MARKET SOLUTIONS FOR DEVELOPMENT: Frontiers in

Infrastructure Finance

Mansoor Dailami Lead Economist, World Bank Institute

April 19, 2023

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PSD

Competition

Infrastructure Finance

FY 2002

Regulation Market Solutionsfor Development

FY 2001FY 2000FY 1999

where we were… …where we are now…

Governance

MS4D: Consolidation of 4 earlier programs

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What is the logic behind MS4D?

Reliance on the potential power of market mechanisms and private initiatives to promote a favorable investment climate:

• Better distribution of risks between public and private sector

• Infrastructure investment and the supporting institutional changes are a core component of WBG poverty alleviation programs

It does not exclude the role of government in establishing sound regulatory systems and protecting property rights

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MS4D: What is it?MS4D: What is it?

Learning program focusing on:Policy, regulatory, governance, and poverty aspects of PPI and PSD, for market-led growth Policy services and implementation processes, using a holistic and cross-sectoral approach Filling market gaps in learning and capacity building

What it does not do:Focus on some sectoral issues (we do not cover education or oil & gas for instance)One-off activitiesCrowd out private sector and other content providers including academics

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MS4D: Content/Design

The rigorous incorporation of Governance concerns and equity/poverty aspects of growth, e.g.

Transparency in infrastructure concessions PPPI and the Poor

A modular design, that will allow us to share and draw upon other relevant programs within and outside WBI

Emphasis on: Research and data that provide the intellectual and

empirical basis for our learning activities; Scaling up through the GDLN and distance and e-learning Frontiers in knowledge, best practices, and emerging

issues

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Infrastructure Finance

to finance: Defined by Webster’s Dictionary as “to raise or provide funds or capital for”

Infrastructure Finance: to raise or provide funds for greenfield or divestiture projects (in power, water, telecom, and transport)

Optionsa) Government finance (management contracts,

supply and civil work contracts)b) Private sector finance

PPP (BOT, estimated at $907 billion planned and funded since 1985)

PFI (£19 billion since inception in 1992)

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Key Objectives

Balancing the need of financers/promoters for long-term off-take contracts with buyers’ desire for flexibility to meet changes in market demand

Designing a financing package to minimize the cost of capital consistent with the project’s risk profile

Devising strategies for equitable sharing of risk

Capitalizing on market innovation: merchant financing, targeted insurance guarantees, new trading markets

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Expanding the possibilities for efficient infrastructure provision through public-private

sector partnership: Community of interest

Government Private Sector

Partnership

Investments that are socially beneficial

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Private Sector Participation:A Continuum of Options

Technicalassistancecontracts

PUBLIC PRIVATE

Supply andcivil workscontracts

Sub-contracting

Managementcontracts Leasing BOT and

concessionBOO Divestiture

Of particular importance

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Evolution of Private Participation in Infrastructure: An Historical Perspective

1970s

1992 19991996 1997

U.S. deregulation of airlines, gas, rail, and telecommunications

Deregulation and privatization in the UK

Russia and Brazil crises

South East Asianfinancial crisis

1980s 1990s 2000s

Decade of 1990s: Liberalization and opening

up of emerging market economies to private sector

1991

Launch of UK Private Finance Initiative (PFI)

Transformation of U.S. electric industry

EU Electricity Directive opens

market to competition

2001

California Power crisis

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Private activity declined in 1998 from a high in 1997, falling most in East Asia and in energy.

Annual Flows to PPI Projects in Developing Countries

0

10

20

30

40

50

60

70

80

90

100

110

120

130

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

1999 $USBn$125.1

$97.3

$65.4

Total: US$573.5 Bn

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by Sector

Telecoms45%

Power & Gas33%

Transport17%

Water & Sanitation

5%

Total: US$573.5 Bn

MENA2%

SA5%

Africa2%

ECA8%

LAC61%

EAP22%

by Region

Total Flows, 1990-99

Telecommunications and energy have been the leading sectors in private participation. Latin America and East Asia the leading regions.

