Public Disclosure Authorized Public Disclosure Authorized

3aG2

Foreign Investment Advisory Service Occasional Paper 9

Foreign Direct Investment in Infrastructure The Challenge

of Southern

and Eastern Africa

David J. Donaldson Frank Sader Dileep M. Wagle

Public Disclosure Authorized

Public Disclosure Authorized

IG

Foreign Investment Advisory Service a joint facility of the International Finance Corporation and the World Bank

Foreign Investment Advisory Service Occasional Paper 9

Foreign Investment Advisory Service a joint facility of the International Finance Corporation and the World Bank

Foreign Direct Investment in Infrastructure The Challengeof Southern and EasternAfrica

David J. Donaldson Frank Sader Dileep M. Wagle

The World Bank Washington, D.C.

© 1997The International Finance Corporation, and the World Bank, 1818H Street, N.W., Washington, D.C. 20433 All rights reserved Manufactured in the United States of America First printing February 1997 The International Finance Corporation (IFc),an affiliate of the World Bank, promotes the economic development of its member countries through investment in the private sector. It is the world's largest multilateral organization providing financial assistance directly in the form of loans and equity to private enterprises in developing countries. The World Bank is a multilateral development institution whose purpose is to assist its developing member countries further their economic and social progress so that their people may live better and fuller lives. The findings, interpretations, and conclusions expressed in this publication are those of the authors and do not necessarily represent the views and policies of the International Finance Corporation or the World Bank or their Boards of Executive Directors or the countries they represent. The IFcand the World Bank do not guarantee the accuracy of the data incduded in this publication and accept no responsibility whatsoever for any consequences of their use. Some sources cited in this paper may be informal documents that are not readily available. The material in this publication is copyrighted. Request for permission to reproduce portions of it should be sent to the General Manager, Foreign Investment Advisory Service (FIAS),at the address shown in the copyright notice above. FIASencourages dissemination of its work and will normally give permission promptly and, when the reproduction is for noncommercial purposes, without asking a fee. Permission to copy portions for classroom use is granted through the Copyright Clearance Center, Inc., Suite 910,222Rosewood Drive, Danvers, Massachusetts 01923,U.S.A. Libraryof Congress Cataloging-in-PublicationData Donaldson, David J., 1938Foreign direct investment in infrastructu. re: the challenge of southern and eastern Africa/ David Donaldson, Frank Sader, Dileep M. Wagle. p. cm. - (Occasional paper ; 9) ISBN 0-8213-3885-4

1. Infrastructure(Economics)-Africa, Southern. 2. Economic development projects-Africa, Southern-Finance. 3. Investments, Foreign-Africa, Southern. 4. Infrastructure(Economics)-Africa, Eastern. 5. Economic development projects-Africa, EasternFinance. 6. Investments,Foreign-Africa, Eastern. I. Sader, Frank. II. Wagle, Dileep M. III. Foreign InvestmentAdvisory Service. IV. Title. V. Series:Occasional paper (Foreign InvestmnentAdvisoryService) ; 9. HC940.Z9C33 1997 332.67'3'096-dc2l 97-2012 CIP

Contents

Abstract Preface

iv v

Executive Summary vi 1.

Introduction

2.

The State of Infrastructure in the Region 2 Telecommunications 2 Electricity 2 Transportation 3 Water 4

3.

Improving Infrastructurethrough Foreign Direct Investment 7

4.

Scope for PrivateInfrastructureInvestment in Southern and Eastern Africa 9

5.

Bringing in the Private Sector 12 Goals and Expectations 12 Constraints and Impediments 13

6.

Conclusion 18

Notes

1

19

Annex I: Infrastructure Indicators for Southern and Eastern Africa 20 Annex II: Policy Obstacles to Foreign Direct Investment in Infrastructure in Developing Countries (by Gary Bond, Corporate Planning Dept., IFC) 23

iii

Abstract

The countries in Southern and Eastern Africa have participated in the worldwide revolution of private infrastructure investments only to a very limited extent so far. While the needs are high to upgrade and expand the service provision in areas such as electricity, telecommunications, transport, water supply, and sanitation, very few private investments have actually been implemented. For one, foreign investors still consider most countries in the region as a high-risk environment, making it difficult to attract commercial financing. Equally important, investors frequently question the overall political commitment

iv

of the countries' governments to allow private investment in these areas. There are often inadequate legal frameworks, insufficient sectoral reforms (such as the removal of government monopolies or the raising of tariffs to market price levels), and weak, or unclear implementing rules and regulations. If the countries in the region want to see a more active participation by the private sector in infrastructure, the governments will have to introduce crucial reform measures to bolster investor confidence and to build a policy environment designed to facilitate the implementation of such projects.

Preface

On March 28 and 29, 1996, the Foreign Investment Advisory Service (FIAS), in cooperation with the United Nations Development Programme (UNDP),hosted a high-level roundtable on the business environment for foreign direct investment in infrastructure in Southern and Eastern Africa. At this meeting a select number of high-level government officials from seventeen African countries met with senior executives from large infrastructure companies and investment banks, and representatives from multilateral agencies. The purpose of the roundtable was to discuss the potential for private foreign direct investment in the region's infrastructure, and to assess the policy, legal, and procedural measures that may be needed to facilitate private involvement. This paper synthesizes the thoughts and ideas expressed during the discussions. It is also based on the background material prepared for the meeting by FIASin cooperation with the Corporate Planning Department of the International Finance Corporation (IFC). These materials describe the state of infrastructure in the region, take stock of actual and potential projects in the various sectors, and analyze the main

impediments to private investment in Southern and Eastern African infrastructure services. In addition, the consulting firm BIPE Conseil, with financial support m the French goverrnment, conducted a survey of current and potential investors, whose views on the investment climate in the region are incorporated in this paper as well. Numerous individuals in the World Bank Group provided valuable comments during the writing of this paper. Special thanks go to Joel Bergsman, Boris Velic, and Jenny Wishart. The paper also benefited from excellent research assistance by Pernille Holtedahl. The Private Sector Development Department contributed recent literature on the topic as well as a database on current and potential infrastructure projects in the region. The Corporate Planning Department of IFC provided support throughout the entire research and writing process. The French Ministry of Foreign Affairs and the French Ministry of Public Works, Housing, Transport and Tourism provided financial support for the investor survey carried out by BIPE Conseil. The UNDP provided generous financial support to the roundtable meeting.

