51769 noTE no. 49 ­ JunE 2009 GRIDLINES Sharing knowledge, experiences, and innovations in public-private partnerships in infrastructure New needs for technical assistance Responding to the effects of the financial crisis on private participation in infrastructure James Leigland and Henry Russell I n developing countries the global finan- are expected to continue through 2009. Interna- cial crisis is leading to serious difficulties tional project finance is now much more expensive for infrastructure projects with private and difficult to arrange because lenders (those still participation. In some cases governments willing and able to offer project finance) have less are responding by simplifying their project money and are more risk averse in selecting proj- approval processes or by substituting public ects and markets. In most emerging economies for private financing. Even if markets recover PPI projects that reached financial closure in the quickly, these responses could pose signifi- first four months of 2009 were either well along cant risks. Containing those risks and dealing in development or relied heavily on a mix of local with the effects of the financial crisis calls for public banks, export credit agencies, and bilateral specialized technical assistance--in assess- and multilateral agencies for finance. But these ing contingent liabilities, maintaining existing financing institutions are unlikely to be able to assets, assisting projects in distress, and main- fully close the gap left by departing private inter- taining a project pipeline. national lenders (Izaguirre 2009). The global financial crisis is likely to have severe Economic impacts adverse effects on private participation in infra- A second set of impacts is expected to stem from structure (PPI) in developing countries. Although the ongoing global economic contraction. In addi- events are still unfolding, available evidence tion to the impact on debt flows, private capital suggests that liquidity for private infrastructure flows of all kinds are expected to decline by half investment is drying up. In mid-2009 a few PPI in 2009, to about 20 percent of the peak level of projects are still reaching financial closure, though 2007 (IIF 2009). Foreign direct investment and with higher spreads, and a few in countries with portfolio investment are sharply down in most deep local financial markets are turning to domes- developing countries. African stock markets have tic debt. But most PPI projects in emerging econo- fallen by an average of about 40 percent. Stock mies are facing serious difficulties as a result of markets in Asia and Latin America are also down. the crisis. These difficulties highlight the need for Remittances, so important to many developing specialized technical assistance. economies, are falling because of the downturn in remittance-sending countries. Economies that depend heavily on exports, such as those in East Three kinds of problems Asia as well as oil producers in various regions, are PPIAF Approved Logo Usage seeing far lower revenues. The sharp drop in the Although the global financial crisis is having dif- prices of commodities will have dramatic effects in ferent overall effects in different regions and coun- many areas where much of the population depends tries, it is affecting PPI projects in at least three Logo - Black in some way on commodity exports. related ways. impacts FinancialINFRASTRUCTURE ADVISORY PUBLIC-PRIVATE FACILITY James Leigland is acting program manager of PPIAF. Financing for infrastructure has fallen sharply, a Henry Russell is manager of the Finance and Guarantees trend already apparent by the end of 2008. The Unit of the World Bank's Finance, Economics, and Urban upward trends in costs, delays, and cancellations Development Department. Logo - 1-color usage (PMS 2955) Helping to eliminate poverty and achieve sustainable development PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FAC ILITY through public-private partnerships in infrastructure 2 The slowdown in economic growth that will result expenditures is critical. O&M expenditures can from these and other factors means a reduction in be scaled up quickly and countercyclically. Larger the ability and willingness to pay for retail infra- investment projects may take some time and require structure services and thus in the revenue streams sound project identification and prioritization. needed for debt service. The economic slowdown will also reduce the ability of government agen- A second response to the crisis is to act aggressively cies and utilities to pay for the off-take of bulk to maintain a role for the private sector in manag- services. ing and financing infrastructure projects. Here, governments are doing at least two related things. Policy impacts First, they are altering their approval processes The crisis may also take on a policy dimension as for PPI projects to reduce or delay the effects of government budgets come under growing stress. debt pricing on these decisions. Governments typi- Empirical evidence from past crises suggests that cally try to review and give preliminary approval policy makers are often tempted to turn away to PPI projects as early as possible in the proj- from constructing, rehabilitating, or even main- ect development process so as to avoid wasting taining infrastructure assets to deal with other, money developing projects that would be unaf- more immediate priorities. This was true in Latin fordable or would not offer value for money.1 But America in the 1990s, when half the fiscal adjust- project finance debt has become too expensive for ment came through cuts in public infrastructure many projects to be judged affordable. And where spending. In Asia many countries severely cut debt may be affordable, the