Ifra development in east asia and the pacific by world bank

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East Asia and Tou:ards a l{eoo Public-Priaate Partncrship A O 1995 by the lntemational Bank for Reconstruction and Development/THE WORLD BANK lBlB H SEeet, NW Washington, DC 2O433 I;SA AII rights rcserved Manufactured in the Unired States of America First printing November 1995 Second printing June 19 The findings, interpretations, and conclusions expressed in this report arc €ntirely those of the ar-rthors The World Bank does not guarantee the accuracy of the data included in $is publication and does not accept any responsibility for the consequence of d)eir use Any judgments expressed are those of World Bank staff or consultants and not necessarily re{lect the views ofthe members ofits Board ofExecutive Directors or the countri€s they represent The material in lhis publicstion is coplrithted Requests for permission to reproduce portions of it should be sent to the East Asia and Pacific Extemal Atrats Unit (EAPVP), at the address in the copyright notice alove The World Bank €ncourages dissemination of its work and will normally give permission promptly and, when reproduction is for non-commercial purposes, without asking a fee Executive Sumrnary I Bachgrould Investment Requirements Case for a New Public-Private Partnership Some Stylized Facts and Lessons of Recent Experiences Critical Constraints to Enhanced Private Participation and Possible Remedies ll Gap in Expectations and Perceptions of Risks Government Objectives, Comrnitment and Processes Sector Policies and Legal and Regulator,v Framework Unbundling, Mitigation and Management of Risks Domestic Capital Nlarkets Nlechanisms to Provide Long-Term Delit Transparency, Competition and Transaction Costs VI A Frarnework for Facilitating Private Inyestments Annex The report was prepared by Harinder Kohli based on background work and inputs by a nurnber of World Bank staff including Kazuko Artus, Hoon-Mok Chung, Shakuntala Gunaratne, llichael Klein, Kali Kondury, Anil Malhotra, Ashoka Modv and Khalid Siraj It bene{itted from valuable comments and sugestions by Graham Barrett, Russell Cheetham Francis Colaco, Bruce Fitzgerald, James Hanson, Robert Hill, Nicholas Hope, Ishrat Husain, Farrukh Iqbal, Abdatlah El Maaroufi, Rachel McColganMohamed, Vineet Nayyar, Richard Newfarmer, Gary Perlin, D.C Rao, Everett Santos, Peter Scherer, Vinod Thomas, Arthony Toft and Michael Walton eveloping economies in East Asia are under seyere pressure to meet a massive new demand for in{rastructure Unless this need is filled, high requirements, particularly in rural roads, mass transit, and water development International evidence suggests economic growth cannot be sustained Economies will run a major risk of faltering in their progress towards playing a greatly expanded role in the global economy At results in more financing being available for infrastruc- that well-structured private participation not only ture projects, but that efficiency and quality are enhanced Private projects also facilitate, through region's huge appetite for infrastructure It offers a means demonstration and competition, improvements in the efficiency of individual public utilities as wel] as public of developing a new public-private partnership involving investment overall the same time, great opportunities are to be found in the in developing and developed economies a.like while providing unprecedented business prospects govemments for the private sector throughout the region ii East Asia's infrastructure challenges arise from three related elements First, the projected investment requirements are vast: during the next decade, developing East Asian economies will need to invest between $1.2-I.5 trillion (by comparison, $0.G{.8 trillion is needed in Latin America), equivalent to abott lVo of GDP or about 2Vo more of GDP than the current levels These investment requirements are driven by: the region's rapid economic growth; the need to compensate past under-investment in most economies in lransition: rapid urbanization that will add a billion people to the region in the next generation; and the rising trade and globalization of the economies Second, both the public at large and the business community are demanding better quality and service And, third, cost effectiveness and choice of infrastructure services are increasingly important for international competitiveness They need to be improved in most countries iii lic Countries in the region acknowledge that the pubsector has neither the finances nor the managerial iv The private sector-operators, suppliers and financial markets from around the world-has demonstrated a keen interest in the investment opportunities in developing economies o{ East Asia and Pacific Examples ofsuccessful private investments in infrastruclure projects are to be seen in countries such as China, Indonesia, lvl.laysia and the Philippines Most of such iniestments are in telecommunications, power and toll roads, with a rising though still modest involvement in water supply and port facilities Two+hirds of the private investments in East Asia are by investors within the region v But demand remains much greater than supply Despite much talk about private investment in infrastructure, there is little action in most countries Neither the govemments nor the private sector are satisfied with pro$ess to date Hundreds of memoranda ofunderstandings on projects totalling hundreds of billion of doLlars are languishing The few projects that have reached implementation took much more time and money to negotiate than first imagined Except in Malaysia and in selected areas of the Philippines (power) and Indonesia (toll roads), the