v

Executive Summary

In recent years, many developing countries have made dramatic progress in promoting private participation in their infrastructure sectors, and large volumes of funds have been mobilized on a non-recourse basis for investment in power, telecommunications, transportation, and water projects. This progress has, however, been relatively uneven, and some regions have been much more successful than others. Compared to East Asia or Latin America, sub-Saharan Africa has not been a major beneficiary of this revolution, and it is clear that investors tend to perceive the region as a relatively unattractive investment location. The current state of infrastructure provision in Southern and Eastern Africa is demonstrably poor. Less than 2 percent of people in the region have a phone connection (compared to 50 percent in North America or Western Europe); electricity production per capita is less than a third of that in middle-income developing countries, and transmission and distribution systems in the region tend to be old and inefficient, with resulting high losses of generated power. Road networks are in particularly bad shape, for the most part unpaved and poorly maintained. Water supply and treatment facilities are unsatisfactory in the quantity as well as the quality of the service provided. Air and sea ports are managed inefficiently, as the congestion of freight and passenger traffic and the significant delays demonstrate. All of these factors constitute important impediments to the economic growth potential of the region, raising the transaction

vi

cost of business and deterring foreign investors from setting up operations. A key reason for this disappointing performance has been the historical predominance of state participation in the delivery of infrastructure services in the region. The state has typically imposed a multiplicity of "social goals", including the creation of employment and the subsidization of prices to consumers, at the expense of commercial objectives. Not surprisingly, public utilities have tended to run into severe financial difficulties, preventing them from undertaking the necessary maintenance or expansion of their facilities. At the same time, these "social goals" introduced distortions into the entire economy, often resulting in evenhigher unemployment and a disproportionate benefit to the wealthier members of society from the subsidization policy. Severe though as they may be, these problems are neither unique nor insurmountable. Many other developing countries faced with similar problems of inadequate infrastructure have seized the opportunity to make greater use of the private sector in financing and operating projects, with very positive results. The failure of most countries in Southern and Eastern Africa to do the same has been the consequence of some basic constraints. For instance, foreign investor perceptions of country risk remain high, with the result that the region faces a severe disadvantage in obtaining commercial financing. Government commitment to private entry is still perceived as weak, and indeed very few privatization programs in the region have effectively taken off.

Project development costs are high, and sponsors of potential projects encounter a difficult and even hostile environment during project preparation and implementation. In addition, domestic financial institutions are weak, and uncertainties regarding the convertibility of project revenues into foreign exchange persist, as do concerns regarding the enforceability of contracts and the transparency of regulatory frameworks. All of these constraints can be removed, but they require a clear understanding by governments of private investor needs in the infrastructure sector. Increasing investor confidence requires decisive policy reform. There is room for cautious optimism here, as country risk

ratings in most of the region's countries have registered a small but clear improvement over the past three or four years, in response to a gradual improvements in the policy environments. But even more far-reaching steps need to be implemented in order to improve the region's business environment and to reduce private investor perceptions of risk. Although the challenge is great, there is also great opportunity in the encouragement of private investment in infrastructure; the economy as a whole stands to benefit, and economic development can be increased through an improved access to capital and expertise, the promotion of competition, the reduction of operating costs, and the creation of greater investor confidence.

vii

I

1 Introduction

During the past five years or so, developing countries the world over have begun to liberalize markets for infrastructure services, with often dramatic results. In Chile, Argentina, Hungary; and the Philippines, among others, private sector participation in the power, telecommunications, transport, and water sectors has led to significant improvements in the quality and quantity of services provided. Such improvements have encouraged further policy liberalization and the likelihood of wider participation in many other developing countries. Private financing of infrastructure projects has in this way undergone a virtual revolution, as large volumes of funds are mobilized on a non-recourse basis for investment in projects in developing countries, and as the dominance of the state-owned sector is visibly reduced in a number of cases. At the same time, the progress has been relatively uneven. Although countries in Latin America and Asia have in many cases seen relatively rapid progress, the impact of these developments has not extended to all regions equally. In fact, this infrastructure revolution appears to have virtually

passed the African continent by, leaving behind the perception that it is a relatively unattractive investment location. Though this negative perception may not be justified in all cases, there is no denying that progress in attracting private participation in infrastructure has been very limited in sub-Saharan Africa. This paper looks at some of the factors influencing these perceptions, some of the real impediments faced by private entrepreneurs seeking entry into these sectors, and the steps that governments might take to establish a more attractive environment for private capital. The first part of the paper looks at the current state of infrastructure in the region, as well as the extent of private involvement. The latter sections provide an overview of the principal impediments to greater involvement of private capital and expertise. An annex, drawing on the worldwide experience of IFC and FIAS with respect to private infrastructure investments, reveals that most of the difficulties encountered in Southern and Eastern Africa are not at all unique, but tend to be problems with which developing countries all around the world are struggling.

