Memorandum submitted by the Commonwealth
Business Council
DELIVERING BASIC SERVICES TO THE POOR NEW
APPROACHES TO OLD PROBLEMS
I. SUMMARY
1. This paper sets out six areas of reforms
designed to increase the levels of private sector involvement
in improving the delivery of public services to poor people.
2. The international community is committed
to challenging targets for improving basic infrastructure services
to the poor through the Millennium Development Goals (MDGs). The
investment required to meet these targets is, however, much greater
than is currently being spent by public and private sectors combined.
Moreover, recent public sector lending to infrastructure is down
sharply from close to $8 billion per annum in 1993 to only $2
billion per annum in 2002. [39]Private
sector investment into emerging markets is also in retreat, falling
from a peak of approximately $130 billion per annum in 1997 to
half this level by 2001.
3. While the large scale transfer of market
risk involved in full divestiture, concessioning, build-own-operate
or transfer can be workable where there is a robust off-take arrangement
or a clearly observable commercial upside, it remains extremely
problematic in infrastructure sectors where basic commercial viability
is difficult to demonstrate, such as with water, sanitation or
road development.
4. In order to attract more private capital—especially
in the current risk averse environment—a wider range of
approaches is needed.
5. The main challenge lies in how to create
sustainable infrastructure business models that are responsive
to the real needs of local communities, that can deliver services
cost-effectively and that are capable of mobilising the large
amounts of long-term capital to finance the heavy front-end expenditure
involved. This paper points to the following areas of reform which,
if addressed collectively, would facilitate a much greater role
for the private sector in meeting the MDG objectives:
6. Universal access not universal standards.
All customers need to be actively involved in decisions about
the trade-offs between standards, cost and affordability. This
points to a "tripartite" approach to project design,
development and management involving civil society (notably national
NGOs), government and business as a means of establishing better
co-operation between groups not always comfortable with each other's
objectives and motives. There needs to be a shift in focus away
from attempting to achieve universal service standards to improving
universal access. Appropriate standards of service are more likely
to have an acceptable level of "full-cost recovery"
fees—making charges affordable and yet maintaining the commercial
sustainability of service delivery.
7. New models for delivery and ownership
of infrastructure. Especially in the more challenging infrastructure
sectors such as water, new models are needed that allow inclusive
stakeholder involvement, whilst retaining business-like management
of the implementation by private sector professionals. In this
process there needs to be greater emphasis in delivery through
partnerships with NGOs and the role, and a building up of the
capabilities of domestic private sector infrastructure managers.
New arrangements, based on the concept of corporate entities where
surpluses are reinvested in network expansion rather than distributed,
operated privately on a fully commercially sustainable basis,
but owned and governed by national stakeholders may be worth investigating
as potential solutions.
8. Attracting commercial operators. This
model is likely to secure much greater commitment from commercial
operators because it involves undertaking controllable cost and
performance risks, but not the regulatory or, at times, revenue
risks which are, for them, non-controllable risks. At the same
time, commercial operators would be fully incentivised to deliver
on performance and be rewarded for the professional skills and
management expertise committed. In other cases, bringing in private
sector management prior to concessioning or sale can sometimes
presage a successful change of ownership. These approaches should
therefore be combined with an emphasis on output based contracting,
which is consistent with output based aid (OBA) approaches being
led by the World Bank. [40]
9. Paying for the service. Whilst it is
essential that user charges pay for the cost of running the infrastructure
service, in many cases such levels of charges would be unaffordable
to large proportions of the poor. Carefully structured subsidies,
utilising OBA approaches, targeted at either specific groups or
else at particular impediments to service uptake (such as up-front
connection costs), will be needed to make delivery of services
viable for private sector investment.
10. Mobilising finance. In an ideal world
much of the required debt capital would be raised from domestic
financial markets. Although this goal should remain within the
policies of international development partners, progress however
is likely to be slow. In the meantime, International Financial
Institution (IFI) credit enhancement mechanisms will be increasingly
needed to address specific country risks impeding the flow of
capital from international credit and capital markets as well
as potential equity, risk sharing, based interventions.
11. Improving the capacity to deliver. The
need for wider and more intelligent stakeholder participation
in designing infrastructure projects, the need for better allocation
of the various risks to those who can most efficiently bear them
and the complexity and long term nature of contract management,
have very significant implications for the capacity of the public
and private sectors to transact and manage infrastructure projects.
This is especially relevant in the poorer nations where good management
is often the scarcest commodity of all. While facilities exist
to improve policy formulation, these must be complemented by tools
to ensure that governments and local business have the capacity
to transact and subsequently manage the structures. A number of
Commonwealth countries such as the UK, and more recently South
Africa, have developed centres of excellence in private sector
participation (PSP) techniques which should be made available
to other Commonwealth members. At the same time, and equally vital,
there must be an overarching sense of pragmatism to ensure that
new implementation structures are not so complex that they cannot
stand the test of practical and cost effective implementation.
