range of skills than that demanded by the tradi- in Thailand, helping to capture these opportunities. tional approach of putting a publicly designed power plant out to bid. Allowing the private sector flexibility to increased combustion efficiencies (China is develop solutions may lead to recommenda- seeking to increase the amount of coal it tions on different aspects of projects: washes from 24 to 30 percent by the end of • Types of projects. If the goal is to make 800 the century). megawatts of power available, a combined * Financing packages. The $30 million grant offer to provide 700 megawatts of new gen- from the Global Environment Facility to the erating capacity with 100 megawatts of mea- Leyte-Luzon geothermal project in the surable energy conservation gains might Philippines is one example of the public better meet the joint power and environmen- financing benefits that can accompany the tal goals at a lower cost (box 5.13). design of projects with an increased "envi- * Locations for projects. It may be possible to ronmental increment." reconfigure the design of hydroelectric facil- The choice of projects still rests with the gov- ities or transportation corridors in order to einment. Recognizing and making explicit the minimize the amount of land affected or the trade-offs made in the final selection of a project is need for resettlement. an important part of the process of minimizing * Technical designs. Both Aguas Argentinas (the public opposition. In some cases the importance operator of the privatized water and sewer- of a particular project for meeting the govern- age system in Buenos Aires) and the Indah ment's goals must be made clear in order to secure Water Konsortium (the national sewerage international financial backing. The proposed $1.2 concessionaire in Malaysia) were able to billion Nam Theun II hydropower project illus- design sewerage systems that met the per- trates many of the issues facing efforts to increase formance standards set by the government private involvement in politically sensitive "spot- for much less than estimated in earlier gov- light" infrastructure projects (box 5.14). enment plans. * Operating practices. Experience with coal Environmental regulatory frameworks. Govern- washing in the United States and Australia ments need to establish and work within dear, pre- demonstrates that substantial economic and dictable, and reliable frameworks for overseeing environrental benefits can be achieved as a private sector environmental performance. Clear result of reduced ash content (reducing both rules allow investors to price and design projects transportation costs and emissions) and to reflect environmental concerns. Governments 80 Choicesfor Efficient Private Provision of Infrastructure in East Asia ox5.14Addresingthecncernso : theintational,ana ialco t oe te N T project in the Lao People's Democratic Repnublaictor ~ke iNn v.Sg'>'n,00011~~~~~~~~~~~~1:;A si7'^' p: 00;rwe foreign exchange. Gross revenues to the iLaogovernment tarel g w0il ;.not invest withoutSdevelopment -basupport;pithe World expected to rise rom $10 millionto well over $100 million a Banik canSnot provide-that support une.ss environnienl and year (inonstant994dollars)over the twenty-five-year con- resettleme isuesae aessd toites -ctin cessio em,dulig freinexchang eannsand increas- To- address ths coc rns,th goer metneesto make in g G D P b y,, 2, 0 p e r e n t d e ar w l( h y d r p o w er is critica t o m e e in th e d e v el p m e n The ew am oul flod pprximtel 45 sqarekl- nesdfbt h LoPol' D~ennemoraic tprb n&e me tners, 30 percent o wichifs forestedandrich in iod ivdersty E j Thailand andSwhy it opted to developlhydropower ratherthaniit: In ddition, W 900poorhouseholds wouldneed tobe relocated oth3er sources ofpower,suchasnuea orecol-nr stati fro thie resevirara Severatosrandpeople in thectch The proec aso ees o b dsinedtoopimieo stream channelareawouldalsobeaectedbythe project term This will require a cot by te Lo geirinnt mnmmTheseenvironmental and resettlmentproblernshave led: to ensure:implementation of the endronmental and resettle- ti to loca andinternatoaopsititon t to Xthe t0project meri0t;r 0progas Efforts are tundert way ;to off et the oso nvronejntalorgnzations hav opposed the los of foests -f forest in thie flooed area wthmuhgreaer rotcino on theNkaPlateau:others have protestedtheresetement largerorestpreservewithintpro s a e bin n pla. Te insiy of these otVecjionis ha}sbXVegXetn Xincrm;eased by 2additin, a more exetensve resettlement