the role of the public and private sector in transport...

1 February 2005Infrastructure Economics & Finance

The Role of the Public and Private Sector in The Role of the Public and Private Sector in Transport Infrastructure Transport Infrastructure

Infrastructure Finance and the Challenges of Infrastructure Finance and the Challenges of Improving Transport Infrastructure and Improving Transport Infrastructure and ServicesServices

Transport Forum 2005Transport Forum 2005Washington DC, March 7Washington DC, March 7thth, 2005, 2005


ContentsContentsWorld Bank Group Lending to the Transport SectorRole of the Public and Private Sector

The economics of Transport InfrastructureThe Real Gap : Cost Recovery and Affordability

Public Private Partnerships (PPPs)Leveraging Public MoneyThe Value for Money ConceptBasicsRisk Assessment and Risk AllocationLeveraging Public Money : Traffic Minimum Revenue Guarantees

Development of Local Capital MarketsChile (transport infrastructure bonds)

Using Output Based Aid MechanismsRoad Maintenance and Rehabilitation

Engaging with the Public Sector in Transport InfrastructureUpcoming Trends and Way Forward


World Bank Group Lending in TransportWorld Bank Group Lending in Transport

World Bank Transport Infrastructure Commitment ($ bn)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Years

Bill

ions

Committed Loan Amount

East Asia

Rusia

Brazil

Argentina


The Role of the Private and Public SectorThe Role of the Private and Public Sector

The Economics of Transport InfrastructureThe Economics of Transport InfrastructureInfrastructure investments are inherently lumpy (involve huge sunk costsand create assets that are long-lived and location-specific).Creation of Infrastructure has economics both of scale and scope (i.e., minimum size of facilities, inelastic adjustment of capacity to demand, long term project completion, etc.).Transport supply systems contain elements of natural monopoly (competition).Demand is wide spread (difficult to target).Revenues are usually in local currency (mismatch if foreign debt financing).Services have an essentiality component that raise legitimate public policy concerns of affordability.

However ..Sound transport infrastructure allows countries to integrate to the global economy and increases competitiveness (together with telecom these sectors are the highest contributors to a countrys competitiveness)Transport services is one of the sectors with greatest impact on poverty alleviation and MDGs.


MDGs: Impact of Transport InfrastructureMDGs: Impact of Transport Infrastructure

Transport: village to town center and Transport: village to town center and transport trunk beyond.transport trunk beyond.

Agriculture. Access to inputs (seeds, fertilizers, technology) improvements in productivity. Access to national and international markets (value added). Decrease in transaction costs. (Poverty)Health. Access to professional health services & drugs, better water services. Evacuation in case of emergencies (infant mortality)Education. Increase school enrollment (girls). Increase quality of teachers and educational systems (primary education, gender)

Transport and The Transport and The Millenium Millenium Development Goals (Africa Union, Development Goals (Africa Union, UN, AFD, IBRD and EU, February UN, AFD, IBRD and EU, February

2005)2005)Rural transport access indicators for selected group of SSA (IDA) countries has an average of only 37% compare with 94% for a group of IBRD countries(Chad was 5% and Mali was 51%)



There is limited affordability in the provision of most of the transport services (when including the costs of the required infrastructure facilities), specially when considering low income end-users. Affordability is determine by household incomelevels and the cost of delivering the transport service.Transport services has strong characteristics as a public good and creates major positive externalities. Full cost recovery is only possible in some situations (i.e., air transport). Most of the public mass transportation system have strong limitations to reach full cost recovery even in developed markets.There is a role for the provision of smartsubsidies to make possible the delivery of the service. The financing gap is a function of the gap between cost recovery and affordability.

Tariffs

Time

Affordability

Cost recovery

The Service Delivery GapThe Service Delivery Gap The ServiceThe ServiceDelivery GapDelivery Gap

OBA Approaches

OBA OBA ApproachesApproaches



The RolesThe RolesShift from ideology to pragmatism (our country clients are different MIC versus IDA, etc.)Public Sector driven by the optimization of public welfare (efficient provision of transport related services to the general public quality standards at lowest cost of provision)Private Sector driven by financial incentives

Public Sector Role in the design, development and enforcement of transport sector policies. In particular in the definition of cost recovery and affordability issues in the context of financial sustainability of the sector. Role in the establishment of smart regulation (I.e., rules of the game that creates level playing field for efficient provision of public services)Role in the provision of transport services where externalities and sector constraints do not provide adequate incentives for private sector engagement.