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Main Characteristics of the Infrastructure Project Finance Market

I. Complex contractual arrangements

II. Dominant use of project financing techniques

III. Risk management strategies and techniques

IV. Project financing mix depends on tariff charged

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Major Parties to an Infrastructure Project

Secu

rity

of D

ebt P

aym

ent

and

Col

late

ral

(con

cess

ion

agre

emen

t)

Build, Operate, Raise

Finances to Provide

Infrastructure Services

Concession Rights,

Fiscal Incentives,

Guarantees

Government

CreditorsProject

PromotersSecurity and Assurance

of Debt Repayment

Term Debt Capital

Each party maximizes its own objectives subject to the constraints set by others’ willingness to participate.

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Sponsor holds a residual claim, after the payment of contractual claims

Financing mixes depend on “negotiated tariff” rate for infrastructure services

Reasonable return on investment

Limited recourse structure

Incentives/Objectives of Project Sponsors

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Have a claim to fixed contractual payments from the project’s cash flows independent of the borrower’s income

Good credit risk

Sufficient and secure cash flows

Managerial capability

Credit support, guarantees

Want to maximize the probability that their loans will be paid on time.

Incentives/Objectives of Creditors

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Serve Public Interest

Low Tariff Rate

Quality of Services

Incentives/Objectives of the Government

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Up-front, specific, risky, and long-term

Examples: power plants, bridges, roads which can not be moved

Lock-in equity capital for a long time

Incentive system of contracting parties changes once the investment is sunk

Infrastructure Investment: Why Long-Term Contracting?

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Forms of Contracts

Long-term formal contracts: three classes of contracts are important:

Concession agreements stipulating a property rights transfer from the government to the project company.

Performance contracts between the project company and contractors and operators.

Loan contracts between creditors and the project company.

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As a result:

Investors are hesitant to make investments without adequate contractual protection, leading to special contracting and risk sharing problems.

Features of Private Infrastructure Investment

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Incomplete Contracts

It is difficult to write complete contingent contracts that will cover all future circumstances, including:

Exogenous shocks Unanticipated changes in operating costs

and conditions

Market innovation: Merchant plants in the power sector

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Emergence of Project Financing:

Appropriate techniques for projects with high capital requirements and a complex risk profile

Payouts are based only on the projects’ own assets and cash flows stream

Creditors rely on the ability of the project for repayment of related debt obligations, non-recourse debt

Multi-source financing: syndicated commercial banks, bonds, ECAs, multilaterals

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Project Financing: Uses of Cash Flows

Revenue Streams

Depreciation &Interest

Taxes

Principal Payments

Depreciation

O & M, Insurance Expenses

Dividend to Shareholders

Governed by a hierarchy of claims and by the prevailing tax codes

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Power Plant Key Parameters

100

84 %

955

95.5

10,000

26MMBTTU/ton

Characteristics of the plant

Capacity (MW):

Capacity factor:

Plant investment cost ($/kw)

Plant investment cost ($million)

Heat rate (BTU/kwh)

Heat content

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Power Plant Key Parameters

70% debt30% equity

20 years

8.5 %

40%

Financial Assumptions

Capital structure:

Term of debt:

Interest rate:

Income tax rate:

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-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

20 25 30 35 40 45

Tariff rate ($/MWH)

An

nu

al R

OE

%ROE Depends Critically

on the Tariff Rate

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Must address the needs of a broad cross-section of people and communities

Environment - complying with global standards

Right investment climate—institutions, political stability, credibility of government commitments

Adequacy and security of cash flows

Summing Up: Criteria for Success

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I. What is driving the infrastructure finance market?

1. Changes in country and risk profiles

2. Technological advances, changes in regulatory policy

3. Government support, guarantees, tax incentives, credit enhancements, and political insurance

II. What are the implications of globalization / consolidation of infrastructure industries?

III. What are the implications for developing countries? What are the requirements to restore investor confidence? What type of financing best fits different countries’ needs, priorities, and local financing conditions?

Emerging trends at the turn of the millennium