- INTRODUCTION
12. The poor of the world lack access to
adequate basic services—safe water, adequate sanitation
and modern energy services, not to mention telephony and modern
modes of transport. It is estimated that about 1 billion people
currently do not have access to safe water, about 2.2 billion
do not have access to any form of improved sanitation service
and in excess of 2 billion do not have access to modern energy
services (electricity and petroleum products). [41]The
consequent cost in both human and economic terms in incalculable.
13. In September 2000, heads of all UN member
states gathered in New York where they adopted a series of resolutions
that set out clearly the priorities and commitments for the international
community to deal with the problem. The resolutions included commitments
"To halve, by the year 2015, the proportion of the world's
people whose income is less than one dollar a day and the proportion
of people who suffer from hunger; and also, by the same date,
to halve the proportion of people who are unable to reach, or
to afford, safe drinking water. [42]These,
together with other targets adopted at the summit, have become
known as the Millennium Development Goals (MDG).
14. Two years later, this time at the World
Summit on Sustainable Development in Johannesburg, world leaders
reaffirmed these resolutions. They also added targets to halve
the proportion of people without access to basic sanitation services
by 2015 as well as a number of commitments on improving access
to modern energy services. Box 1 outlines key commitments as summarised
in the UN "Key Outcomes of the Summit" document.
Box 1: Key commitments from the World Summit on
Sustainable Development
| Water | Halve, by the year 2015, the proportion of people without access to safe drinking water (reaffirmation of Millennium Development Goal).
|
| Sanitation | Halve, by the year 2015, the proportion of people who do not have access to basic sanitation.
|
| Access to energy | Improve access to reliable, affordable, economically viable socially acceptable and environmentally sound energy services and resources, sufficient to achieve the Development Goals, including the goal of halving the proportion of people in poverty by 2015.
|
| Renewable energy | Diversify energy supply and substantially increase the global share of renewable energy sources in order to increase its contribution to total energy supply.
|
| Energy markets | Remove market distortions including the restructuring of taxes and the phasing out of harmful subsidies.
|
| |
15. This paper argues that whilst both the private and
public sectors have worked hard to develop partnerships in infrastructure
development, significant challenges still remain due to the complexity
of the issues. Reverting to public sector only solutions, which
have consistently failed in increasing access to basic utility
services, is not an option. At the same time, the means by which
the private sector is involved, particularly in highly sensitive
sectors, arguably also needs to be revisited to take account of
current realities and the lessons that have been learnt. The private
sector still has a major role to play, not least if the major
financing requirements are to be met. Greater innovation is therefore
called for, which combines a number of different models, if a
balanced approach is to be achieved and if the benefits of private
sector participation (PSP) are to be maximised.
16. While we take for granted that an appropriate legal
and regulatory environment is a major prerequisite for private
sector involvement, this paper focuses on:
— some of the key challenges to be addressed in
meeting the MDGs, not least the scale of the funding requirement;
— key principles to be applied in developing new
and innovative public-private approaches that can address traditionally
thorny problems;
— the means by which infrastructure services can
be paid for; and
— how the necessary long term debt and equity funding
might be raised.
III. CHALLENGES
17. It is one thing to set targets as ambitious as the
MDGs and quite another to achieve them. The challenges facing
developing countries and the donor community seeking to redress
the situation are systemic and chronic.
(a) The funding gap—why private capital is so important
18. It is very difficult to even estimate a figure for
the resources required to achieve the MDGs and those targets added
in Johannesburg. In water management alone, the Global Water Partnership,
in their report to the World Water Commission, states that the
current expenditure of $70 billion per annum will need to be increased
to $170 billion per annum. Other analyses suggest that this figure
is still likely to be an underestimate. The situation in the sanitation
and modern energy sectors is similar. With rapid population growth
and the deterioration of existing assets the funding requirements
are only set to grow.
19. Current levels of public and private investment are
insufficient, by a long way, to satisfy these growing requirements.
Firstly, the developing countries' fiscal positions have never
been sufficient to tackle the infrastructure problems properly,
and if anything, have become more strained over the last decade
due to economic crises, population growth, AIDS, climatic calamities
etc. Secondly, international development partners, which have
been supplementing these fiscal deficits for years, are not able
to keep up with the demand. Estimates of the average annual amount
of official aid over the last three years, in the water and sanitation
sectors, suggest that it amounts to only around $9 billion per
annum. [43]There is little,
if any, prospect of this figure increasing significantly in the
foreseeable future. Moreover, figures for IBRD—public sector
lending to infrastructure more widely, shows a deep downward trajectory
from close to $8 billion per annum in 1993 to only $2 billion
per annum in 2002. [44]
20. The private sector, which in the 1990s invested significant
amounts into emerging markets' infrastructure, is also in retreat.