Private SectorCapital Financing (i.e., equity and debt)Construction and Operations of Transport FacilitiesOperations of Transport Services (efficiency)



Criteria for deciding between pure public sector infrastructure investment and some forms of investments involving private sector participation (PPPs):(test how different options affect sector performance)

Transport Infrastructure (facilities)Transport Infrastructure (facilities) Provision of Transport ServicesProvision of Transport Services

Access to the Service Quality of the Service Affordability of the Service (vs. willingness to pay use of targeted subsidies)Nature of the service (i.e., competition vs. monopoly)Financial Sustainability (i.e., tendency towards cost recovery)

An additional important consideration .Fiscal Space. Infrastructure investment needs (catch up with pending investments upgrade and rehabilitation plus new investments to keep up economic growth) are likely to exceed available public sector resources (publicmoney)


Private Public Partnerships : Leveraging Private Public Partnerships : Leveraging Public MoneyPublic Money

Need to reconcile transport infrastructure development needs with criteria for fiscal prudence (i.e., public sector resources available for infrastructure investments will be limited financing gap).Need to mobilize additional private capital to match the gap if infrastructure development is to keep its pace sustaining economic growth.Need to maximize private capital mobilization per unit of public sector contribution (e.g., direct investment, subsidies, guarantees, etc.).Need to develop PPPs approaches as a procurement tool for better and efficient allocation of scarce public sector resources (the concept of value for money).Need to develop an adequate risk management framework to manage contingent liabilities arising for public money support to PPPs development.

PPP hold the promise of increasing the supply of infrastructure without overburdening a countrys public finances. An infusion of private capital and management can ease fiscal constraints and boost efficiency IMF, Finance & Develoment, December 2004


The Value for Money Concept (when to use The Value for Money Concept (when to use PPPs PPPs instead of pure public investments)instead of pure public investments)

PPP projects should be able to provide equivalent or better value for money than a 100 % public sector project approach

develop base case with which to assess incremental benefits of the PPP approach

Incremental Benefits may accrue from:speedier Implementation (fiscal constraints)total long-term costs (life costs) of the operationBetter service (cost & efficiency) and coverage

Adequate distribution of risks :

Too little: Too little: no Value no Value

For For MoneyMoney

Too much: Too much: project project failurefailure

Risk TransferRisk Transfer

Optimal: efficient Optimal: efficient sharing of riskssharing of risks

Public Sector Contribution

InvestmentGuaranteesSubsidies


Public Private Partnerships: Basics Public Private Partnerships: Basics

PPPs are contractual arrangements between the public sector and a private sector party for the private delivery of public infrastructure services or other basic services. PPPs are complex structures, involving different parties, long and demanding negotiations and relatively high transaction costs.

PPPs are a procurement toolprocurement tool where the focus is payment for delivery of services rendered (outputs outcomes). Transfer of the performance risk.

Project related risks (i.e., technical, performance, market and financial risks are transferred (to a great extent) to the private entity. Political, regulatory and macro-economic risks should be allocated to the party best suited to deal with them (government, international financial institution, private insurers).

Contract payments are usually structured in such a way that the public authority and / or users pay only for services rendered satisfactorily and not for assets, which are inputs to service provision. Revenues are generated via: (i) user fees, (ii) government payments (subsidies) and (iii) multilateral / donor grant funding and or (iv) a combination of all of the above.


PPPsPPPs : Spectrum of Options: Spectrum of Options

Transport Infrastructure Transport Infrastructure (Facilities)(Facilities)

Provision of Transport Provision of Transport ServicesServices


PPPsPPPs in Transport Infrastructure Financing : in Transport Infrastructure Financing : Risk AssessmentRisk Assessment

Project Related Risks Project Related Risks (relatively manageable by sponsors (relatively manageable by sponsors

and lenders)and lenders)

Completion Risk (engineering & construction cost / time cost control)Operational Performance Risk (technical & operational know-how)Market RiskMarket Risk (Traffic)Financial Risk (Exchange Rate and Interest Rate Fluctuations)Environmental Risk (past and future liabilities, project delays, costs overruns)

NonNon--Project Related RisksProject Related Risks(non(non--manageable by sponsors and manageable by sponsors and

lenders)lenders)

Political Risk (expropriation, political violence, currency convertibility & transferconvertibility & transfer)Contractual RiskContractual Risk [Regulatory Risks]. (Governments default on contractual obligations, i.e., pricing formulas, right of way )pricing formulas, right of way )Macroeconomics Environment --Volatility RiskVolatility Risk (changes in macro balance in relatively short periods, i.e., exchange rateexchange rate, inflation, etc...)Legal Environment (rule of lawrule of law, i.e., judicial system, regulatory procedures and arbitration)

Best possible mitigation is toMatch local revenue generation

With local currency financing

Best possible mitigation is toMatch local revenue generation


key role in the availability and pricing of transportconcession finance (i.e.(economic regulation)

key role in the availability and pricing of transportconcession finance (i.e.(economic regulation)


Leveraging Public Money : Case of Toll RoadsLeveraging Public Money : Case of Toll Roads

Consider a case, in which the privately financed firms sells to end users, not the government or SOE, and, to simplify, consider three types of risk.Construction, operating, and maintenance cost risks: private sector normally has most influence over these costs, so government does not benefit from bearing them.Price risk: if government controls the toll, it probably benefits from bearing price risk (that is, from agreeing to compensate if it doesnt increase toll according to concession contract).Demand risk (given price): appropriate policy is less clear.