I

2 The State of Infrastructure in the Region

The level of infrastructure provision in Southern and Eastern Africa is one of the lowest in the world. Most of the countries in the region face difficulties in the provision of basic services at an acceptable level of quantity and quality, whether in telecommunications, roads and transportation, electricity,or water and sanitation.

completion rate of only about 60 percent. Furthermore, the existing telephone companies tend to be highly inefficient, suffering from substantial excess manpower. An average employee in the region's companies was responsible for only 24 mainlines, while a colleague in middleincome countries handled about 88 mainlines.

Telecommunications

Electricity

Telecommunications services in the region are generally poor, in terms of both availability and quality. Excluding Botswana, South Africa, Namibia, and Swaziland, the average penetration rate is o'ily 0.5 percent, compared to an average 11 percent in middle-income countries. Even in South Africa, just 9 percent of the population has telephone connections. Overall, less than two people out of every one hundred in the region have a phone connection, compared to about fifty out of a hundred in Western Europe or North America (see Figure 1 and Annex 1, Table A). In addition, these small networks are characterized by outdated technology, which is highly unreliable. In 1993, mainline failure occurred on average 1.4 times a year, reaching in extreme cases a rate of 3.8 in Uganda and 2.5 in Zimbabwe. In Swaziland, a country with a respectable penetration rate, the failure rate reached 2.4. These technical difficulties are also reflected in low call completion rates. In Madagascar, for example, only 35 percent of all attempted local calls went through in 1992.Even South Africa's relatively large network had a call

The provision of electric power in Southern and Eastern Africa is similarly unsatisfactory. In 1992, electricity production was on average less than 600 kW/h per person, with production in Mozambique a mere 24 kW/h (see Annex 1, Table B). In comparison, middle-income countries generated more than 2,000kW/h per capita. In addition, the region's generation, transmission, and distribution systems tend to be old and inefficient,resulting in often substantial losses of generated energy, as much as 40 percent in the case of Uganda. These system losses have further limited the amount of energy available for production and consumption. Furthermore, in many countries consumers have experienced frequent power outages as well as voltage fluctuations, which damage electronic equipment and motors. This unreliability has forced many enterprises in the region to buy and install their own generators, raising their overhead costs. Most of the electric power utilities in the region are stateowned and typically too poor to upgrade their facilities since electricity tariffs tend to be set at highly subsidized rates. With prices insufficient

2

Figure 1: Telephone Networks by Continent (Linesper 100 inhabitants:1994data) 60 50.

30

20

.

.

_.

10

-

----.

...

0 Southem and Eastern

AsiaPacific

Latin America & Caribbean

Central and Eastern Europe

Western Europe

Nordh America

Africa Unionandthe WorldBank. Telecommunications International Sources:

to cover costs, electric utilities have been running continuous losses, which have had to be covered from the general state budget. Realizing the desperate condition of its power sector, the Ethiopian government recently decided to increase average tariffs by 60 percent over the next five years. Even so, tariff rates will still be no more than 72 percent of long-run marginal costs. Transportation The region's most severe infrastructural constraint is the road network, which carries the major share of passenger as well as freight traffic. The problem is not quantity as much as quality. Relative to GNP, sub-Saharan Africa has ten times more roads than France, for example, but only a small percentage of these are paved. Even in countries with a relatively extensive network, such as Botswana and Zimbabwe, only about 15 percent of all main roads have a paved surface. On average, the density of paved roads in the region is slightly below 800 km per million persons, compared to almost 2,900km per million in middle-income countries (see Annex 1, Table C). Even where paved roads exist, they are often in poor condition for lack of regular maintenance. In Zambia, for example, only about 12 percent of the network received the required maintenance

during 1991. Similarly, in 1989 the World Bank estimated that just 10 percent of Uganda's roads were in good condition. Most freight transport in the region is undertaken by truck because rail typically is not a viable alternative. Railroad companies tend to concentrate on passenger traffic and are not equipped to handle large volumes of freight. At the same time, most state-owned railroads are required to subsidize passenger traffic through relatively cheap fares, resulting in steady financial losses for the companies and limiting their ability to maintain the existing network, let alone upgrade or expand it. In Kenya and Tanzania, for example, only about half of all diesel locomotives were in use during 1993. Tracks, rolling stock, and traffic control systems are usually in unsatisfactory condition. At the same time, however, many governments find themselves forced to keep these enterprises in operation. For example, the southern branch of Madagascar's rail network, practically bankrupt, remains the main link between the capital and the country's main port, because the parallel road was not designed to handle heavy freight traffic. All countries in the region have at least one international airport as well as several smaller regional airports. However, few of them are capable of handling large amounts of traffic.

3

Many runways urgently need rehabilitation and expansion, and air traffic control systems are often outdated. Luggage and freight handling facilities, as well as the terminals themselves, tend to be too small. Businesses frequently complain about delays and an unreliable air freight service, which poses a major impediment to the delivery of intermediate and final goods. Sea transport is the major transportation mode for exports and imports. However, port productivity is, on average, only about a third of international norms. Poor management, excessive bureaucracy, and inadequate availability and reliability of equipment pose significant obstacles to international trade. Delays in clearing goods are frequently a problem; for example, traders expect a shipment from Europe to Kenya to take about six to eight weeks until they have the goods in their possession, with three to four weeks for the sea transport itself and the same amount of time needed for goods clearance. Transportation difficulties are compounded for land-locked countries by problems in intermodal transport. Countries like Malawi, Uganda, Zimbabwe, and Zambia depend on good connections with African ports in neighboring countries to ensure reliable delivery. In many cases, railroad systems differ among countries, schedules are not coordinated, and even in transport by road, goods tend to be delayed by customs controls. A Ugandan businessman, for example, has to wait about three and a half months from the time of shipment departure from Europe until arrival in Kampala, three times what would be needed under comparable conditions elsewhere in the world. Water Water supply and treatment are also deficient in the region. In 1991,only about 44 percent of the region's population had access to safe water, with this share being as low as 15 percent in Uganda and 17 percent in Ethiopia (see Annex 1, Table D). Often, even urban households do not have access to piped water. In Uganda, for example, only about 20 percent of urban households have in-house water connections. Water treatnmtent is often worse: in 1990,just 13 percent of all Namibians and 15 percent of all Malawians had sanitation services. Most of the water pipe networks are old and urgently require repair and replacement to avoid the often substantial water losses, but even rehabilitation plans are difficult

