AMERICAS — Developing world seeks private funding for new

In the 1990s, infrastructure investment in the developing world is projected to exceed US$200 billion annually, almost one-third of total expected fixed investment.

In Argentina, the power, telecommunications, transport, water and waste treatment sectors account for more than 15% of gross domestic product (GDP), and it has been estimated that a sustained 20% increase in the productivity of these services would increase the country’s growth rate by one percentage point.

The sheer size of the sector’s financing needs, coupled with the importance of modernizing infrastructure for future economic growth, has motivated policy-makers to look to private investors. In Latin America and the Caribbean alone, infrastructure projects totalling about US$40 billion are on offer.

Governments in the region are using three approaches to attract private investors: the direct privatization of existing state-owned enterprises (SOEs);

allowing new private entry into certain infrastructure activities; and the deepening of domestic capital markets to help provide the local currency financing necessary for most infrastructure projects.

The rationale for privatizing infrastructure can be summarized as follows: generally speaking, the public sector’s performance in infrastructure has been weak; the relatively few examples of private sector provision of infrastructure services have shown positive results; and the importance of infrastructure, in terms of both its direct share of GDP and its impact on other sectors, has convinced policymakers to employ a more pragmatic approach. Six developing countries (including four in Latin America and the Caribbean) completed infrastructure privatizations for a total value of almost US$8 billion in transactions completed by 17 countries (six in Latin America and the Caribbean). The pace of privatization activity in the region’s infrastructure continues to grow, in terms of both the countries involved and the number and size of transactions.

The International Finance Corp. (IFC) is advising the governments of Trinidad and Tobago, Columbia and Peru on the privatization of SOEs in their power sectors. Often, part of IFC’s advisory role involves preparing state-owned utilities for privatization.

In the power sector, state-owned utilities typically carry out power generation, transmission and distribution as integrated operations. To promote more competition and thus a healthier market, the preparation process often entails dividing a state-owned utility into separate entities responsible for the different functions, prior to sale.

As an example, the generating business of the Trinidad and Tobago Electricity Commission has been separated from its transmission and distribution activities, and negotiations are currently taking place with private investors bidding for a stake in the new generating company. In Peru, the government has established a new regulatory framework as a basis for offering the two main state-owned entities, Electrolima and Electroperu, to private investors. Electrolima has been split into three separate entities (one generator and two distributors). Terms and conditions for the sale of 60% stakes in Edelnor and Edelsur, the distribution companies, were issued in January, 1994; bids were due in July. A 60% stake in Edegel, the generating company, will be sold shortly thereafter. More than 60 potential investors were expressing interest.

To a greater extent than in other sectors, the transition to private ownership of infrastructure services is being fueled by private investment in new projects. In many countries, the political costs and regulatory complexity of the direct privatization of an existing publicly owned monopoly have prompted reform-minded governments to pursue the alternative route of first allowing private entry into certain activities or niche markets. Typical examples include the granting of cellular telephone licences to private operators and the encouragement of independent power producers (IPPs), sometimes through build-operate-transfer or build-operate-own schemes. IFC is financing several of these new private entrants. For instance, Celular de Telefonia S.A. de C.V. (Cedetel) is setting up a cellular telephone system serving the northeastern region of Mexico around Monterey; in Belize, construction started in July, 1992, on the 25-megawatt Macal River hydroelectric power plant; and the ground-breaking Puerto Vallarta water treatment facility in Mexico entered its construction phase in April, 1993. One advantage of the incremental approach to private entry, as opposed to direct privatization, is that it enables governments to introduce market forces into a sector without having to set up a completely new regulatory framework.

Clearly, uncertainty about the future regulatory framework will pose a risk to private investors entering a market. However, in most cases, for the project in question, this risk can be addressed up-front through a series of long-term contracts between the key players (equity investor, government, contractor, purchasing utility and lenders).

Recent developments in the Colombian power sector provide a good illustration of how governments can combine direct privatization and new private investment in infrastructure. A severe drought in 1992, which brought on 13 months of power rationing, highlighted two key factors. First, the country’s power supply was overly dependent on hydro generation, and second, at least 2,000 megawatts in additional generation capacity would be needed by the end of the decade.

The government wisely realized that it needed the private sector’s help in building the additional (mainly thermal) capacity that was required. Moreover, private sector entry could not wait until a new regulatory framework for the sector was established.

Consequently, government policy has focused on encouraging new private entry, although not to the exclusion of direct privatization. IFC is advising the government on the privatization of Central Hidroelectrica de Betania, a 510-megawatt hydroelectric plant commissioned in 1987. Meanwhile, even though the future regulatory framework for the power sector has not yet been defined, several IPPs have already been set up, backed by long-term power purchase agreements.

Although short-term debt and equity markets have developed strongly in a number of Latin American and Caribbean countries, the volume and availability of term lending from commercial banks remains small. This constraint limits the capacity of domestic capital markets to provide local finance, which is particularly important in projects where currency mismatches cannot be completely offset.

Ironically, one of the reasons capital markets in the region have developed in this lop-sided fashion is precisely the absence of private utilities issuing long-term securities.

Consequently, governments in the region are striving to liberalize their capital markets so as to stimulate term lending and domestic bond markets. Privatization itself is acting as a catalyst for this process, as private investors seek to finance their new investments by issuing long-term securities on the local markets. And, as local capital markets deepen and broaden, so it becomes easier for governments to attract further private investment into infrastructure services.

— Gavin Wilson is senior investment officer in IFC’s corporate finance services department.