use of loan agreement infrastructure investment in the wake of the 1997 clauses like "market flex," which have the effect of financial crisis, then suffered years of sharply lower delaying final lender pricing, means that tests of GDP growth. affordability and value for money cannot be done with any certainty until projects reach financial This "turning away" from infrastructure is unfor- closure--and sometimes not even then. tunate for several reasons. Neglecting operations and maintenance (O&M) expenditures increases Some governments, particularly in developed the economic costs of a recession through lost countries, are responding to this uncertainty by capacity and lower employment. In the long run simply delaying as long as possible the require- the cost of replacing an asset is higher than the ment for firm financial commitments that must cost of continuing to maintain it. Allowing project Governments pipelines to become depleted also compounds the be met for government approval of a project. The French government is exploring ways of developing and their cost of a downturn: since infrastructure projects and approving PPI projects--even accepting final have long preparation lags, they often take much partners are longer to recover after an economic crisis than the offers from bidders--without such commitments. The Polish government has awarded a 35-year toll responding to economy itself. The Asian crisis led to the post- road project to a firm that will start on design and ponement of long-gestating infrastructure projects, the crisis in contributing to what is sometimes referred to as construction, though financial closure has been postponed for a year. During that time an assess- several ways the "lost decade" of infrastructure investment for ment will be made of the project's capital invest- many Asian countries. ment needs and market pricing options. Some banks and financial advisers in Western Europe are promoting the use of "mini perm" financing Responses to the crisis for PPI projects. The term, borrowed from real Governments and their development partners are estate development, refers to loans meant to cover responding to the crisis in several ways. One way a project's construction period, after which the is to recognize that infrastructure investment is debt must be refinanced. an important tool for dealing with the economic downturn. Many countries are considering--or Second, governments are providing some or all have already put into place--some form of stim- of the financing for PPI projects, through loans, ulus package in response to the financial crisis, equity, grants, or guarantees. Again, developed often highlighting infrastructure. Well-planned countries, such as Australia and the United King- infrastructure investments not only provide coun- dom, have taken the lead. The U.K. government tercyclical economic stimulus; they also help lay is attempting to salvage its Private Finance Initia- the foundations for economic growth in the long tive with a proposed investment fund that would term. A judicious mix of O&M and investment provide up to 100 percent of the financing needed New needs for technical assistance 3 for projects to proceed. The financing is intended On the basis of this kind of liability assessment, to be as short term as possible, with the loans governments can prepare frameworks for respond- refinanced from commercial sources as soon as ing to overtures by project companies on project markets recover. restructuring and can act preemptively to avoid problems on some projects. Over the longer term In developing countries such as Brazil, India, Mex- governments may be willing to work out risk man- ico, and South Africa government-owned develop- agement frameworks that integrate contingent ment finance institutions are providing funding or liabilities on PPI projects into their budgeting pro- The risks guarantees to kick-start PPI projects. In countries cesses. Finally, understanding contingent liabilities without such resources, donors and multilateral on existing projects is a prerequisite to prioritizing associated development banks are preparing to help fill the new projects, some of which may need to move with some of gap. The International Finance Corporation is creating a global fund that will substitute donor forward in a timely way while others may need to be delayed until markets more fully recover. the emergency funding for commercial finance to start new PPI measures are projects and keep existing ones alive. In other developing countries donor or multilateral devel- Maintaining existing assets substantial This is a good time for governments and their opment funding may allow infrastructure projects development partners to consider the value of PPI to begin using conventional public sector procure- arrangements that focus primarily on O&M rather ment and implementation, with the aim being to than investment. A greater focus on O&M projects bring in private participation when it becomes at this point makes sense both economically and feasible. practically because they are relatively easy to struc- ture at a time of constrained liquidity. Because of their smaller size, O&M contracts often involve The role of technical assistance the domestic private sector, including small and Even if markets recover quickly, the risks asso- micro enterprises. In addition, some O&M con- ciated with some of these emergency measures tracts can be designed to shift to longer-term, are substantial.2 By downplaying debt pricing as capital-intensive PPI projects after markets begin a way to evaluate PPI projects, governments may to recover. increase the risk of being stuck with contingent liabilities on projects that are unaffordable or even Assisting projects in distress nonviable. The same