Neither firm nor government may have much influence.Decision needs to consider other aspects of managing risk: who can best forecast and anticipate demand to determine whether to build road? Who can best absorb the risk?


Demand risk in toll roadDemand risk in toll road

Whether government should bear demand risk in toll roads is therefore controversial

Chile, Colombia, Korea, and Spain, for example, have provided revenue guarantees (often in return for upside risk sharing).(Italy and Turkey gave revenue guarantees for privately financedrailways in the nineteenth century: PPPs are not new.)Australia, Canada, United States have not.

Target any guarantee to the real problem:Is total demand risk the issue or is it whether government will build a competing road or complete a planned complementary road or port?Is risk the problem, or is it just that government doesnt want to set tolls high enough to consider costs? If so, a subsidy may bebetter.


Valuing revenue guaranteesValuing revenue guarantees

Step 1. Develop model of traffic revenue that allows for random fluctuation (that is, risk) as well as trend rates of growth.Step 2. For the trend, take forecasts traffic-revenue growth developed for tendering the toll road.Step 3. Estimate the expected size of traffic revenue fluctuation (risk), from previous local or international experience.Step 4. Estimate consequent expected payments by government (seenext slides).Step 5. Discount those expected payments at the risk-free rate to get the value of the guarantee.(Possible addition to Step 4: adjust expected cash flows for an estimate of risk, using the capital-asset-pricing model).


0

50

100

150

200

250

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

ForecastrevenueGuaranteedrevenue

Forecast and guaranteed revenue on Forecast and guaranteed revenue on hypothetical toll roadhypothetical toll road

Estimated Initial Investment: $ 500 MM

$ MM


A possible good outcomeA possible good outcome

0

50

100

150

200

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

$million

ForecastrevenueActualrevenueGuaranteedrevenue


A possible bad outcomeA possible bad outcome

0

50

100

150

200

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

$million

PaymentForecastrevenueActualrevenueGuaranteedrevenue


0

1000

2000

3000

4000

5000

6000

7000

8000

9000

0 5 10 15 20 25 30 35 40 45 50 More

Paymentbins

Frequency

Valuation: Frequency distribution of government Valuation: Frequency distribution of government payments in 2016 (10,000 possible outcomes)payments in 2016 (10,000 possible outcomes)

Average payment in 2016 is $4.19 millionAssume risk free rate is 5%Approximate value of 2016 component of guarantee is

4.19/(1.05)11 = $2.45 millionRepeat for all years. (illustration purposes = $75.0 million)

This calculation will allow providing a value to theFiscal impact of this option. This is a necessary first stepIn the decision-making process for public sector optionsFor infrastructure development.


Transport Infrastructure: Developing Local Transport Infrastructure: Developing Local Capital MarketsCapital Markets

There is no best substitute for foreign exchange risk mitigation than matching the currency revenue generation with the currency of debt payment services (matching assets and liabilities).Financing transport facilities and services (local currency based) in the foreign debt markets adds substantial risk to the structuring of adequate PPPs creating the need for additional public money support. Local institutional investors (I.e., pension funds, insurance companies, life annuities, etc.) have a natural demand for long-term local currency debt instruments to match their liabilities. In most cases, local capital markets initiate their development via the creation of a sovereign bond market (long-term yield curve). After the establishment of such market, investors develop a need to diversify the risk profile of their investments and the return mix, providing the incentives for the development of a private bond market, creating the opportunity for the introduction of infrastructure or utilities bonds (long-term annuities).It is in the governments best interest to stimulate, via adequate securities regulation and institutional investors overseeing, the development of local capital markets as a source of long-term local currency funding for needed PPPsinfrastructure projects.


Developing Local Capital Markets : ChileDeveloping Local Capital Markets : ChileSource: IMF, Fiscal Affairs Dept.,January 2005

By the early 1990s, a sizable infrastructure gap had emerged in Chile, and significant investment was needed to prevent transportation and other bottlenecks from becoming a major obstacle to future growthA challenge for the government was to close this gap while maintaining fiscal discipline that had placed public debt on a rapidly declining path. The solution lay in promoting private sector involvement in the provision of public infrastructure through public-private partnerships (PPPs). Chile thus embarked on an ambitious concessions program in 1994, centered around a number of projects to develop the highway network.The concessions program in Chile covers 44 contracted projects with a total value of US$5.7 billion (about 6 percent of 2004 GDP). These include: 8 projects to rehabilitate and upgrade the Route 5 highway which runs the length of Chile, with financing from tolls (US$2 billion); 11 other highway projects for connecting roads to Route 5 (US$1.3 billion); 10 airport projects (US$240 million); 6 urban road projects (US$1.8 billion); and 9 other projects (including prisons, public buildings, a reservoir, for US$360 million). Approximately 75% was funded in the local capital markets via local currency infrastructure bonds.The government provides guarantees to concession operators. A minimum

revenue guarantee is provided for highway and airport concessions, under which concession firms are compensated when traffic or traffic revenue falls below an annual threshold. In return for the minimum revenue guarantee, the concession firm enters into a revenue sharing agreement in which it shares a percentage of revenue with the government once a threshold is exceeded.