pan bei id th i e;Entte,rnaibona spotigt on lrg hydropoer pEroects;N in Asa :eEred thatwoul alo thbeloca ppuaioqn to share in te gec-; (Thiireie Gorges,i Narmada,tBakun)as well -as by thle protests0S $Hnornic benefltsofthe project.Lk-ingsuch effoits toer,o i tihe overi0 rpleen n ofthe environmental mitigation planforI projec may result inmo e ffectiveroteco of ala trac the Pak Mun hydro project in Thailand. of ~~rain fiorest. Th0E projEecit i salso financiall isky :Thet projectedcost is 4 0000;l g All of these issues are now under consideration byf project:i 0 equivalentto about 75 percentofthe countrys 1994 GNP and sponsors and the government. .Support for thepro and..has ,e,t,ere Lao People's Democratic Reblic northeprivate be eceived fr woiernionl eron l e sponors Trasiled ofAusrali, Elctrcitde Fanc. an (th Widlif Conervtio Socet adteWrldfiCons evain Ital ian- T h afi a n d P h a r a Tena k to f h ila n d ) ' i S h a v t h r e s o r c e U ni o n), a n t h e p o s b l ty o f in o v n th U ie d N a tio n s ilitnecessary Catng 4a 00projectattractiv to internatinal sat> for fdevlopent-4 o0f te resttleen plan has been0 financiers requires that environmenta and rsetlmn isXsues:A :discuse;: ;<; 0 ; : j d. can then decide if the cost of compliance is too * Environmental review procedures to be high. If the rules are not clear or if they are incon- followed. sistently applied, private investors will assign a * Administrative procedures to be followed by higher risk premium to environmental issues, the government in deciding on authoriza- resulting in higher than necessary project costs. tions for the project, including mechanisms An "ideal" environmental regulatory frame- for contesting aspects of the government's work for an infrastructure project consists of an decision. integrated package of laws and contracts that * Monitoring, reporting, and inspection proce- specifies the following: dures to be followed, including the role (if * Standards of performance (set in terms of any) of the public and of NGOs. simple emission limits and other readily * Sanctions to be applied in the event of non- measurable factors) that leave the private performance or environmental damage, operator the flexibility to determining how to including identification of all parties that meet the standards. may impose the sanctions, the procedures * Relationship of current and future environ- for doing so, and the mechanisms for con- mental performance standards to the level testing the sanctions. and regulation of user fees, particularly in * Remedies available to the private operator, if light of fees previously charged (or not) by any, in the event the government changes the government for such services. environmental standards in the future. Managing Environmental and Resettlement Risks and Opportunities in Infrastructure 81 Given such a framework private investors can build environmental considerations into Box 5. 15 Meengthe ewironent stdards of the US. E*ort-lmport. Bank. The f*on i- (Indonesia - project design, internal environmental manage- d -- ( -o---p-o. - and S ual (lippine power pojd ment systems, community outreach programs, .. .... subcontracts with suppliers, insurance, and Two lare p verpojectswerefnedwhthehelpofthe other project components. inenaonal 1inanciaI comm -n- No . 9l cant public . . . . . ~~~~~~~~~~oppositio to the projects was; raised, and ao.*te intema- Requiring private investors to meet such - t the o wd t tional institutions involved were satisfted that environmental standards need not mean that projects will be ;stdards had been rmet;- . too expensive or will fail to attract investors. In The $2.5 billion Paiton Ipoject invlees tio baseload fact, two of Asia Money's 1995 project finance 615-megapwatt coal-fire p units in noheast java, "deals of the year" were power stations that Indonesia The U.S. Export- IportBankprovid itca successfully met the environmental standards riskerfora$540milionloan.TheU.SOverseasrivate applied by both the national governments and Investment Corporation (OPIC) provided $20 million in the U.S. Export-Import Bank (box 5.15). financing. The $1.35 bilion Sua prcject involes a 1,200- -megawattcoal-fired stationin th Pangas prvic of the Philippines. The US. Export-Import Bank guateed more. Resettlement plans. Reducing the risk of pub- than $37 miion in debt and-the Interaional inance lic opposition through fair and equitable treat- Corporation (IFC) provided bothidirect loans and symdica- ment of the affected populations