Placing infrastructure, utilities and services with private operators

After suffering the biggest natural disaster in its history last October, an image of strength and resilience has emerged in the world when looking at Pakistan's relief and reconstruction efforts. We are truly impressed by the Government's leadership in this time of extreme adversity.
A large-scale loss of life - anticipated in the winter - has been successfully averted. The resolve shown by the people in the earthquake-affected areas to cope and deal with hardship, to deal with a period of immense trial and tribulation is simply admirable.
It is also good to see that the development community has done its part. In November 2005, it agreed to provide long-term assistance, this time for reconstruction and rehabilitation, at the successful Donor Conference organised in Islamabad. I would like to take this opportunity to reassure the authorities of ADB's continued commitment and support in this endeavour.
The earthquake showed Government at its best. But it also showed how civil society organisations and the private sector can work side by side with the Government at the central and local level - first on earthquake relief and then on reconstruction. The private sector includes big multinational companies, as well as large and small national businesses. Each of these reacted positively and quickly to the challenge. In many ways, but not surprisingly, the experience has shown the acceptable and the "other" face of the corporate world. The non profit oriented face.
Turning now away from the emergency, and into the drivers for economic growth, a question that is being posed here today is why and how should the private sector be encouraged or unleashed on the economy? The best standpoint from which to debate this issue is by focusing for a moment on the need versus the capacity to finance it.
This leads to other questions: what is this need, and in which sectors or services areas does it manifest itself most? Are these areas really important to growth and development?
Where do they rank in relation to others, for instance macroeconomic stability, regulatory and legal frameworks, structural reform, etc? Also critical to ask is what is the government's capacity to finance the need on its own? And if it cannot finance it all on its own, to who should the Government turn for help? And if the private sector is an option, what terms and conditions it is likely to require? Conversely, we should ask about what type of things should the public administration be asking for before and after it engages and partners the private sector.
Pakistan, just like any other emerging market economy, has huge and rapidly increasing investment needs, particularly in relation to the rehabilitation and expansion of basic infrastructure, key utilities and selected public services such as roads, ports, airports, railway systems, telecommunications, electricity, gas, water, wastewater and waste management. These are determinants and drivers for growth, employment, income and ultimately for poverty reduction.
They impact on direct foreign investment, on productivity and on competitiveness. They also affect the livelihood and quality of life of all citizens.
But these areas, individually and combined, require major outlays over the next few years - calling on huge amounts of capital and recurrent expenditures. In the region as a whole, the investment requirement in these areas runs into $300 billion a year - an amount equivalent to around 10% to 11 % of GDP. In Pakistan the investment need is more or less in this order of magnitude.
But financing this level of investment is the real challenge, in Pakistan and elsewhere. The establishment and adherence to a balanced monetary and fiscal policy stance, which from experience we know is essential to ensure macroeconomic stability and predictability, makes it difficult, if not next to impossible, for the public sector be a sole financier of such endeavour. Doing so will mean printing money, and doing that will lead to inflation, forcing millions into poverty, not prosperity.
Other monies must and need to be mobilised - including domestic savings and international funds. This scenario indicates why the private sector should be tapped and unleashed for the purposes of investing and managing productive activities but also development projects.
This scenario also suggests that such involvement should be in the form of "win win" partnerships. And a partnership between public and private sponsors almost always implies, and leads to, a partnership between public and private sector monies.
Put in another way, the financing of public/private partnerships can, and should, combine government funds, including state-owned enterprise shareholder advances, commercial bank lending, capital market operations, private equity, and bilateral, official, export credit agency, and multilateral development bank assistance. I will come back later to this.
But unleashing the private sector into infrastructure, utilities and public services requires well-crafted policy frameworks. Partnerships need to be supported by set of minimum criteria. These are often intertwined and almost always interdependent. Striking the right balance is not easy. Doing so yields dividends. Not doing so yields risks and ultimately poor results and discontent. These frameworks include sound monetary and fiscal policies, structural reforms, governance, capacity, transparent and efficient procedures and systems for bidding and contracts, regulatory arrangements that provide confidence and predictability, and a strong financial system.
The first building block to allow the private sector to invest and manage projects is the one that creates the entry point or it in the first place. This effectively means structured and targeted public sector reform calling precisely for that. Such reform can take place at the central and local government level. In other words, it starts with dedicated advisory mandates to place infrastructure, utilities and services with private operators.
This placement does not have to mean selling assets. The range of modalities that can be used to engage the private sector is diverse and broad. The so-called private sector content can range from a "little to a lot". It can go from management contracts to joint ventures, concessions, BOTs, partial sales and outright sales.
But before any of these modalities can be applied, a key success factor is to have a properly organised, transparent and efficient process, backed by the framework of various policies on the legal, regulatory, financial, bidding, and other fronts. This means that the entry point in itself is never enough. Private sector interest, its investment plans, its continuity and ultimately its success, needs actions or clear-cut measures that feed stability and predictability. Risk cutting, risk sharing and risk mitigation are important to the private and the public investor alike.
Another factor behind the successful incorporation of the private sector in investment and management of development projects is political commitment. The political dividend to a public administration arising out of private public/partnerships is not always immediate or apparent. Service efficiency gains, greater physical coverage, improved quality and continuity are basic service targets.
But these need investments and time to come to fruition. Tariff hikes are felt immediately by the end-user - quite often well before the services are improved. If we depart from a premise that shows that the economic cost of delivering services may well have been hidden for years or one where the ability of endusers to pay may be constrained, political commitment may require a "transition strategy". This may involve viability gap financing assistance, output based contracts backed by financial support and protective measures for lower income end-users.
It may also involve the alignment of investment programs to the end-user's ability to pay. Working on efficiency gains first before asking the private sector to embark on major investments, which by definition always requires the right fee structure to ensure cost recovery and profit, is an alternative strategy. This approach can normally be handled through the contractual arrangements.
Political commitment is also related to the modality chosen. This too is an area that requires careful crafting. Ownership is often a "deal breaker" for the authorities. But this does not have to be a stumbling block. In fact, in the case of most utilities and public services, ownership has tended to remain with the public sector.
The involvement of the private sector can include, as already suggested, management contracts with or without specific investment conditions, joint ventures, concessions and BOTs. Partial and outright sales often only take place in a few sectors. Telecommunications and electricity distribution are cases in point. But other services such as water, wastewater, waste management and electricity transmission, normally involve the other modalities. IPOs and private placements are also interesting options. These often take place in local or domestic capital markets.
There will never be an avalanche of private investors into the infrastructure and utilities field in the short to medium term unless we create special incentives and risk sharing and risk mitigation arrangements. Besides the use of political risk and partial credit risk guarantees to support financiers -accompanying the private sector, and the definition and financing of reforms, ADB is also working on the establishment of a special purpose vehicle or fund and support policy program to foster PPPs.
The approach taken by us and the authorities is to come up with "viability gap" financing schemes to support transition strategies in projects and with an instrument to kick start and/or co-finance operations involving the public and private sector - that is, by providing seed capital and advisory services. We are optimistic that this program and special purpose vehicle will increase the level of PPP activity and deal flow.
The special purpose vehicle will need to be backed with financial resources and expertise to undertake basic due diligence on the technical, commercial, financial, legal, regulatory, safeguards, social and other fields. It will also need work with the local banking community to encourage business proposals and co-financing. A policy framework will also be put in place to remove obstacles in target sectors.