4

to implement. In some cases such as Angola, the water supply and sanitation system is so old that plans for the existing pipeline network are not available. This situation forces many companies and the more affluent members of society to provide their own water and sanitation facilities. Infrastructure weaknesses pose fundamental social problems and also constitute a major impediment to economic growth, since a great deal of economic activity is highly dependent on the reliable provision of these services. If manufacturing units do not have access to adequate telecommunications services and modes of transportation, their ability to stay in touch with clients and suppliers will be severely limited. If they cannot rely on an adequate and reliable supply of power and water, their output will suffer from frequent breakdowns of the production process and higher production costs. Thus, many promising ventures will be uncompetitive or even impossible. Many foreign investors are hesitant to operate in the countries of the region precisely because of these difficulties. A recent surveyl of foreign investors in five East African countries-Ethiopia, Eritrea, Kenya, Tanzania, and Uganda-showed that the current state of the infrastructure was one of their main concerns. Of the almost one hundred companies interviewed, two-thirds ranked infrastructure as a serious constraint in future operations in the region. Although uncertainty regarding the political and policy environment aroused the most concern, difficulties with infrastructure services ranked a close second (see Figure 2). Unreliable power supply and telecommunications services, as well as the poor quality of roads, were considered particularly damaging. What are the reasons for such a disappointing performance? As in most other developing countries, the governments in the region have traditionally assumed responsibility for almost all of these infrastructure services through stateowned enterprises. These public entities were created precisely in order to make socially productive investments so as to eliminate impediments to the overall economic development. However, as part of the public sector, these enterprises tend to suffer from multiple, and often conflicting, objectives. Besides trying to provide a particular service at an acceptable quality, they are also expected to pursue a variety of "social" goals, including the creation of employment and the subsidization of prices to consumers,

Figure2: Infrastructureas an Impediment to Foreign Investment (Basedon survey in Ethiopia,Eritrea,Kenya,Tanzania,Uganda)

Political and Policy l Uncertaintyj...X Power Breakdowns/ Voltage Fluctuations Average Basic Infrastructure Quality of Roads Telecom Problerms Quality of Port Handling Facilities Average Transport Infrastructure Lack of Road Transportation Quality of Rail TranspDort

Water Supply Problems Waste Treatrnent Problems 0

0.5

1

1.5

2

2.5

3

3.5

Nvote: Scaleranges from 0 to 5, with5 indicatinga 'very senous obstacle' to future operations Source:EconomistiAssociati,"EasternAfrica - Suvey of Foren Inestors', Vol3, Tables82, &7 and 9 1.

ostensibly with the view to providing broad and affordable access to the poorer parts of society. These objectives have in reality imposed a variety of costs on the enterprises. In many of the region's countries, the use of public enterprises as a major employment mechanism has resulted in significantly bloated workforces. Similarly,the subsidization of services in reality often allows the more affluent citizens to benefit disproportionately from artificially low prices by providing them with better access to these services. In Lusaka, Zambia, for instance, only 28 percent of the households in the poorest fifth of the population have access to electricity, compared to 70 percent in the richest segment. Similarly, it has been estimated that the poorest fifth of the population in Tanzania receives only about 10 percent of the government subsidy for water, whereas the richest fifth receives about 40 percent.

At the same time, these subsidization policies have invariably translated into smaller revenues. Prices of electricity in Southern and Eastern Africa have typically been only around 3 to 4 cents per kW/h, compared to 8 or 9 cents, or higher, in the industrialized countries. Prices as low as this have been insufficient to generate revenues adequate to cover long-run marginal costs, taking into account asset depreciation. These problems are often further exacerbated by difficulties in bill collection. In Uganda, the government raised electricity prices closer to long-run marginal costs, but only 67 percent of the energy generated is billed, and barely more than half of all bills are usually collected each year. Public utilities have thus often found themselves in the difficult financial position of not being able to cover their operating expenses. It has not been possible in many cases to maintain

5

existing facilities adequately, and new investments have consistently had to be postponed. At the same time, most governments have suffered from chronic budget deficits, which have kept them from filling the financial gap. In the end,

6

countries have been left with inadequate infrastructural facilities, while the responsible enterprises, not motivated by commercial objectives, have had little incentive to improve their performance significantly.

Improving Infrastructure through Foreign Direct Investment Although the infrastructure problems of Southern and Eastern Africa may be severe, they are not urique; most developing countlies are stLuggling with the consequences of inadequate infrastructure services. In recent years, however, many have realized that competition and the involvement of the private sector offers the advantages of much better service at lower prices, and help to free up scarce governmental budgetary resources for other social investments. Several countries have in this way seized the opportunity to make greater use of the private sector to finance and operate projects that can be run on the basis of commercial principles and have been successful in improving their provision of infrastructure services. Faced with a major power crisis in the early 1990s, the Philippines for instance initiated a massive program to attract private investment in new projects to increase capacity and in the rehabilitation of existing utilities. The country managed to resolve the crisis by adding about 4,200 MW of new capacity in 25 power projects. Another 20 projects involving 5,800 MW of new capacity are currently under preparation. Similarly, Argentina's government set into motion a massive privatization program in 1990 in an attempt to drastically improve the economy's efficiency and generate urgently needed financing. Infrastructure enterprises played a key role in the program, attracting substantial interest from foreign investors. By end-1995, privatization in Argentina's power and telecom sectors alone resulted in cash payments and external