The flows of 1990s were driven by investments into the power and
telecommunications sectors of East Asia and Latin America, which
have gone into reverse as both regions hit crises during the later
part of the decade. From a peak of approximately $130 billion
per annum in 1997—the year of the onset of the Asian crisis—annual
flows had more than halved by 2001. The picture is slightly more
optimistic for those low income countries, who never really benefited
from the desire for emerging market exposure in the 1990s, as
they have actually seen a slight increase in flows. The amounts
of capital in question, however, still fall far short of what
is required.
21. The outlook across all the countries may even be
more unfavourable than the historical outturn as the availability
of new capital is becoming increasingly rationed, driven by falling
global stock markets and retrenchments by many utility and telecommunications
companies following the corporate excesses of the last decade.
22. With annual global savings at around $7 trillion
per annum (World Bank SIMA database), private sector capital is
plentiful, which is why it is so relevant. However, in an era
of risk averse capital, the additional risks associated with emerging
markets have done little to improve the appetite for continued
investment in these markets. This conundrum is a challenge for
both policy makers and investors alike and requires a careful
reassessment of what is required to reinvigorate investment flows
to developing and transitional countries.
(b) Unsuccessful delivery models
23. There have been problems with both public and private
sector infrastructure service delivery models. The public sector
monopolies of the second part of the twentieth century have often
been grossly inefficient. They have been unable to maintain existing
assets, improve service to existing customers and importantly,
have not been able to meet the ever-growing demand in developing
countries—especially from the poor. Decisions by poorly
trained and unmotivated public sector work force tend to be driven
by political pressures and not commercial sustainability and/or
technical necessity. These weaknesses are well known by those
active in this sector in developing countries. [45]
24. On the other hand, private sector solutions have
repeatedly been presented as a panacea for all problems, often
with little understanding of the role that the private sector
is able to take in a given situation. Large scale transfer of
market—pricing and volume—risk involved in full divestiture,
concession/build-own-operate (BOO) and build-operate-transfer
(BOT) can, for example, be workable where there is a robust off-take
arrangement (independent power production) or a clearly observable
commercial upside—(for example, airports in buoyant economies,
electricity transmission etc), but extremely problematic in infrastructure
sectors where basic commercial viability is difficult to demonstrate.
The building of toll roads and water and sanitation often fall
well within this latter grouping.
25. To these basic commercial impediments must be added
the full range of financial (interest rate and currency devaluation)
and particularly political (such as currency transfer) and wider
country risks. Regulatory risk arising from an independent regulator
making arbitrary changes to prices—often in the face of
popular hostility to a PSP arrangement—represents a continuing
impediment to private sector investment.
26. A number of development partners have been extremely
keen to pursue the most radical forms of PSP largely in the belief
that it is the best way to raise private capital. The highly publicised
recent failures of this approach—for instance in Bolivia—has
done little for the cause. Pushing unacceptable risks on to the
private sector will either result in failure of the approach—as
witnessed by a number of recently abandoned transactions such
as the Manila water concession (Mayniland) in the Philippines,
or transactions taking place on terms which are undesirable for
all stakeholders, often leading to subsequent renegotiation of
badly performing contracts. In designing PSP approaches it is
therefore imperative to be realistic about what risks the private
sector is willing to take so that the ensuing arrangements both
represent value for money and are more sustainable.
27. In addition to concessions, it is important to consider
other approaches, particularly in the more challenging sectors,
such as lease arrangements (water) and revenue bonds for municipal
financings. As will be discussed, it is perfectly acceptable and
in many cases necessary, to allow for subsidies in the design
of projects, as long as they are targeted on the underlying problem
(such as the high costs of grid connection to households who can
otherwise afford the ongoing service) and leverage in private
finance rather than crowd it out (as in the case of bilateral
concessional loans which can displace private money).
28. In summary, whilst we are still on the learning curve
as regards developing appropriate forms of PSP solution, the approach
remains valid in the fact of continuing public sector failure
and the need for private sector financing. The issue should therefore
be seen as not so much one of whether or not the private sector
should be involved, but rather the precise manner in which its
role maximises the benefit to all.
(c) The need for tariff reform
29. A basic tenet of commercial viability is that revenues
are higher than all-in costs, whether this be through the tariff
rate or through other income flows such as subsidies. But the
pricing of many infrastructure services—not least water—is
often highly politicised.
30. Many feel that water and sanitation services are
a public good that should be provided free at the point of use.
This belief has made setting cost recovery tariff levels and having
effective collection procedures very problematic. Financing services
out of (local or national) taxes is undermined by low levels of
economic activity and widespread tax evasion. The difficulty lies
in reconciling this reality with the simple fact that, at the
end of the day, someone must pay for these services.