concerns hold for govern- Some governments will need technical assistance ment or donor funding support--and are even to help with projects already in distress or to put greater for projects with simplified approval pro- into place measures for dealing with contractual cesses followed by large public investment. Rigor- issues that may arise. Governments will have to ous appraisal, selection, development, structuring, make decisions on whether to slow or stop invest- and implementation of projects will be essential ments, how to respond to the potential entry of for many of these emergency measures to work. In new investors into distressed projects, and whether emerging economies, that suggests a need for spe- to contribute their own debt or equity to proj- cialized capacity building and technical assistance. ects, allow asset sales, permit extraordinary tariff Several priority types of such assistance appear to increases, or negotiate mothballing of projects or be emerging. termination of contracts. And in some cases they will need to consider social programs to protect Assessing contingent liabilities the most vulnerable groups in society. Govern- Many governments, especially those with sig- ments in these situations will need legal, technical, nificant PPI project portfolios, will need rapid- economic, and financial advice to help compare response assessments of the contingent liabilities options and conduct negotiations with project they face with existing projects. Which projects are companies and lenders. likely to come under stress because of the crisis? How have project risks been allocated, how much Maintaining a pipeline of projects have these risks changed, and what has been done Finally, many governments will need help in main- to mitigate risk? How do the contracts and agree- taining their PPI project development pipelines in ments with lenders handle the catastrophic lack of the face of changing market realities. Once these global market liquidity? In particular, what liabili- pipelines shut down, fully restarting them typically ties do governments face if projects are terminated takes years. To keep the momentum going, govern- early under such conditions? ments will need to evaluate innovative approaches 4 to structuring PPI projects. These could include misunderstood the contingent liabilities associated using public sector debt and equity to replace com- with these contracts, and under the intense pres- mercial finance; designing public projects so that sure of the Asian crisis, many simply repudiated they can be transformed into PPI projects when the these obligations. markets begin to recover; using subsidies to lessen the impact of necessarily high tariffs, especially for Today the situation is different. Many govern- poor customers; and adjusting legal and regulatory ments in developing countries are taking a more frameworks to facilitate the development of PPI pragmatic approach toward PPI-related issues. projects under the changing conditions. Not all of them fully understand their contingent liabilities on PPI projects, but many now recognize that such liabilities exist and are asking for help in Conclusion understanding them. While many PPI projects are likely to experience problems, the PPI model does Some changes in the global project finance mar- not appear to be under threat. That should help ket are likely to be long term. Whether this will ease efforts in emerging economies to find innova- lead to another "lost decade" for infrastructure tive PPI approaches for dealing with the long-term investment in emerging economies is still open to market changes. question. But it is already clear that the technical assistance needs and challenges stemming from Notes today's financial crisis are markedly different from 1. Probably the best-known vetting techniques are those associated those of the Asian crisis that began in 1997. Today with the U.K. Private Finance Initiative, though variations of far fewer governments in emerging economies are these are widely used in many developed and some developing countries. criticizing the basic PPI model than in the late 2. A companion note (Leigland and Russell 2009) discusses in 1990s, when many did not fully understand how greater detail the possibility that some market changes may be PPI contracts were supposed to work. long term. References In the early 1990s many governments had come IIF (Institute of International Finance). 2009. "Capital Flows to to use these mechanisms out of a belief that they Emerging Market Economies." Washington, DC. January 27. could turn over all responsibility for infrastructure Izaguirre, Ada Karina. 2009. "Assessment of the Impact of the provision to private partners, who would cover all Crisis on New PPI Projects: Update 2." Private Participation in Infrastructure Database, World Bank, Washington, DC. costs and accept all related business risks. When projects became distressed during the Asian crisis Leigland, James, and Henry Russell. 2009. "Another Lost Decade? Effects of the Financial Crisis on Project Finance for Infrastructure." and private partners did not do this, they were Gridlines series, no. 48, PPIAF, Washington, DC. accused of reneging on promises and the PPI model came under attack. Governments often ignored or GRIDLINES PPIAF Approved Logo Usage Gridlines share emerging knowledge on public-private partnership and give an Logo - Black overview of a wide selection of projects from various regions of the world. Past notes can be found at www.ppiaf.org/gridlines. Gridlines are a PUBLIC-PRIVAT E IN F R A S T R U C T U R E A D V IS O RY FA C IL IT Y publication of PPIAF (Public-Private Infrastructure Advisory Facility), a multidonor technical assistance facility. 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