public has yet to see any visible results of new strategies to involve the private sector resources to meet all the emerging infiastructure needs, In most countries efforts are underway to encourage private participation in the provision of such services, though in most countries the public sector will remain responsible [or significant infrastructure investment vi Despite progress in getting a few projects staxted and the creation of a few big infrastructure funds, signif- icant challenges remain, namely broadening the sector reforms and unleashing private capital flows These challenges must be met, and met fast, to raise much needed additional savings from the private sector and avoid the looming infrastructure crisis Time is of the essence Pu}lic satisfaction with the new strategies in the region is still fragile and investors are increasingly worried that early gains may not be sustained vii The World Bank has identified seven major con- mechanisms to select private partners, plus streamlined straints to enhanced private participation after a review of global experience, countryJevel work in the region and a detailed survey of the private sector: (i) existence of a public decision-making; and (iv) development of local capital markets and creation of mechanisms to facilitate provision of long-term debt by public as well as private financial institutions and institutional investors In addition, there is a universal need for a concerted and continuous effort to mobilize public opinion in favor of private participation Favorable public opinion is criti- wide gap between the expectations of govemments and the private sector on what is reasonable and acceptable; A (ii) lack oI clarity about govemment objectiyes and commitment and complex decision-making; (iii) need for more conducive sector policies (pricing, competition, public monopolies) and inadequate legal and regulatory policies, including investment codes and dispute-resolu- cal for the success of such programs ix need for gleater transparency and competition to redrrce llost of the actions needed to enhance private participalion are country and even sector specific Such actions would need to be and can only be taken by individual developing countries after consultations with the private sector As most developing economies in the region face similar challenges, there is considerable merit in leaming from each other's expelience Region- costs, assure equity and improve public support Not all a1 tion mechanisms; (iv) need to unbundle and manage risks and to increase credibility of goyernment policies; (v) under-developed domestic capital markets; (vi) need for new mechanisms to provide from private sources large amounts of long-term finance at affordable terms and (vii) of these constraints necessarily apply to each country viii a strategy for private participation, and reform of sector policies and the regulatory and legal framework to support the strategy; (ii) putting in place an explicit framework and mechanisms for unbundling, mitigating and managing risks, including selective government guamntees to make the policies more credible; (iii) reduction of transaction costs through transparent and competitive World Bank experience in both developed and developing economies indicates that these constraints would be alleviated, by a conducive and credible policy and institutional framework, and increase private participation While individual country and sector conditions would vary in most circumstances the framework would include two components The first component relales to policies and actions necessary to promote overall economic growth and private sector development in all economic activities In this context, two aspects deserve special emphasis: maintenance of a stable macroeconomic environment; and a transparent and robust investment environment These policies are a necessary but not a sufficient condition for enhanced private participalion in infrastructure The second component relates to policies and actions specifically concerning infrastructure These fall into four complementary areas: (i) clarification of government objectives and sharing of information, cooperation and collaboration could also yield considerable benefit by creating synergies from parallel or complementary actions taken in the same policy areas In parallel, OECD members and multilateral institutions can take steps that directly or indirectly would have a beneficial effect on private investment in the developing economies of the region x On its part, a{filiates of the World Bank Group- ItC, MIGA, FIAS and IBRD-are expanding their efTorts to facilitate and promote private investmenl in irfrastructure These efforts include: increased support to individual countries in the development of the framework for private participation; more intensified contacts with the private sector; creation and greater use of new financial instruments and mechanisms to support private infrastructure projects (e.g partial risk guarantees, single currency Ioans, infrastructure funds); and expanded technical assistance for institutional and human development as well as greater sharing of information and research findings eveloping economies in East Asia and Pacific face huge challenges in meeting their infrastructure needs East Asian economies will be unable to sustain high economic growth rates unless these challenges are successfully met They will run a serious risk of in their progress towards playing a $eatly expanded role in the global economy At the same time, their massive infrastructure needs offer an opportunity to develop new public-private partnerships while providing unprecedented business opportunities for the private sec- faltering