Economic and Financial

Instruments for IWRM

Financing water and sanitation through bonds, BOTs and reforms Meine Pieter van Dijk, UNESCO-IHE 28-08-2007

Goal and objectives of the session

To look at the availability of a capital market at the national level and the possibility to use it for integrated water resource management

To identify the different legal forms used for funding, which go with the different financial instruments which can be used in the water sector and have been introduced in the previous chapters

To indicate how such a local capital market can be developed over time if the right attitude and policies are in place

Learning objectives of the session: to

1. Make participants aware of the importance of developing local capital markets

2. Learn to appreciate the importance of legal constructions to secure finance in the water sector

3. Provide arguments in favour and against private sector involvement in the water sector

4. Show importance & composition of foreign capital

5. Identify financial risks and discuss possibilities to mitigate risks

6. Understand reforms that need to be carried out

Outline presentation

1a The distinction between legal forms and

financing instruments

1b Introduce the notion of capital market

1c The importance of the capital market in your

country

2a The Indian experiences with such an approach

2b How to develop a local capital market

3a Africa’s experience in with bond markets

3b Exercise, or role play on sources of finance

Introduction

Link water issues of the participants to

what can be achieved through mobilizing

capital from the local capital market

Explain that with different sources of

finance you may also have different legal

forms but this requires a legal framework

Financial instruments and legal forms

Legal forms:

Special Purpose Vehicle (SPV):

Build-Operate and Transfer

(BOT) and its variants such as

Build-Operate and Own

(BOO), Build-Operate and

Lease (BOL)

Private Public Partnerships PPPs,

through joint ownership, for

ex. through a joint venture

Concession

Service and management

contracts

Financial instruments:

Bonds or loans

Shares

Lease arrangement

Venture capital

Contribution in kind

Labour made available, or a

cashflow from cost recovery

Micro savings &

micro finance

Islamic banking

Municipal development fund

Infrastructure investment fund

Definitions of major instruments

Bonds a fixed term debt with a fixed rate of interest and a priority treatment in case of bankruptcy

BOT the project is carried out with (foreign) partners who operate the facility (for example a power plant) for 25 years or longer

Capital market place where demand &supply for capital meet

International capital market: place where international suppliers of capital are brought in contact with international demand for capital

Joint venture instrument of cooperation between enterprises

Legal instruments for obtaining finance a legal agreement which sets out conditions of cooperation between different parties

Local capital market local capital demand & supply meet

Municipal development fund is a pool of money operated at a level above that of the individual municipality, for investments in urban infrastructure, services and enterprise through municipality

PPPs a co-operative ventures between a public entity and a private

Municipal bond markets

Municipal bond markets are a growing market in

developing countries

FIRE project is helping for example Indian cities to

prepare projects in such a way that bonds can be

issued at the local or American capital market,

using a partial USAID guarantee

Water supply, sewerage, roads, land development,

education and health facilities could be financed

Dedicated cash flow necessary to serve the bond

The development of the bond market in India

FIRE created possibilities for local governments to

gain access to the local and international capital

markets to allow them to finance infrastructure

Questions asked are: what are the pre-requisites

to make PPPs a success, what kind of legal

framework is required and where would the funds

come from?

The emphasis is on the conditions that need to be

satisfied to attract different sources of finance

Conditions that need to be satisfied to attract

different sources of finance

Obtain a credit rating before issuing bonds

The Gujarat State government prepared an

infrastructure 2000 Plan with vision and strategy

The state was the first one in the country to draft

a Build Operate and Transfer law &

Has experience with giving concessions to the

private sector

Find sources of finance to serve and eventually

repay the bond

Things going wrong with India’s bonds: lack of …

Genuine political commitment to reforms

Clarity in scope and framework for PSP, no adequate concern for management improvements

Rigor in project and contract development, no risk management

Concern for financial viability

Quality support &funding for project development

Appropriate regulatory framework

Participation & capacity building for stakeholders

Continuity of champions for the projects when leaders got transferred or defeated in elections

Ownership for the project within the city; while

Strong opposition from the existing rent seekers

Mechanisms for financing water and sanitation:

developing the local capital market

Development of domestic debt markets requires an efficient & liquid market for government debt

It also requires the development of institutions engaged in mobilizing long-term savings, especially insurances and pensions funds

Alternative: go for credit enhancement through partial credit risk guarantees (offered by multilateral development banks)

Continue to tap funds from international lending agencies and utilize these resources as seed capital for leveraging funds from the market

Initiatives in Africa

A number of countries have taken initiatives to develop their local capital markets

Countries are eager to use bonds and equity to finance their infrastructure

Ethiopia has bond market. The ministry of finance organizes auctions regularly to sell national bonds

Ethiopian cities will be allowed to finance their infrastructure in that way

Many countries wants to move to what is a called a sub-sovereign bond market: public bodies below the level of the national state can issue bonds

An example, Johannesburg in South Africa

In South Africa it has already happened: Johannesburg has issued bonds with a guarantee of the IFC, the commercial wing of the World Bank and the national government (through the Development Bank of South Africa, DBSA)

Although the city has not audited its accounts over the last years, it is so big and important for the South African economy that the government and the IFC were willing to guarantee the bond

The bond was taken up (bought) by local insurance companies and investment funds

Arguments in favour of PPPs: complementarity

Public sector is strong:

Government is expected to strive

for general good

Used to weighing of interests

Is good in assuring legal aspects

of the project are in order

Will take the political

responsibility

Good in planning & preparing

Can regulate private sector

Weak points

Can not run major financial

risks

Often cost overruns on

government run projects

Private sector is strong, because

Private sector is driven by profit

motive, but supposed to be more

efficient

Has the technical expertise and

provides continuity in know how

Willing and able to take risks

Large degree of freedom in

organizational structure

Can mobilise finance and can

run financial risks

Willing and able to organize

O&M

Weak point

May inflate cost

Conclusions

Indian cities have started issuing bonds

The easiest instrument to finance your water infrastructure remains the BOT

Conditions for success: have the required legislation in place, have bankable projects and the unit going for the BOT should have prepared a good cost benefit analysis

Infrastructure should generate a cash flow

Think about it

Discuss your experiences with a more

sophisticated way of financing the water

sector, while indicating the advantages and

disadvantages of each approach (of the

different ways of tapping the capital

market)

End

Now you need to apply these ideas, in the

next chapter we summarize some of the

suggestions how to finance IWRM plans

The last chapter takes the different actors

and shows what they can contribute: local

governments, small companies, NGOs &

financial institutions