debt reductions of $14 billion, while concession agreements in the transport sector generated another $13 billion in foreign investment. While the Philippines and Argentina are among the most aggressive countries in trying to attract foreign investment into their infrastructure sectors, their efforts reflect a global trend. The World Bank's Private Infrastructure Project Database shows a total of 1,170 privately financed infrastructure projects worldwide during the period from 1985 to 1995.Although data on costs are patchy for many countries and projects,2 it is clear that private sector involvement in infrastructure has been adopted most extensively in the East Asia/Pacific region, Western Europe, Latin America, and the United States (see Table 1). These four regions account for 95 percent of the $450 billion of private infrastructure financed over the past decade. As Table 1 shows, however, private involvement in Africa's infrastructure has been quite limited. Of the sixty-four projects recorded for sub-Saharan Africa as a whole, only seventeen are located in Southern and Eastern Africa, and these projects are concentrated in only six countries. Moreover, most of them have been in the form of management contracts and have not resulted in large amounts of new investment. The most extensive project is the operation of ten toll roads in South Africa, only one of which is actually privately owned. In Queenstown, South Africa, the French company Lyonnaise des Eaux has an operation and management contract to operate that city's water system. Aeroports de 7

Box 1. Private Providers Solving Public Problems Africa needs more infrastructure and better standards of service at acceptable price levels. Many countries around the world have involved the private sector in infrastructure provision and realized remarkable efficiencygains. Water:In 1993, private firms competed for a thirtyyear concession to run the Buenos Aires water and sewerage network. The bidders competed against each other to offer the lowest tariff, and the winner's rate was 27 percent lower than pre-existing municipal rates. The winning firm also committed to $4 billion of new investments and eliminated the need for government subsidy. In addition, they achieved the first summer in years without water shortages and the elimination on raw sewage disposal in the bay. Furthermore, the workforce was cut in half through voluntary retirements. Telecommunications:Hungary has reformed its entire telecommunications industry by permitting private cellular companies to enter the market, by creating private regional concessions to provide

Paris has a lease agreement with the government of Madagascar for the operation of the country's twelve major airports. Mozambique has privatized several port terminals under concession agreements of ten to fifteen years. In many cases, however, operation of these terminals has been contracted out to the previous main user of the facilities, resulting in vertical integration rather than the introduction of private competition.

local services, and by privatizing the main operator. The sale of the state-owned operation raised nearly $2 billion for state coffers and resulted in commitments to expand the number of lines by 15 percent a year. In 1995the private operator actually increased the number of lines by 24 percent. Power:By the end of the 1980s,the Philippines was experiencing severe power shortages and invited a private firm to build a small power station and operate it for ten years before transferring it to state ownership (BOT). The success of the project contrasted with steadily worsening power availability countrywide from state-owned electric utilities, and spawned twenty-fiveother BOTarrangementsto provide around 4,200 MW of new electricity generation. While the first few arrangements provided power at around 8.5 US cents per kW/h, the benchmark price has since dropped to around 5 cents per kW/h. Power outages have virtually disappeared, saving the country an estimated $1 billion a year in economic losses.

Three countries in the region-Madagascar, South Africa, and Tanzania-have awarded licenses for cellular telephone services to foreign operators. Several countries in the region are currently preparing BOT agreements for private power generators. The most advanced of these is Tanzania's Songo-Songo project, a 142.5 MW power plant near Dar-es-Salaam that will be supplied from a gas field off Songo-Songo Island.

Table 1. Private Infrastructure Projects Worldwide, 1985-95 Cost US$ billion

Region

Numberofprojects total with projectcosts

East Asia/Pacific OECD Europe Latin America USA/Canada South Asia Middle East/N. Africa C&E Europe Former Soviet Union Other sub-Saharan Africa Southem and Eastem Africa

223 252 233 290 27 13 38 30 47 17

165 145 168 219 13 7 18 14 6 1

185.6 156.6 58.5 31.1 6.3 4.7 3.5 2.5 1.1 0.1

1,170

756

450.0

Total

Source: WorldBankInfrastructureProjectDatabaseand FIAS,WorldBankGroup.

8

4 Scope for Private Infrastructure Investment in Southern and Eastern Africa Why have private investors not yet seized the opportunity to develop Africa's infrastructure markets, as they have done in Latin America and elsewhere? According to World Bank estimates, African economies are expected to grow at about 4 percent annually over the next two years, and Southern and Eastern Africa are expected to perform slightly better than that. The rates compare favorably with a realized growth rate of only 1 percent in 1994 and an average of 2.2 percent per year during the period from 1974to 1990.While the countries of Southern and Eastern Africa certainly are at a lower stage of economic development compared to most other regions in the world, their potential for future investments appears to be steadily improving. Despite this promising outlook, most private investors do not consider Southern and Eastern Africa an attractive location for infrastructural investment at this time. One argument frequently advanced is that the region's low average income means that effective demand for infrastructure services from African consumers is lower than demand estimated on the basis of notional consumer "needs". The fragmentation and small size of markets would almost certainly impose economies-of-scale constraints sufficient to affect the viability of some types of ventures. Another argument is that the average level of infrastructure provision in the region is similar to that of other countries at similar income levels, and that infrastructure should only expand as income expands. While this may be true in general, such arguments are not equally applicable to all ventures in Africa. A casual analysis of