should be the tion of com.mnercial bank debt. cornerstone of risk management from a project's The U.S.x bport-ImpoOt BBank, OIC and ite IFC all inception. Minimizing risks to investors goes app their own procedural and substantve ervronmental hand in hand with minimizing risks to people standardstothe projectstheys t In adion two of the affected by the project. commercial banks involved inthese deas-Chase Manhattan . affected by the project. .an iiakofiwi-bkSLwrd s-- The process should begin with a clear a tank-confirrthatteyltouchilig rld"stan- p ~~~~~~~~~~~~~~dards for comfort as part of their due dligence on the envi- definition of the tasks and responsibilities ronmentrisks facingpwerprojecs. assigned to different parties in the deal. This can be done though a combination of national laws and contracts. The resulting package of respon- governments need to take the lead, especially in sibilities should cover the following areas: cases involving involuntary resettlement of * Preparation of the resettlement plan, includ- large numbers of people, including squatters ing the items to be covered and standards to and indigenous peoples. Private investors are be followed in doing so. less equipped to handle involuntary resettle- * Acquisition of the land to be taken for both ment issues because they are often unfamiliar the project and the relocated people. with local conditions and lack credibility among * Relocation of the affected people. the local population. Moreover, the political * Economic rehabilitation of the affected peo- risks of leaving involuntary resettlement in pri- ple, both those relocated and those otherwise vate hands are considerable and could increase affected by the project. the level of resettlement payment. * Monitoring and supervision of implementa- International investors are extremely reluc- tion of the resettlement plan. tant to commit financing to a project until invol- * Mechanisms for resolving disputes on reset- untary resettlement issues are addressed, even if tlement matters, including those between the the government provides complete cover for the government and the affected people and financial risks posed. For example, at least one those between the government and the pri- international investor active in power projects vate sponsors or investors. has decided not to pursue the lb Valley project Where truly voluntary resettlement (wholly in India, in part because the new project has revi- consensual purchases of the necessary land at talized old, unresolved resettlement claims in open market prices) is involved, the private the area. sponsors of the project will be able to take the The forcible clearing of a site by the govern- lead in relocating the affected parties. Where ment is not likely to address international involuntary resettlement is involved, however, investors' concerns, particularly when viewed 82 Choicesfor Efficient Private Provision of Infrastructure in East Asia ln~lutaryresetlemnt i almst alays ore ifiult,moreductive areas created1bythe project f'oighm in expensive, an moire lime c n than g oventszf prjet- hiring nd ancillary developments, and assist- iexp;Eect,i iiacco. d ing to the Workj -,i Bd-.i .ankE, (1994)5 E. Several factoiir sS ing them in uilding impred housing Will h iti appear o explin the iffereces beween sucessfu and gte the adverse~ efflects onthese people. unsuccessf''ul resettlementi'efforts: * Accurnte casting and financing . ' Poor performance on:j *&rengpoii,,ltrtlccmit'f,m,ent.,mt- Th e ad'to of egal resettitlemeniitt wasit on e n trcedto iaequate ec-tti00 |.0Mnresettlment efj:0--is an early 0009 expresion lX:0j of poi 00;tica 0l000,i20 corn- 0S costs onto th ece oplto, and0 undrfian mimet Conscientious and lirnelyo -Teimph:dlementationkLl::C;;:00 ing I th0Ee iwenty asesreiewded, resetlLemn >csts:XE4 sa2-- tion o provisio of Sieies(r relemn Jnd confirmsltl that 000lS4no t s percet. i t@0r- +t0000f fi*g?- . ou onfi; 0,rtinme ret,stoat e on. Creationgi the ondtionst: ca-S ;L;fL fl: : to informeaffected ppulationsfthe possibler t tlement efforts. Aeving t goal is enhanced when able solutiotoIC eseD so oft the pry0gSfiiioject Moving affetedpe0rer00000tb00h parties to newly pro- opposi-ion overthe .4Sl:00000S2ifed o g XXf ag 02VSlong-aE*:00 lAtl!0 Eerm!S concess ion,00 bCecause * Begi communit outeac as$l earl as possi- fl:|g!J X;i: te futurhee n olcino srfe) n fro ad 9 eto. tf ewn inc:4A1reased losangterm risks to rproec fc ilemities, *:: Consider::-: gihow;5:fe to::;: ;addrePss th:e d