31. Further aggravating the problem is that, in country after
country, the limited financial resources that are available are
misallocated. The better-off tend to enjoy deeply subsidised prices
for their infrastructure service while the poor receive no service
at all—in fact they often pay much higher prices for significantly
lower quality service (eg questionable quality water from unlicensed
street vendors). Despite repeated urging by donors to abolish
these subsidies and divert the funds towards financing basic service
access by the poor, the political realities remain hard to shift.
The better-off tend to be more politically empowered and therefore
have greater leverage on national and in particular local level
politicians to pursue their self-interest.
32. What needs to be recognised by all—including
those (often foreign) pressure groups who are against private
sector involvement—is that infrastructure services need
to be cost recovering—irrespective of ownership. In a context
of finite resources, where subsidies are employed (whether for
the benefit of the rich or poor), the opportunity cost of providing
them must be evaluated against other key social services forgone—such
as health and education.
IV. NEW APPROACHES
Harris, 2003 The Beginning of the End or the End of the Beginning?
A review of Private Participation in Infrastructure in Developing
Countries, The World Bank.
33. The challenge, therefore, is to create sustainable
PSP models that recognise the challenges faced by the private
sector, even once various forms of official risk mitigation (such
as political risk insurance) are taken into account, but which
are responsive to the real needs of businesses and local communities
(including the poor) in developing countries. Such approaches
need to be able to deliver services to existing and new customers
cost-effectively whilst minimising the barriers to the flow of
long-term finance from domestic and international financial markets.
34. Achieving this combination will not be easy; however,
adopting the following principles and structures, which recognise
the central though, differing role of the private sector, may
assist in making this more achievable.
(a) Appropriate service standards and means of delivery
35. A starting point is the nature of the service provided.
Networked water, sanitation and modern energy solutions generally
provide a significantly higher standard of service to connected
customers than non-networked solutions. However, the cost of providing
networked services to the entire population of a country (in particular
with regards to water and sanitation) is prohibitive. There therefore
needs to be a shift in focus away from attempting to achieve universal
service standards to improving universal access. In essence, this
means accepting the fact that it will be impossible, at least
in the short term, to provide every household with the same level
of utility service, irrespective of the costs of doing so. Policy-makers
need to be realistic in recognising that one size does not fit
all, in terms of both the nature of the service and who delivers
it, with the result that some people may receive a higher level
of service than others, although everyone should be better off.
In the longer term, however, these anomalies can be corrected
for many customers, not least because there will be a greater
ability to fund the costs of higher levels of service—such
as connecting more geographically isolated customers to the grid—from
a much larger customer base.
36. A related point is that of being more prepared to
accept the role, and to build on the capabilities of existing
domestic private suppliers. Whilst it is recognised that sometimes
these suppliers operate high cost monopolies, the response should
neither be one of closing them down nor ignoring them, especially
where they are the sole providers of a much needed service. As
there is unlikely to be a major element of natural monopoly in
the market structure, as elsewhere, the introduction of competitors
will be likely to reduce prices and increase quality of service.
[46]
37. In short, local entrepreneurial, customer focused
behaviour should be encouraged as the domestic private sector
will often be in a better position to assess business risk than
foreign suppliers. A further advantage of local, especially smaller
scale, approaches is that they are often more financeable—either
through formal or informal channels, than large scale networked
solutions which require long term, difficult to raise, local and
international financing. More usually, however, there are attempts
to frustrate smaller scale suppliers—such as auto-producers
of electricity who sell their surplus to neighbouring households
and villages—through regressive legislation/regulation or
through imposing unrealistic technical standards. (The issue of
improving regulatory impact assessment is an area that CBC and
others are seeking to tackle).
38. In the final analysis, the objective should be about
delivering a service that is appropriate to the ability and willingness
to pay of different groups, rather than the form of the delivery.
As such, the appropriate solution may differ both between infrastructure
sectors and between different areas.
(i) Urban areas
39. Urban areas present the greatest opportunities for
more traditional forms of single utility and have traditionally
been more able to attract larger, especially foreign, private
sector operators. It is most likely that higher levels of income,
a greater potential for some cross subsidy between commercial
and industrial customers and households, and the lower average
costs of connection arising from greater population density, will
make concession of divestiture models more viable. Even here,
however, rather than assuming that a consortium from an OECD country
will seek the opportunity, investors and financiers from other
developing countries may be best suited to such opportunities,
bringing highly relevant experience from their own countries.
(ii) Peri-urban areas
40. In small towns and peri-urban areas of larger towns,
lower cost and lower specification solutions are likely to be
needed if widespread access to basic services is to be achieved.