the evidence suggests that there may well be substantial excess demand in some sub-sectors and also some services that could be supplied commercially. Indications in the telecommunications sector, for example, are fairly positive. Telephone usage in most countries tends to rise as per capita income increases. However, in Africa, differences among countries at the same income level are revealing. Malawi, with about the same per capita income as Uganda, boasts a penetration rate almost triple that of Uganda. Kenya, only slightly better off than Malawi, has a penetration rate two and a half times higher. Botswana has one of the highest line penetrations in the region, but, by contrast, Chileans have access to twice as many lines, even though per capita incomes are the same. Following the privatization of Chile's telecommunications company in 1987, the number of telephone lines doubled in four years. The existence of a robust potential market for telephones is supported by the fact that African consumers are currently paying a substantial amount to use a telephone. Average rates are comparatively high, especially for international calls. There are nevertheless long waiting lists, reportedly up to five years in some countries. And cellular systems, which are much more expensive than line-borne calls,have witnessed a burgeoning demand in several African countries, often far in excess of expectations. A private cellular operator in one East African country found that $900 handsets were in high demand, with locals rather than expatriates composing the largest customer group. Similarly, cellular 9

operators have found Ghana a highly attractive market, and an increasing number of operators are competing for market share, resulting in lower costs and higher penetration. At lower, more competitive prices, a rapid doubling of telephone penetration in the region does not seem to be outside the realm of possibility. Some anecdotal evidence suggests that there is also a strong market potential in the water sector. Even the poorest consumers appear to be quite willing to pay comparatively high prices to have access to clean water. In Angola, for example, inner-city residents of Luanda pay the ridiculously low price of $0.0015per cubic meter, while people on the outskirts of the city have to rely on water supplied by private trucks at prices up to almost $17 per cubic meter. Similarly,in Maputo, Mozambique, poorer consumers, with no access to piped water connections, pay up to $10 per cubic meter for privately marketed water, a figure 600 times that charged for piped water. Private customers also appear quite willing to pay for a reliable supply of electric power. Private companies and individual households in most countries in the region install individual power generation units simply to bridge periods of blackout or to avoid damage from power fluctuations. Compared to the power supplied by large state-owned utilities, independent power generation is far less efficient and substantially more expensive in terms of capital as well operating costs; it is about 100 times more costly in the case of Kenya, for example. The average generator installed by small- and medium-sized enterprises in Uganda costs about $25,000new and needs another $10,000annually for fuel and maintenance. There is no doubt that demand for expanded and improved infrastructure projects does exist in the region. What would it cost to meet this demand? Assuming that the stock of infrastructure will have to double over the next decade in order to sustain economic growth of about 5 percent while satisfying the needs of a population growing by about 3 percent annually, investment expenditures for infrastructure in telecommunications, power, and water alone will be in the range of $25 billion.3 If these investments were to be handled in the state-owned sector, the region's governments would thus have to mobilize $2.5 billion annually, equivalent to about 5 percent of GDP or 40 percent of concessional official development loans each year. Given that governments have many other priorities,

10

including social expenditures and the maintenance of the existing infrastructure, such an expansion would clearly be beyond the capacity of the public purse. As a result, an increasing number of countries are now seriously considering the involvement of the private sector as a way to ameliorate the pressures of an inadequate infrastructure. Private involvement can come either through the entry of new competitors into a market monopolized by state-owned enterprises or via the privatization of these enterprises. At the present time, some 40 privately funded projects-involving both privatization and new entry-are under discussion in different countries in the region.4 A key question for governments is how to maintain a socially acceptable provision of services while switching from public to private operators. It is now recognized that appropriate regulation can generate and maintain competition, given that continued competition among suppliers is the surest way of guaranteeing the best deal for the customer. Cellular suppliers compete against line-based carriers. Independent power producers can compete to sell power to the national grid. Railroads compete against truckers. In the telecom sector, licenses for cellular services are under preparation in a number of countries, including Kenya, Madagascar, Uganda, and Zimbabwe. Angola, Mozambique, Tanzania, Zambia, and Zimbabwe are preparing BOT agreements for power plants. Competition, however, may not always be a viable option. In some cases, markets are simply too small to allow for more than one operator, despite recent technological innovations that limit the need for economies of scale. With the exception of South Africa, the economies of the region are small by world standards, and African governments will therefore have to depend on good regulation to deal with monopoly suppliers of infrastructural services. This also emphasizes the need for privatization of existing assets rather than the construction of new facilities. Privatization is, however, politically more difficult than competition because it carries with it associations of "selling off the family silver". In addition, a number of interest groups exist, such as the managers and employees of the stateowned enterprises, who would not immediately benefit from-and would hence oppose-a sale. A further constraint is that the purchase of existing assets, involving the inheritance of existing staff, technology, and management, is often

much less attractive to private sponsors than the complete flexibilityallowed by a greenfield project. About a third of all the future infrastructure projects currently under discussion in Southern and Eastern Africa are potential privatizations. During the first half of 1996, Kenya successfully completed the sale of Kenya Airways, and the country may also privatize its state-owned telecom operator. Madagascar, Swaziland, Uganda, Zambia, and Zimbabwe are also in the process of evaluating the possible privatization of their telecom monopolies and Zambia's major power utilities are potential privatization candidates as well. The sale of South Africa's large public monopolies in power, telecommunications, and

transport is a possibility, despite protracted political debates in the country, and Mozambique is planning to give the private sector the responsibility for managing transport links between Maputo and South Africa. Many of these projects, whether privatizations or greenfield investments, have been in the "potential" category for quite some time, however. Why have they not yet become realities? The following sections focus on this issue, arguing that the central problem lies in the divergence of the goals and objectives among the parties involved in such projects, as well as in misperceptions about the capacities and responsibilities of each.