Road rehabilitation and maintenance traditionally done through input-based payments to private contractors.Increasingly, output-based approaches, for example the Performance-based Maintenance and Management in Roads (PMMR), being introduced in Europe, Asia and Africa, and similar KREMA contracts, functional for several years in Latin America (Argentina, Brazil, Uruguay).Expand private sectors role from simple execution of works to include maintenance, rehabilitation and management of road assets.Operator paid after outputs delivered and quality standards met (per KM or similar).Multi-year and consumer-driven out-look, shifting performance risk to operator, and allowing for innovation and efficiency.

Using Performance Based Subsidies (Using Performance Based Subsidies (OBAsOBAs) in ) in Transport Transport PPPs PPPs : Road Asset Management: Road Asset Management

Output-based aid (OBA) is a strategy for supporting the delivery of infrastructure services that depends at least in part on public funding where payment is linked to service delivery.. At the core of the OBA approach is contracting out service provision to a third party usually the private sector with payment tied to the actual delivery of services.



Transport : Engaging with the Public SectorTransport : Engaging with the Public Sector

The World Bank strongly encourages transport infrastructure solutions that involve the private sector (i.e., economic development, incentives and efficiencies, fiscal space. Etc.).However . It recognizes the difficulties and challenges of establishing adequate policy and regulatory environment supporting private sector solutions (plus private sector risk aversion to some situations) while having at the same time to satisfy immediate infrastructure needs in order to restore economic growth and improve living standards (avoid the poverty trap). World Bank intervention supporting public entities, particularly in the rehabilitation and development of needed infrastructure (facilities) is in many cases necessary and if carefully targeted and supported by adequate policies could have a positive impact in attracting further private sector involvement. Intervention could have better results if provided to public entities run on a commercial basis (corporatized), and moving towards cost recovery management systems, even if there is still a need for transparent government subsidies.


Transport : Engaging with the Public SectorTransport : Engaging with the Public Sector

Preference to engage (provide financing support) directly with the project entity responsible for managing the facility [infrastructure] or providing the service (passenger or cargo).

Better accountability (governance) and easier measure and monitor of performance Improves chances of corporatizing the transport public utilityReduces risk of lack of focus in the implementation of Bank intervention

Need to use a transparent mechanism for dealing with the gap between cost recovery and affordability (output or performance based subsidies). Need to developed schemes for the long-term financial sustainability of the entity (long-term planning of the use and transition of subsidies).

Initiates path for self-financial sustainability and independent access to financial markets (public transport entity).


Transport : Spectrum of Bank interventions Transport : Spectrum of Bank interventions across Subsacross Subs--sectorssectors

Pure PublicPure Public Pure PrivatePure Private

AccessAccess

QualityQuality

AffordabilityAffordability

CompetitionCompetition

SustainabilitySustainability

Air Navigation (ATC)

Sea Navigation

Airlines

Shipping

Urban Transport Services (bus, taxis, etc.)

Port Services

Airport Services

Airport Terminal

Port Terminal

Freight and Passenger Railways Services

Integrated Railways Network

Toll Roads (motorways, bridges, highways)

Dedicated MasssTransit System

Road Network and Rural Roads.

Subways (metro)

WBG Support : Policy Dialogue / Technical Assistance / IBRD, IDA, IFC Investment Loans and Guarantees/ MIGA Guarantees


Transport Infrastructure : Upcoming trendsTransport Infrastructure : Upcoming trends

Increasing importance of the provision of transport services and regional linkages and interconnectivity as key contributor to economic growth and MDGs and as a key driver of countrys competitiveness. Broader use of PPP schemes as a way to maximize public money leveraging for infrastructure development.Increasing use of output based subsidies as a way to utilize better private sector resources via effective allocation of performance risks (PPPs to deliver services to poorer communities). Development of local capital markets (local currency debt instruments) as a mechanism for improving effective access to infrastructure financing by transport PPPs. MLAs and Donors direct engagement with sub-national entities (well run public utilities) without sovereign support in the transport sector.