For water services the appropriate technology for such areas may
therefore be largely standpipe/kiosk based, supplemented by provision
of service points for tanker services and water vendors to ensure
that the service can keep up with the rapidly changing patterns
of settlement. Government acceptance of these alternatives and
therefore better (water quality) regulation will protect public
health whilst the competition from numerous alternative points
of supply will keep the prices down.
41. Appropriate technical solutions in sanitation, that
are economically feasible in poor peri-urban districts (often
with unclear land tenure), are likely to be limited to simple
private on-site solutions such as dry pit latrines or, where local
culture and strong incentives and institutional arrangements for
maintenance permit, shared public latrine blocks.
(iii) Rural
42. Networked solutions for the basic infrastructure
services will, in most cases, be even less appropriate for rural
areas. A fully reticulated water supply system, for example, will
not be economically feasible, except in the very long-term. For
the smallest village communities, the appropriate technical/economic
solution for water supply, in the short-term, may be limited to
local manual abstraction at or near the source—for example
a protected well or borehole with a hand-pump. In larger communities
it may be appropriate to pump the water from source to an intermediate
storage tank or reservoir, allowing the water to be distributed
to standpipe/tap house facilities and offering the scope to move
progressively from shared communal facilities to a networked solution
with individual household connections.
43. Whilst the costs of connecting peri-urban areas to
a national electricity grid can be within reach of many developing
countries' budgets, they become prohibitively expensive in rural
areas. Isolated networks with local generation capacity (diesel
or preferably renewable sources—solar or hydro power) are
likely to be the more appropriate solutions. Often, in very remote
areas, house specific (possibly solar) generating power capacity
may be the most efficient and effective way of providing energy
to the household.
(b) Empowering the customer
44. As with any service, however, it should not be for
national (and even for local) governments alone or for development
partners to take decisions about the trade-offs between service
standards, costs and charges—local communities, as consumers
of services, must be centrally involved in these decisions. This
point was emphasised at the recent commonwealth Local Government
Forum in South Africa. It is only through this invaluable "voice
of the customer" feedback, that services can be adequately
structured. Indeed, unlike most public sector providers, the private
sector typically needs to be responsive to customer requirements
if it is to prosper, or in many cases, survive.
45. Recent efforts to adopt a "tripartite"
approach to project design, development and management involving
civil society (notably national NGOs), government and business
have shown promise as a means of establishing better co-operation
between groups that are not always comfortable with each other's
objectives and motives. A starting point is to be clear about
the objectives, roles and responsibilities of all stakeholders.
Although slower to get started, such decentralised and demand
led approaches are much more likely to be sustainable. With more
affordable solutions and community buy-in there will also be a
greater willingness of beneficiaries to pay user charges and/or
additional local taxes. The challenge remains to develop institutions
and processes that provide for informed local involvement in decision
making while retaining a disciplined commercial environment conducive
to mobilising the required finance.
(c) New forms of partnership
46. As discussed, full concession and divestiture business
models have in many cases proven to be inappropriate (examples
include water concessions in the Philippines, Bolivia, Argentina
etc). This approach has proven to be unacceptable to national
stakeholders and to private sector water companies (given their
limited appetite for non-controllable risk). Having said this,
the commercial discipline needed for operational cost-efficiency,
raising of finance on international and potentially domestic financial
markets, as well as a high degree of responsiveness to customer
needs, is most likely to be achieved through some form of a private
sector approach. Going back to publicly managed monopolies will
not, generally, be the appropriate solution. It is therefore time
to consider more innovative approaches, particularly in the more
problematic infrastructure sectors.
(d) A not-for profit distribution vehicle in the
water sector?
47. To address this point in sectors such as water, while
maximising the benefits of PSP, it is perhaps time to consider
new models which combine inclusive stakeholder involvement, while
retaining business-like management of the implementation of agreed
investment programmes by "sector professionals". While
sector expertise might initially come from abroad, there must
be a partnership with local managers wherever possible and with
the aim of building local expertise for the long term. Such a
model would be likely to retain a limited liability corporate
vehicle; however, it might operate on a not-for-profit-distribution
basis, with all profits being reinvested in continued network
expansion.
48. As the private sector operator may not always be
in a position to commit to a significant financial stake in such
an arrangement, it is imperative that an appropriate incentive
regime is established to encourage the commitment of human resources.
In other words, the provider needs to be contracted to deliver
specified outputs and rewarded for results, if as an equity investor
it is not able to take on the full range of business and country
risks. The "client" and contracting counterparty with
the service providers would be the licensed corporate vehicle
set up to develop and operate the infrastructure services within
a defined area. With output-based contracts the contractor finances
the implementation of the agreed investment programme and is paid
on agreed bases as and when it delivers the contracted outputs.