tor throughout the region The most dramatic shift has been in the Philippines in the power sector In response to major and persistent power shortfalls, the government in 1991 launched a crash program to have the private sector build the necessary generating capacity (the distribution companies are mainly private) under BOT-type schemes A number of fast-track power projects have already been completed, and, by end-1994, over a dozen private projects were operational; another 20-odd projects have been signed It is anticipated that by l99B as much as B07o of national generating capacity could be in the pdvate hands, compared to none in 1991 Based on this positive Governments are increasingly keen to allow the private sector to expand its role in the provision of inlrastructure services While this is graduallv becoming a global experience, the government has decided that all future generation capacity will be private It is considering full deregulation of the power sector, and has opened dis- trend, East Asia, along with Latin America, is at the forefront of evolving the new paradigm cussions to expand private financing to other infrastruc- In many East Asian countries, private sector participation (including financing and management) in new infrastruc- Nearly ture pmjects has either become, or is close to becoming, a one form or another Some countries, having successfully reality a In Malaysia, major to1l highways have been financed by the private sector under a Build, Own and Transfer (BOT) arrangement, as have a number of water supply and sewerage treatment projects In Thailand, the Bangkok Expressway toll road is now in operation, and a rural telecommunications project is progressing well; both were built and partly financed by Japanese promoters under BOT+ype schemes In China, two power projects and a major toll highway in the South, all promoted and funded by a Hong Kong Chinese company, e now operational; a container port in Shanghai is a 50:50 joint venture with another Hong Kong company and a number ofother projects are at an advanced stage In Indonesia, a number of toll roads funded by the private sector are in operation and a major power project is finally underway About two-thirds of the private inyestment in infrastructure in East Asia is by investors fiom within the region The competition remains keen among the "sellers." ture sectors (pons, roads, airports and water supply) all countries in East Asia are now seeking increased private sector participation in infrastructure in invited private investment in a number of infrastructure projects (namely in power, telecommunications and highways) are now formulating policies and approaches to enhance efficiency gains, increase competition and reduce risks to private promoters Despite these efforts and the few successes mentioned above, results have failed to meet expectations Experience highlights some "ommon problems whose resolulion is necessar) to atlracI private capital flows on a Iarger scale and on a more sustained and efficient basis Time is of the essence in lhe region since public support for the new strategies is still fragile and the private sector increasingly concerned if the early gains can be maintained Practical ways have to be found to move ahead with a larger number of "good" projects rather than waiting for the ideal solutions The basic objectives of this paper are: to outline the challenges {aced by East Asia economies in irfrastruc- ture development; to describe their experiences in evolving a nera public-private partnership; to identify, based on World Bank global and country specific expe- rience, the major common issues and constraints to enhanced private participation in the provision oI infrastructure services; and to propose a framework for possible ways of alleviating the constraints While most of the remedial actions would necessarily be country and sector specific, in some areas discussions within regional forums may be of benefit to all More specifically, the remaining parts of the paper (i) outline the massive investment and financing requirements in the developing East Asian economies; (ii) revier,v briefly the case for a new public-private partnership and for enhanced private participation; (iii) present stylized facts and lessons of recent experience in East Asia and Latin America in evolving this new public-private partnership; (iv) identify key common issues and critical constraints to an enhanced and more efficient private participation; and (v) outline a framework for alleviating these constraints Over the next decade, lnfrastructure investment ln China alone ls proiected to exceed 700 billlon dollars Regional lnvestment Needs by Country, 199+2004 ldorcsia tL% Philippines II ^ ,^ INYESTIIENT REQUIRE}IENTS eveloping economies in East Asia lace a huge challenge in achieving investment levels necessary to overcome current bottlenecks and meet rapidly increasing demand As detailed,in Annex 1, after making modest levels of investments in the 1970s, East Asian economies have steadily increased investment in in{rastructure in absolute terms and as a proportion of pines Second, is the need to sustain high economic GDP Total investments in infrastructure rose from 3.67o of GDP in the I970s to about 4.67c in the l980s and to around 5.0-5.57o of GDP in 1993 Total investmentboth public and private-is estimated to have reached or even exceeded $70 billion in 1993 This high growth is expected to continue for a few years at least Dwing the next decade, the region is projected to grow al 7-890 per year e.g increase per capita income by about 6Va per annum This high growth in turn requires that investment levels in infrastructure rise as a proportion of GDP in order to forestall