Thanks Thanks

World Bank GroupInfrastructure Economics and Finance

March 7th , 2005

Contents World Bank Group Lending in TransportThe Role of the Private and Public SectorMDGs: Impact of Transport InfrastructureThe Role of the Private and Public SectorThe Role of the Private and Public SectorThe Role of the Private and Public SectorPrivate Public Partnerships : Leveraging Public MoneyThe Value for Money Concept (when to use PPPs instead of pure public investments)Public Private Partnerships: Basics PPPs : Spectrum of OptionsPPPs in Transport Infrastructure Financing : Risk AssessmentLeveraging Public Money : Case of Toll RoadsDemand risk in toll roadValuing revenue guaranteesForecast and guaranteed revenue on hypothetical toll roadA possible good outcomeA possible bad outcomeValuation: Frequency distribution of government payments in 2016 (10,000 possible outcomes)Transport Infrastructure: Developing Local Capital MarketsDeveloping Local Capital Markets : ChileSource: IMF, Fiscal Affairs Dept.,January 2005Using Performance Based Subsidies (OBAs) in Transport PPPs : Road Asset ManagementTransport : Engaging with the Public SectorTransport : Engaging with the Public SectorTransport : Spectrum of Bank interventions across Subs-sectorsTransport Infrastructure : Upcoming trendsThanks

February 2005

Infrastructure Economics & Finance

The Role of the Public and Private Sector in Transport Infrastructure

Infrastructure Finance and the Challenges of Improving Transport Infrastructure and Services

Transport Forum 2005

Washington DC, March 7th, 2005

February 2005


Contents

World Bank Group Lending to the Transport Sector

Role of the Public and Private Sector

The economics of Transport Infrastructure

The Real Gap : Cost Recovery and Affordability

Public Private Partnerships (PPPs)

Leveraging Public Money

The Value for Money Concept

Basics

Risk Assessment and Risk Allocation

Leveraging Public Money : Traffic Minimum Revenue Guarantees

Development of Local Capital Markets

Chile (transport infrastructure bonds)

Using Output Based Aid Mechanisms

Road Maintenance and Rehabilitation

Engaging with the Public Sector in Transport Infrastructure

Upcoming Trends and Way Forward

February 2005


World Bank Group Lending in Transport

East Asia

Rusia

Brazil

Argentina

Chart1

excel

Region(s):ALLCountry(s):ALL

Borrower(s):ALLLoan(s):ALL

Sector: Transport

FinancierInclude IFC:LendingYearAggregationPeriod

IBRD,IDA CreditsYESPROJECT, ADJUSTMENTCALENDARANNUALLYJAN-1991 to JAN-2005

IDA Grants

YEARLOAN COUNTCOMMITTED AMT

1991221.1507

1992423.0114

1993463.1067

1994403.1346

1995392.3464

1996424.0137

1997272.3772

1998293.5650

1999262.1298

2000292.4553

2001262.7122

2002233.1735

2003272.4518

2004324.1616

Grand Total :45039.7899

excel

0

0

0

0

0

0

0

0

0

0

0

0

0

0


Years

Billions


Chart1

1.1507

3.0114

3.1067

3.1346

2.3464

4.0137

2.3772

3.565

2.1298

2.4553

2.7122

3.1735

2.4518

4.1616


Years

Billions


excel

Region(s):ALLCountry(s):ALL

Borrower(s):ALLLoan(s):ALL

Sector: Transport

FinancierInclude IFC:LendingYearAggregationPeriod

IBRD,IDA CreditsYESPROJECT, ADJUSTMENTCALENDARANNUALLYJAN-1991 to JAN-2005

IDA Grants

YEARLOAN COUNTCOMMITTED AMT

1991221.1507

1992423.0114

1993463.1067

1994403.1346

1995392.3464

1996424.0137

1997272.3772

1998293.5650

1999262.1298

2000292.4553

2001262.7122

2002233.1735

2003272.4518

2004324.1616

Grand Total :45039.7899

excel


Years

Billions


February 2005


The Role of the Private and Public Sector

The Economics of Transport Infrastructure

Infrastructure investments are inherently lumpy (involve huge sunk costs and create assets that are long-lived and location-specific).

Creation of Infrastructure has economics both of scale and scope (i.e., minimum size of facilities, inelastic adjustment of capacity to demand, long term project completion, etc.).

Transport supply systems contain elements of natural monopoly (competition).

Demand is wide spread (difficult to target).

Revenues are usually in local currency (mismatch if foreign debt financing).

Services have an essentiality component that raise legitimate public policy concerns of affordability.

However ..

Sound transport infrastructure allows countries to integrate to the global economy and increases competitiveness (together with telecom these sectors are the highest contributors to a countrys competitiveness)

Transport services is one of the sectors with greatest impact on poverty alleviation and MDGs.

February 2005


MDGs: Impact of Transport Infrastructure

Transport: village to town center and transport trunk beyond.