49. Involving the foreign private sector in this way
has several important advantages:
(i) the model is likely to secure much greater commitment
from foreign operators because it involves them taking controllable
cost and performance risks with appropriate rewards, but not the
regulatory and revenue risks which are, for them, non-controllable
risks;
(ii) in many countries it should be more acceptable to
governments and local communities than the concession model, because
surpluses are not paid out in profits, but rather reinvested in
the service and/or used to reduce user charges. This could unlock
opportunities for the benefit of users and private sector service
providers alike;
(iii) the use of the corporate structure is likely to
make it easier to reach agreement on charging arrangements that
will cover full cost of service (whatever level of service that
may be);
(iv) the transfer of controllable cost and performance
risks to the private sector service providers will help ensure
cost effective service delivery; and
(v) it will assist in the mobilisation of long-term debt
to finance the investments as an appropriately incentivised private
sector operator will be more credible with private banks.
(e) Involvement of the local private sector
50. Involving the national private sector, sometimes
as partners with the foreign private sector, is also very important.
This is probably the best way that a strong national capability
in delivery of basic infrastructure services can be built up over
time. This will also reduce the tendency for entrenchment into
"Us" and "Them" positions often seen in concession
models operated by the large international private sector companies.
51. National and foreign non-governmental organisations
(NGOs) also have an important role to play working with local
communities to strengthen their capacity to engage effectively
in the process of decision making about what to do, as partners
often with good local knowledge and contributing to the delivery
of basic services for the poor.
V. PAYING FOR
INFRASTRUCTURE SERVICES
52. We now return to one of the major impediments discussed
above—payment for infrastructure services. As set out, the
fact that services must be paid for—and not by the private
sector—must be accepted. Investment in infrastructure services
requires heavy front-ended expenditure on capital assets that
deliver a flow of benefits to users over many decades. The front-end
expenditures must be financed—by public or private sector
borrowing and/or equity finance. Over the life of the project,
revenues generated must be sufficient to recoup the full cost
of providing the services including the cost of capital (interest
on debt and/or return on equity). Those revenues can be derived
from just four possible sources:
— user charges levied on the beneficiaries of the
services once they are available;
— increased user charges levied on existing connected
customers;
— new national or local taxes; and
— donor grants and subsidies.
53. Ideally, the user charges would be set to "full-cost
recovery" levels, which would mean that the expected revenues
generated over the life of the asset would be sufficient to recover
the capital and operating costs (including the costs of capital).
However, the problem arises when large segments of the population
are not able to afford the "full-cost recovery" levels,
as is the case in many developing countries.
(a) Subsidies
54. In cases where the affordable level of service by
households is deemed to be below a socially and politically acceptable
level, carefully targeted subsidies will be needed to supplement
the shortfall.
55. Traditionally multilateral and bilateral international
financial institutions (IFIs) have supported infrastructure services
development by making commercial and/or concessional loans to
parastatal utilities. This approach is widely recognised as having
provided very weak incentives on borrowers/operators. The quality
of investment has often been poor, cost over-runs considerable
and there have been very limited benefits for the poor in most
developing countries.
56. A new approach—output based aid—builds
on the concept of output-based contracting referred to earlier.
The development partner or IFI contracts—as part of a wider
financial plan—to make payments to the contractor as and
when it delivers a pre-agreed output specification (quantity and
quality). For example, a service provider to a medium-size town
may agree that, in addition to providing services from which the
future revenues can be expected to cover the costs, it will also
provide certain "non-commercial" services (ie services
that are not able to recoup the costs from its users) in peri-urban
areas. The IFI agrees to make future payments contingent on the
contractors' performance sufficient to meet the difference between
the expected costs and the revenues received from (subsidised)
users. The contractor is able to raise the required working capital
from its bankers to mobilise and implement the contract on the
basis that it will receive contract revenues from donors subject
only to delivery of the contracted outputs.
57. The advantages of OBA are similar to those of output-based
contracting:
— payments are linked to performance regimes which
maintain strong incentives to deliver defined outputs at least
cost (because cost and performance risks remain with the contractor);
— payments are targeted on pro-poor outcomes (contributing
to affordability for target groups) and only made when outputs
are delivered;
— costs are minimised when payment schedules are
set by competition; and
— the schemes can be designed in a way that customers
have a significant say in their design.
58. Output-based aid programmes will require a different
approach by development partners to supporting pro-poor basic
infrastructure services. Commitments are made to a non-sovereign,
non-public sector borrower (the regulated corporate vehicle) and
to a (private sector) service provider to make future payments
contingent on contractor performance. The commitments will typically
involve disbursing funds many years in the future. This is an
unfamiliar approach (particularly for bilateral donors). To date
most OBA schemes have been used principally for rural electrification
schemes in middle income developing countries, but more and more
examples, in different sectors, are being tested. [47]
59. Considering that funding from development partners
and the IFIs is finite, it is still of paramount importance when
designing the infrastructure solutions that the service standards
are appropriate to the customers' affordability levels and costs
of service. Customer involvement in these trade-offs will be crucial.