11

5 Bringing in the Private Sector

Goals and Expectations Private participation in the ownership and operation of infrastructure services is still relatively new in developing countries, and the last five years have seen a great deal of learning-bydoing. For example, the first private concession to manage, operate, and expand an urban water and sewerage system (as distinct from contracts limited purely to the management of such systems) was not structured until 1993, for the Buenos Aires water supply in Argentina. A body of knowledge on how to promote and manage private investments in infrastructure has developed only recently. At the same time, the circumstances of individual countries entering this arena are quite different. Strategies are not designed in a vacuum, and the best practices for one country may not be appropriate, or even feasible, in another. In Africa, as anywhere else, strategies designed to introduce private involvement into the infrastructure have to be tailored to specific circumstances. At the same time, however, all these projects are characterized by certain commonalities, built around the two primary groups of players involved. On one side is the government, representing the consumers of existing infrastructure services, the managers and employees of the state-owned enterprises that provide the services and the government agencies that own these enterprises and that set the rules for service provision. Large parts of the population have no access to infra-

12

structure services or suffer from the low quality of the services provided. However, not everybody benefits immediately from privatization. Connected consumers who have typically enjoyed artificially low, subsidized tariffs are often vocal in their resentment over price increases. Managers and employees of stateowned enterprises who have typically enjoyed job security, good remuneration, and a range of social and economic benefits, would tend to resist any change of the status quo, be it through privatization of the enterprise or through increased competition from new market entrants. Governments are the brokers of these interests, and civil servants the implementors of government policy. But even this group is not monolithic, and while some may seek to serve the national interest by resisting private-and especially foreign-operators, others are simply trying to protect their own institutional turf or even to extract profits from the control they enjoy. On the other side are the private investors; they are united by their commercial principles and by a desire to balance risks and returns. Beyond this, they are fairly diverse players. The two main groups involved are sponsors and lenders, with their individual interests defined by their risk-reward perceptions. Because they have different roles in such projects, their objectives and concerns are not always identical, and call for differentiated policy responses from the governments concerned. Sponsors, who provide the major share of the equity financing, are typically large international

project development companies. They are usually willing to take some amount of risk as long as it is compensated by higher returns on investment. The structuring of the project and its management is therefore critical to them in order to assure profitable long-term operations. Because of the relatively long time span of such investments, sponsors are especially concerned with establishing a viable framework over the lifetime of the project. This involves the creation of reliable partnerships with other companies responsible for the financing and the construction and maintenance of the assets. Sponsors also look for a reasonably predictable business environment. Doubts about market rights, pricing, and the future adjustment of tariffs, as well as the adequacy of the legal arrangements, including the neutrality of a country's judicial system, can all affectperceptionsof risk and expected profitability. Commercial lenders, on the other hand, are relatively risk-averse, particularly for longerterm loans. Their caution is natural, since, unlike sponsors, they do not exercise direct control over operations nor share in the profits. They do share, though, in all of the downside risks, given that their financial return is entirely dependent on loan repayments, which have to be generated through the project's cash flow.Lenders have typically provided between half and three-quarters of the financing of most infrastructure projects, especially since domestic capital markets in developing countries have tended to be small. While the cautious and selective approach of commercial lenders often makes it more difficult to develop a project, they have a valuable role to play. A key priority for them is to ensure that the project, as set out at its inception, will generate an adequate and reliable cash flow. This means not only that the project must be technically viable, but also that the environment in which it will operate is sufficiently stable. In particular, lenders will want to make sure that the project is perceived as fair by the government and consumers. Popular resentment against such foreign-owned and financed infrastructure projects can easily lead to regulatory changes that could adversely affect future cash flows and the company's ability to service the loans. From the perspective of Southern and Eastern Africa it is important to note that, with the exception of certain projects in South Africa, no project in the region has yet managed to include commercial lenders. Most projects have tended to be small by world standards and fully

supported by sponsor equity, supplemented by loans from bilateral and multilateral agencies. However, for any larger project, debt financing will be essential. At present, it appears that most investment bankers simply consider Africa as a whole to be too risky to support any mediumterm project financing. If private participation in infrastructure is to succeed to any real degree in the region, this perception will need to be addressed and changed. Constraintsand Impediments Most investors would probably consider subSaharan Africa as the riskiest region in the world. In September 1995 the Institutional Investor Index gave the nations of Southern and Eastern Africa an average score of 23.6, significantly below the global average of 38.5 for 135 countries (with the score of 100 representing a perfectly risk-free environmerit). There was, however, a wide divergence among the African countries, and four countries in the region received no rating at all. Angola was given 11.3, making it 122nd in the world, while Botswana on the other hand had a score of 49.0, placing it 43rd (see Figure 3). At the same time, country risk in almost all of the region's countries has fallen more quickly recently than in the rest of the world. While the index has improved globally by 2.6 percentage points over the last three years, the area of Southern and Eastern Africa has improved by 5.6 percentage points. Only for Angola has the score dropped, thanks to the protracted civil war. Botswana's rating improved by an impressive 13.7points, and perceived risk also has fallen substantially in Swaziland, Uganda, and Ethiopia. The decline in the area's country risk index indicates that in the eyes of private investors, the region has more than recaptured the ground yielded during the "lost decade" of the 1980s.In fact, some countries in the region are slowly gaining consideration as an attractive investment location. If governments can take the actions necessary to address the key factors influencing investor perceptions of risk, particularly of political and non-conmmercialrisk, there is no reason why private capital cannot be attracted to these countries on a more sustained basis. Of course, government actions are themselves determined by an assessment of risks, primarily political and social. The withdrawal of political support by disaffected groups, pressures from

13

Figure 3: Institutional Investor Index for Southem and Eastern Africa Institutional Investor Rating, September 1995 122