Agriculture. Access to inputs (seeds, fertilizers, technology) improvements in productivity. Access to national and international markets (value added). Decrease in transaction costs. (Poverty)

Health. Access to professional health services & drugs, better water services. Evacuation in case of emergencies (infant mortality)

Education. Increase school enrollment (girls). Increase quality of teachers and educational systems (primary education, gender)

Transport and The Millenium Development Goals (Africa Union, UN, AFD, IBRD and EU, February 2005)

Rural transport access indicators for selected group of SSA (IDA) countries has an average of only 37% compare with 94% for a group of IBRD countries

(Chad was 5% and Mali was 51%)

February 2005



There is limited affordability in the provision of most of the transport services (when including the costs of the required infrastructure facilities), specially when considering low income end-users.

Affordability is determine by household income levels and the cost of delivering the transport service.

Transport services has strong characteristics as a public good and creates major positive externalities.

Full cost recovery is only possible in some situations (i.e., air transport). Most of the public mass transportation system have strong limitations to reach full cost recovery even in developed markets.

There is a role for the provision of smart subsidies to make possible the delivery of the service.

The financing gap is a function of the gap between cost recovery and affordability.

Tariffs

Time

Affordability

Cost recovery

The Service Delivery Gap

The Service

Delivery Gap

OBA Approaches

February 2005



The Roles

Shift from ideology to pragmatism (our country clients are different MIC versus IDA, etc.)

Public Sector driven by the optimization of public welfare (efficient provision of transport related services to the general public quality standards at lowest cost of provision)

Private Sector driven by financial incentives

Public Sector

Role in the design, development and enforcement of transport sector policies. In particular in the definition of cost recovery and affordability issues in the context of financial sustainability of the sector.

Role in the establishment of smart regulation (I.e., rules of the game that creates level playing field for efficient provision of public services)

Role in the provision of transport services where externalities and sector constraints do not provide adequate incentives for private sector engagement.

Private Sector

Capital Financing (i.e., equity and debt)

Construction and Operations of Transport Facilities

Operations of Transport Services (efficiency)

February 2005



Criteria for deciding between pure public sector infrastructure investment and some forms of investments involving private sector participation (PPPs):

(test how different options affect sector performance)

Transport Infrastructure (facilities) Provision of Transport Services

Access to the Service

Quality of the Service

Affordability of the Service (vs. willingness to pay use of targeted subsidies)

Nature of the service (i.e., competition vs. monopoly)

Financial Sustainability (i.e., tendency towards cost recovery)

An additional important consideration .

Fiscal Space. Infrastructure investment needs (catch up with pending investments upgrade and rehabilitation plus new investments to keep up economic growth) are likely to exceed available public sector resources (public money)

February 2005


Private Public Partnerships : Leveraging Public Money

Need to reconcile transport infrastructure development needs with criteria for fiscal prudence (i.e., public sector resources available for infrastructure investments will be limited financing gap).

Need to mobilize additional private capital to match the gap if infrastructure development is to keep its pace sustaining economic growth.

Need to maximize private capital mobilization per unit of public sector contribution (e.g., direct investment, subsidies, guarantees, etc.).

Need to develop PPPs approaches as a procurement tool for better and efficient allocation of scarce public sector resources (the concept of value for money).

Need to develop an adequate risk management framework to manage contingent liabilities arising for public money support to PPPs development.

PPP hold the promise of increasing the supply of infrastructure without overburdening a countrys public finances. An infusion of private capital and management can ease fiscal constraints and boost efficiency IMF, Finance & Develoment, December 2004

February 2005


The Value for Money Concept (when to use PPPs instead of pure public investments)

PPP projects should be able to provide equivalent or better value for money than a 100 % public sector project approach

develop base case with which to assess incremental benefits of the PPP approach

Incremental Benefits may accrue from:

speedier Implementation (fiscal constraints)

total long-term costs (life costs) of the operation

Better service (cost & efficiency) and coverage

Adequate distribution of risks :

Too little: no Value For Money

Too much: project failure

Risk Transfer

Optimal: efficient sharing of risks

Public Sector Contribution

Investment

Guarantees

Subsidies

February 2005


Public Private Partnerships: Basics

PPPs are contractual arrangements between the public sector and a private sector party for the private delivery of public infrastructure services or other basic services. PPPs are complex structures, involving different parties, long and demanding negotiations and relatively high transaction costs.

PPPs are a procurement tool where the focus is payment for delivery of services rendered (outputs outcomes). Transfer of the performance risk.

Project related risks (i.e., technical, performance, market and financial risks are transferred (to a great extent) to the private entity. Political, regulatory and macro-economic risks should be allocated to the party best suited to deal with them (government, international financial institution, private insurers).

Contract payments are usually structured in such a way that the public authority and / or users pay only for services rendered satisfactorily and not for assets, which are inputs to service provision. Revenues are generated via: (i) user fees, (ii) government payments (subsidies) and (iii) multilateral / donor grant funding and or (iv) a combination of all of the above.