In addition, governments will need to pursue more vigorously the
removal of subsidies from better-off customers, redirecting them
to supplement any OBA donor funding.
VI. MOBILISING LONG-TERM
FINANCE
60. As mentioned earlier, large amounts of long-term
finance are required to finance the basic infrastructure investment
programmes—at least for major "production" or
"trunk" projects which have lumpy, up-front financing
requirements. This provides major challenges for both debt and
equity finance.
(a) Debt
61. Long-term debt, either from credit or capital (bond)
markets, is usually desirable for infrastructure projects as it
is cheaper than equity and acts so as to keep the cost of capital
(and therefore user charges) as low as possible (unlike dividends,
interest is also normally tax deductible). The debt will be secured
on the future revenues to be derived from user charges, from additional
taxes (if any) agreed with local or national government and from
payments by the development partners (eg under output-based aid
contracts).
62. There are, of course, limits to the amount of debt
that can be raised for a project—the more risky the project,
the greater the proportion of equity required so as to be able
to service the debt. The greater the project risk is reduced,
through, for instance, appropriate risk allocation, the more debt
can be raised within a given financing structure.
(b) Local currency debt
63. In an ideal world much of this debt would be raised
from the domestic financial market and in the local currency.
Such a scenario would improve domestic saving and investment opportunities,
strengthen the domestic financial markets and eliminate the foreign
currency exposures faced by so many of the private sector operators
in developing countries. Indeed, recent research quoted in an
Economist magazine survey, shows empirically that a mix
of foreign equity and local debt is optimal for economic development.
64. In most cases, however, this is not possible. A major
problem in many developing countries is that the savings rate
is not high enough to generate a sufficiently large pool of funding,
a fact compounded by the lack of development of local credit and
capital markets, which have extremely limited, if any, long term
liquidity required for major infrastructure financing. Funding
of smaller scale infrastructure services is, however, much more
possible.
65. Recognising these problems and the considerable benefits
that can arise at both the project (better matching of revenue
and cost flows) and macroeconomic level (reduced strain on scarce
foreign exchange resources) many donors have been seeking to develop
support mechanisms for local currency funding. In particular,
the Swedish and UK governments have taken a lead in developing
GuarantCo which will help infrastructure companies tap into local
institutional markets through appropriately structured credit
enhancements (see below). Such approaches remain, however, very
much in their infancy.
(c) International debt and the need for credit enhancement
66. The availability of such local finance will, however,
be constrained by a number of factors including the overall pool
of national savings as well as the low inflation environment required
to keep local interest rates competitive. A considerable amount
of finance for infrastructure will therefore inevitably be foreign
currency debt, raised from multi-lateral and bilateral institutions
and from the international debt markets. The quantum of finance
required to meet the MDGs/Johannesburg targets, for example, far
exceeds what is likely currently to be available from official
lenders or domestic capital markets, so recourse to the international
private sector debt market will be necessary. However, perceptions
of country risk, in particular, prevent many developing countries
from accessing (the relatively plentiful) long term debt to finance
infrastructure investments. Even where opportunities offer a clear
prospect of generating future revenues sufficient to repay the
debt, finance will not flow in the absence of official financial
interventions or so-called credit enhancements. This problem is
set to be aggravated following the latest Basel round, in which
country risk exposures are more likely to be heavily penalised
than they are at the moment, further discouraging lending.
67. Credit enhancement is a mechanism for selectively
transferring specified risks from borrowers to the provider of
credit enhancement (for a fee). It increases the availability,
and reduces the cost, of debt to the borrower. If credit enhancement
fees are modest then the all-in cost of debt is reduced—allowing
a reduction in average charges on users over the project life.
68. Box 2 sets out a range of credit enhancement instruments
that have been used by private sector project sponsors to mitigate
project risks to facilitate financing at a reasonable cost.
BOX 2: FORMS
OF CREDIT
ENHANCEMENT
| Risks covered | % of exposure guaranteed
| Nature of credit enhancement |
| All risks | 100% | "Full faith" guarantee
|
| All risks | <100% | Partial credit guarantee
|
| Political risk only | Up to 100%
| Political risk guarantee |
| Specific risks (government breach of contract, regulatory risk)
| Up to 100% | Partial risk guarantee
|
| Demand-side risk only | Up to 100%
| Minimum revenue (take or pay)
undertaking
|
| Supply-side completion risks | Up to 100%
| Completion guarantee |
| Performance risks | Up to 100%
| Minimum performance
undertaking |
69. Why should the IFIs provide credit enhancement? Why
not, instead just increase lending? In the short term there are
many IFIs with available capital to support basic infrastructure
investment programmes when they are structured as viable business
opportunities generating sufficient revenue to repay the debt.