infrastructure constraints from restricting economic growth Third, rapid urbanization throughout the region raises the need for much higher investment in urban infrastructure WorlC Bank projections indicate that, even if the current urban growth rale of 4Va a year moderates, more than one billion people would be added to urban areas in the next generation They will need access to clean water, sanitation, urban transport, telecommuni- Despite these large and rising investments, the region is plagued by infrastructure constraints As shown in the charts on the previous page, most East Asian economies lag behind other developing countries, particularly those of Latin America, at their level of per capita income Demand is outstripping supply even in some of the most basic services such as water supply and sanitation Industry and urban areas are particularly hard hit ln 1990, just 6OVo of the region's population had access to sale drinking water and abott 779o had access to sanitation This translates into 460 million and 350 million people without access to safe drinking water and sanitation respectively; the coverage is even lower in rural areas The penetration ratio in telecommunications is very low, at about 17 telephones per 1000 people Power outages and brownouts are common across the region Urban transport and environmental problems are legendary In nearly every country infrastructure constraints are a top economic, social and political issue growth rates World Bank analysis of global experience reveals a strong correlation between economic growth and infrastructure investments for every I7o growth in per capita GDP, infrastructure stock or investment needs to increase hy abou lVo East Asia has been the fastest growing region in the world for the past 25 years cations, power and housing And, fourth, the rising trade and globalization of economies require world-class infrastructure services, particularly in power, communications and bansport Based on Wbrld Bank country and sector specific reviews and on a quantitative modelling exercise, infrastructure investment requirements in developing East Asian economies are projected at between $1.3-1.5 trillion for 1995-2004 This suggests a need for a substantial increase in the investment to GDP ratio from about 57o to between 6.5-77a Detailed projections are given in Anncx l The baseline scenario is summarized in the Future investment requirements are massive and are driven by four major in{luences First is the urgent need table below and on the two charts on the following page to overcome current bottlenecks and make up for past under-investment, particularlv in countries in transition (Cambodia, Laos, Mongolia, Vietnam) and the Philip- These numbers must be regarded as orders of magnitude There is much uncertainty about the underlying assumptions Actual inyestments may deviate signifi- cantly from projections But it is clear that in both absolute terms and as a share of GDP, future investment requirements are so massive as to require special planning and provision The largest lncreases have been in transportation, with China in the lead Du ng the next decade, ,egional investment in infiastructure projected to exceed to US$I trillion lndicative Investment Requirements in lnfrastructure, 1995-2004 Baseline Scenario (lEC baseline growth) lndonesia a Estimates were available only for the public sector b others comprise Cambodia, Fiji, Kiribati, Lao PDR, [4aldives, lvlongolia, lvlyanmar, Solomon lslands Tonga, Vanuatu, Vietnam and Western Samoa c EastAsia includes China, lndonesia, Korea, Nlalaysia, Philippines, Thailand and 'Others." For many more private projects to proceed on a more sustainable basis, it is necessary to reduce both the per- and commercial risks and may require assurances from the government only on its future ability to repatriate capital to overseas investors and lenders and that tariffs will be adjusted in a timely and acceptable manner An ception and the reality of risk, and to unlundle the various risks so as to determine which participant is best placed to manage which risk at the lowest cost and how independent power producer typically wants several additional assurances such as that the local utility will be able to honor its obligations under the take-or-pay the cost of risk mitigation can be shared equitably The best way to manage or reduce uncertainties and contract and that the fuel will be available etc Toll highway and bridge projects typically have required even more assurances from the state (e.g land acquisition, risks associated with a project is to put in place an appropriate policy, legal and regulatory framework as proposed above A complementary need is to agree on mutually acceptable mechanisms, including neutral arbitration procedures, for enforcement of contractual obligations In addition, for sponsors to assume the commercial risks, they must be allowed to make their own decisions on the technical and managerial aspects of the equipment needed for the project (instead of the current situation in many countries, where govemment entities prefer to dictate decisions on plant size, Iocation, technology, local participation, implementation arrangements, and so on, as used to be done for projects under and to increase lransparency and competition attempts are being made in a few countries to develop "templates" for each major sector, clarifying ahead of bid competition as to who will mitigate what risks and how This way all potential participants in a given sector would be treated equally and would know the rules of the game before submitting proposals public monopolies) The basic approa h to risk management should be b
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