February 2005


PPPs : Spectrum of Options

Transport Infrastructure (Facilities)

Provision of Transport Services

February 2005


PPPs in Transport Infrastructure Financing : Risk Assessment

Project Related Risks

(relatively manageable by sponsors and lenders)

Completion Risk (engineering & construction cost / time cost control)

Operational Performance Risk (technical & operational know-how)

Market Risk (Traffic)

Financial Risk (Exchange Rate and Interest Rate Fluctuations)

Environmental Risk (past and future liabilities, project delays, costs overruns)

Non-Project Related Risks

(non-manageable by sponsors and lenders)

Political Risk (expropriation, political violence, currency convertibility & transfer)

Contractual Risk [Regulatory Risks]. (Governments default on contractual obligations, i.e., pricing formulas, right of way )

Macroeconomics Environment -- Volatility Risk (changes in macro balance in relatively short periods, i.e., exchange rate, inflation, etc...)

Legal Environment (rule of law, i.e., judicial system, regulatory procedures and arbitration)

Best possible mitigation is to

Match local revenue generation


key role in the availability

and pricing of transport

concession finance (i.e.

(economic regulation)

February 2005


Leveraging Public Money : Case of Toll Roads

Consider a case, in which the privately financed firms sells to end users, not the government or SOE, and, to simplify, consider three types of risk.

Construction, operating, and maintenance cost risks: private sector normally has most influence over these costs, so government does not benefit from bearing them.

Price risk: if government controls the toll, it probably benefits from bearing price risk (that is, from agreeing to compensate if it doesnt increase toll according to concession contract).

Demand risk (given price): appropriate policy is less clear.

Neither firm nor government may have much influence.

Decision needs to consider other aspects of managing risk: who can best forecast and anticipate demand to determine whether to build road? Who can best absorb the risk?

February 2005


Demand risk in toll road

Whether government should bear demand risk in toll roads is therefore controversial

Chile, Colombia, Korea, and Spain, for example, have provided revenue guarantees (often in return for upside risk sharing).

(Italy and Turkey gave revenue guarantees for privately financed railways in the nineteenth century: PPPs are not new.)

Australia, Canada, United States have not.

Target any guarantee to the real problem:

Is total demand risk the issue or is it whether government will build a competing road or complete a planned complementary road or port?

Is risk the problem, or is it just that government doesnt want to set tolls high enough to consider costs? If so, a subsidy may be better.

February 2005


Valuing revenue guarantees

Step 1. Develop model of traffic revenue that allows for random fluctuation (that is, risk) as well as trend rates of growth.

Step 2. For the trend, take forecasts traffic-revenue growth developed for tendering the toll road.

Step 3. Estimate the expected size of traffic revenue fluctuation (risk), from previous local or international experience.

Step 4. Estimate consequent expected payments by government (see next slides).

Step 5. Discount those expected payments at the risk-free rate to get the value of the guarantee.

(Possible addition to Step 4: adjust expected cash flows for an estimate of risk, using the capital-asset-pricing model).

February 2005


Forecast and guaranteed revenue on hypothetical toll road

Estimated Initial Investment: $ 500 MM

$ MM

February 2005


A possible good outcome

February 2005


A possible bad outcome

February 2005


Valuation: Frequency distribution of government payments in 2016 (10,000 possible outcomes)

Average payment in 2016 is $4.19 million

Assume risk free rate is 5%

Approximate value of 2016 component of guarantee is

4.19/(1.05)11 = $2.45 million

Repeat for all years. (illustration purposes = $75.0 million)

This calculation will allow providing a value to the

Fiscal impact of this option. This is a necessary first step

In the decision-making process for public sector options

For infrastructure development.

February 2005


Transport Infrastructure: Developing Local Capital Markets

There is no best substitute for foreign exchange risk mitigation than matching the currency revenue generation with the currency of debt payment services (matching assets and liabilities).

Financing transport facilities and services (local currency based) in the foreign debt markets adds substantial risk to the structuring of adequate PPPs creating the need for additional public money support.

Local institutional investors (I.e., pension funds, insurance companies, life annuities, etc.) have a natural demand for long-term local currency debt instruments to match their liabilities.

In most cases, local capital markets initiate their development via the creation of a sovereign bond market (long-term yield curve). After the establishment of such market, investors develop a need to diversify the risk profile of their investments and the return mix, providing the incentives for the development of a private bond market, creating the opportunity for the introduction of infrastructure or utilities bonds (long-term annuities).

It is in the governments best interest to stimulate, via adequate securities regulation and institutional investors overseeing, the development of local capital markets as a source of long-term local currency funding for needed PPPs infrastructure projects.