In the short-term therefore the constraint is not lack of funds—at
least IFI funding—it is lack of opportunities. [48]But,
in the medium-term, if the financial flows required to meet the
MDGs/Johannesburg targets are to be mobilised, new sources of
capital from the private sector financial markets will be needed.
70. Why credit enhancement rather than more loans? They
are four key reasons. First, to maximise leverage—by this
we mean the ability to mobilise more than $1 of debt finance by
"using" $1 of IFI funds. Provision of partial risk guarantees
offers the prospect over time of diversifying the risk portfolio,
thereby enabling IFIs to mobilise from the debt markets amounts
of credit that are a multiple of the value of the IFI support.
Second, partial risk credit enhancement is cost-effective because
it leaves controllable risks with the party best able to control
and manage them (eg supply-side commercial risk with service providers).
Third, leaving commercial risk exposure with commercial risk with
service providers). Third, leaving commercial risk exposure with
commercial lenders provides a strong incentive for them to re-assure
themselves that the commercial opportunity is well structured
and economically viable. Finally, providing partial credit guarantees
to domestic lenders and bond investors supports the longer-term
objective of developing deep, domestic financial markets.
(d) Equity
71. Whilst keenly priced debt is highly attractive, it
is, however, extremely difficult to remove the need for some form
of equity cushion all together. In reality, at least with the
array of risk mitigation devices currently available, it is difficult
to fully cover off all risks—especially in developing markets.
Ultimately, the customer will need to pick up the tab for unfavourable
market developments, but lenders will normally look for some equity
protection, especially where there is considerable market risk.
Whilst the not for profit distribution corporate model has been
applied in the UK within the water sector, this benefits from
a relatively stable regulatory environment, with the market being
largely mature and the consequent risks being possible to mitigate
through retained profits acting as quasi-equity. The developing
world will be different. Most importantly, whilst equity was not
seen as a major constraint during the late 1990s, the reality
on the ground is that such risk capital is fairly scarce.
72. As equity inevitably bears all risks, many development
partners have normally shied away from providing it, sticking
instead to the provision of political risk mitigation. In today's
market, however, development partners and/or governments are often
the only group in a position to take, or at least substantially
shoulder, certain risks. The objective of any such financial intervention—for
instance—through development partners taking a share of
the equity or first loss risk and the private sector taking a
mix of first loss (equity) and second loss (eg mezzanine) risks,
would be to leverage private capital. This should not be undertaken
in a way that the providers of such capital take all of the downside
but none of the upside, but rather in a genuine risk sharing manner,
ideally with the discipline of the private sector "bidding"
to take risk at the least cost. Such approaches to financial structuring—which
need to be combined with appropriately structured performance
contracting—should be more actively considered now than
they have been hitherto if the current shortage of risk capital
is to be addressed.
VII. CAPACITY
73. There is a temptation to lose sight of the practical
implications when new approaches to transactions are considered.
The need for wider and more intelligent stakeholder participation
in designing infrastructure projects, the need for better allocation
of the various risks to those who can most efficiently bear them
and the complexity and long term nature of contract management,
all have significant implications for the capacity of the public
and private sectors to transact and manage infrastructure projects.
This is especially relevant in the poorer nations where good management
is often the scarcest commodity of all. While facilities such
as the World Bank's PPIAF exist to improve policy formulation,
these facilities must urgently be complemented by tools to ensure
that governments and local business have the capacity to transact
and subsequently manage the structures. At the same time, and
equally vital, there must be an overarching sense of pragmatism
to ensure that any new structures are not so complex that they
cannot stand the test of practical and cost effective implementation.
October 2003
39
Harris, 2003 The beginning of the End or the End of the Beginning?
A Review of Private Participation in Infrastructure in Developing
Countries, The World Bank. Back
40
The Global Partnership for Output Based Aid (GPOBA) has recently
been established by the World Bank and the UK Department for International
Development. Back
41
Global Water and Sanitation Assessment 2000 Report-WHO/UNICEF
Joint Monitoring Programme. Back
42
UN Millennium Declaration-September 2000. Back
43
DfID "Addressing the Water Crisis" March 2001. Back
44
Harris, 2003 The Beginning of the End or the End of the Beginning?
A review of Private Participation in Infrastructure in Developing
Countries, The World Bank.
Back
45
"Making connections"-a DfID consultation document 2002. Back
46 Back
47
See, for example, Brook, PJ and Smith, SM (Eds) 2001, Contracting
for Public Services. Output-based aid and its applications,
World Bank. Back
48
As shown in market analysis carried out by the Emerging Africa
Infrastructure Fund. Back
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