February 2005


Developing Local Capital Markets : Chile

Source: IMF, Fiscal Affairs Dept.,January 2005

By the early 1990s, a sizable infrastructure gap had emerged in Chile, and significant investment was needed to prevent transportation and other bottlenecks from becoming a major obstacle to future growth

A challenge for the government was to close this gap while maintaining fiscal discipline that had placed public debt on a rapidly declining path. The solution lay in promoting private sector involvement in the provision of public infrastructure through public-private partnerships (PPPs). Chile thus embarked on an ambitious concessions program in 1994, centered around a number of projects to develop the highway network.

The concessions program in Chile covers 44 contracted projects with a total value of US$5.7 billion (about 6 percent of 2004 GDP). These include: 8 projects to rehabilitate and upgrade the Route 5 highway which runs the length of Chile, with financing from tolls (US$2 billion); 11 other highway projects for connecting roads to Route 5 (US$1.3 billion); 10 airport projects (US$240 million); 6 urban road projects (US$1.8 billion); and 9 other projects (including prisons, public buildings, a reservoir, for US$360 million). Approximately 75% was funded in the local capital markets via local currency infrastructure bonds.

The government provides guarantees to concession operators. A minimum revenue guarantee is provided for highway and airport concessions, under which concession firms are compensated when traffic or traffic revenue falls below an annual threshold. In return for the minimum revenue guarantee, the concession firm enters into a revenue sharing agreement in which it shares a percentage of revenue with the government once a threshold is exceeded.

February 2005


Using Performance Based Subsidies (OBAs) in Transport PPPs : Road Asset Management

Road rehabilitation and maintenance traditionally done through input-based payments to private contractors.

Increasingly, output-based approaches, for example the Performance-based Maintenance and Management in Roads (PMMR), being introduced in Europe, Asia and Africa, and similar KREMA contracts, functional for several years in Latin America (Argentina, Brazil, Uruguay).

Expand private sectors role from simple execution of works to include maintenance, rehabilitation and management of road assets.

Operator paid after outputs delivered and quality standards met (per KM or similar).

Multi-year and consumer-driven out-look, shifting performance risk to operator, and allowing for innovation and efficiency.


February 2005


Transport : Engaging with the Public Sector

The World Bank strongly encourages transport infrastructure solutions that involve the private sector (i.e., economic development, incentives and efficiencies, fiscal space. Etc.).

However . It recognizes the difficulties and challenges of establishing adequate policy and regulatory environment supporting private sector solutions (plus private sector risk aversion to some situations) while having at the same time to satisfy immediate infrastructure needs in order to restore economic growth and improve living standards (avoid the poverty trap).

World Bank intervention supporting public entities, particularly in the rehabilitation and development of needed infrastructure (facilities) is in many cases necessary and if carefully targeted and supported by adequate policies could have a positive impact in attracting further private sector involvement.

Intervention could have better results if provided to public entities run on a commercial basis (corporatized), and moving towards cost recovery management systems, even if there is still a need for transparent government subsidies.

February 2005


Transport : Engaging with the Public Sector

Preference to engage (provide financing support) directly with the project entity responsible for managing the facility [infrastructure] or providing the service (passenger or cargo).

Better accountability (governance) and easier measure and monitor of performance

Improves chances of corporatizing the transport public utility

Reduces risk of lack of focus in the implementation of Bank intervention

Need to use a transparent mechanism for dealing with the gap between cost recovery and affordability (output or performance based subsidies). Need to developed schemes for the long-term financial sustainability of the entity (long-term planning of the use and transition of subsidies).

Initiates path for self-financial sustainability and independent access to financial markets (public transport entity).

February 2005


Transport : Spectrum of Bank interventions across Subs-sectors

Pure Public

Pure Private

Access

Quality

Affordability

Competition

Sustainability

Air Navigation (ATC)

Sea Navigation

Airlines

Shipping

Urban Transport Services (bus, taxis, etc.)

Port Services

Airport Services

Airport Terminal

Port Terminal

Freight and Passenger Railways Services

Integrated Railways Network

Toll Roads (motorways, bridges, highways)

Dedicated Masss Transit System

Road Network and Rural Roads.

Subways (metro)

WBG Support : Policy Dialogue / Technical Assistance / IBRD, IDA, IFC Investment Loans and Guarantees/ MIGA Guarantees

February 2005


Transport Infrastructure : Upcoming trends

Increasing importance of the provision of transport services and regional linkages and interconnectivity as key contributor to economic growth and MDGs and as a key driver of countrys competitiveness.

Broader use of PPP schemes as a way to maximize public money leveraging for infrastructure development.

Increasing use of output based subsidies as a way to utilize better private sector resources via effective allocation of performance risks (PPPs to deliver services to poorer communities).

Development of local capital markets (local currency debt instruments) as a mechanism for improving effective access to infrastructure financing by transport PPPs.

MLAs and Donors direct engagement with sub-national entities (well run public utilities) without sovereign support in the transport sector.

Thanks

World Bank Group

Infrastructure Economics and Finance

March 7th , 2005

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