Angola Mozambique Uganda Ethiopia Zambia Tanzania

_

_

120 119 118 115 108 E_ 100

Malawi Kenya Regional avenage Swaziland Zimbabwe Global avenage: South Africa Botswana

~~l

77 73 66

_

47 43

0.0

10.0

20.0

30.0

40.0

50.0

60.0

Three-YearChangein the Institutional Investor Rating Angola Global avenge Ke'nya. Maladv Tanzania Zimbabwe Mozambique_ South fic

i

Zarnia. Regional aves er

countries rated~ -4.0

Ethiopia Uganda Swaziland ~Botswana_ ric -2.0 0.0

_ 2.0

_

___ 8.0 4.0 6.o Change in Percentage Points

10.0

12.0

14.0

tO the rightof the barsindicatethe country'srankingamongall 135 NVote: A scoreof '100' mclicatesa perfectlynsk-freeenvirorlnent Num'oers countriesrated Source Institutional InvJestor

protectionist business concerns, and dernonstrations against price increases are a few examples of the kinds of risks governments run when they contemplate making an investment of political capital in policy reform. If there has been an improvement in investor perceptions of Africa, it has been because an increasing number of African governments have in fact shown themselves ready to take on the political risk of economic reform measures.

14

However, the ability to attract private risk capital from international sources does not only depend upon factors contributing to generalized country risk, but also on project specifics. Infrastructure projects in particular, involving relatively large capital outlays and longer-term finance, are very sensitive to non-commercial risks of all kinds, and pose a number of additional obstacles to investors. The manner in which a government helps manage and mitigate

these risks has an important bearing on whether or not investors will find non-commercial risks for a given country acceptable. In practice, there are numerous stumbling blocks on the road to the private provision of infrastructure that go beyond general macroeconomic policies and political stability. Investor interest in a country is a function of various factors including perceptions regarding the nature and the transparency of the business environment. The experiences of even the relatively few projects that are under negotiation, and the difficulties encountered-which may have resulted in costly delays-can play a major role in influencing these perceptions. The most commonly encountered difficulties in Southern and Eastern Africa include the following: Lack of Government Commitment:Foreign investors often encounter a difficult, and occasionally hostile, environment during project preparation and operation. Even when the government publicly expresses its commitment to such projects, difficulties can arise within sectoral line ministries or at the regional or municipal level. Many investors are thus left with doubts about the goverinent's willingness to introduce private infrastructure operations, and even about the government's true commitment to its obligations in a project. In Uganda and Kenya, for example, project developers experienced substantial resistance from line ministries or state-owned enterprises despite expressions of full support for their projects by the president himself. True commitment requires more than rhetoric: it is reflected in matters of detail, and calls for consistent policies over time, as well as at all levels of government. High transaction costs and uncertainty in dealing with governments:Sponsors of projects in Africa often find themselves confronted with a bewildering array of red tape. Few governments in the region have developed clear guidelines for attracting infrastructure investors or have established a coordination office. In some sectors it may not even be clear whether private entry is permitted. Sponsors therefore often face the prospect of spending large amounts of time and money in negotiating permission to proceed from government ministries, local government offices, and state-owned enterprises. As most of these entities are themselves undergoing major transformation, sponsors often encounter frus-

trating changes in key personnel and policies. Cellular operators who try to develop projects in several countries in the region are often daunted by the lengthy licensing and approval process. Similarly,power developers frequently complain about the lack of technical and financial expertise of their counterparts, resulting in protracted delays in the project development phase. Governments often overlook the fact that higher development costs eventually translate into higher project costs and tariffs, that is, if the efforts of the private developers result in concrete projects at all. A ReliablePrivatization Program:When deciding to invest in the privatization of existing public enterprises, investors are particularly concerned about the reliability and effectiveness of the sales process. In practice this means the clear definition of key issues, namely (i) the degree of access to certain sectors through the elimination of monopoly arrangements, (ii) the decision-making authority on privatizations or project finance transactions, and (iii) the precise procedures by which individual projects are awarded. Especially in African privatizations, the process tends to suffer from political indecisiveness, interference, and apparently arbitrary decision-making by government authorities; investors are therefore reluctant to participate. The lengthy political debate on whether or not to privatize the infrastructure enterprises in South Africa has not improved investor perceptions of government commitment. Similarly,complaints about irregularities in the sale of commercial enterprises in countries such as Kenya, and the lack of a fullfledged privatization program in Angola, have intensified investor concerns regarding the fairness and reliability of future infrastructure privatizations. Non-TransparentNegotiations:In the face of a policy and procedural vacuum from the government side, individual sponsors and project developers frequently contact government agencies directly, proposing and negotiating individual projects. Sometimes this has proved to be an effective way to focus attention on the issues to be resolved, and to make progress towards achieving financial closure. In other cases, this process has aroused opposition from critics complaining that deals have been negotiated in secret and may have been based on illegitimate procedures. For example, the sudden appearance

15

of a private power project in Uganda, outside of the standard procedures applied to other projects, raised suspicions of irregularities. Foreign investors in Zimbabwe are complaining frequently that the tendering system is not open and fair. In October 1996,for example, President Mugabe decided to sell 51 percent of the Hwange power station to a Malaysian company outside of the established tendering procedure, resulting in vigorous protests from the investor community. Automaticity, transparency, and predictability are keys to the development of an attractive framework. Investors have tended to stay away from countries where selection is perceived to be based more on the strength of political ties and other non-transparent criteria rather than on technical and financial merits. Limited Domestic Entrepreneurship:Although the number of domestic entrepreneurs in many African countries has begun to take off, nurturing a home-grown business community takes time. To varying degrees in different countries, there are few entrepreneurs with the financial strength and technical expertise to be able to operate infrastructure facilities. Under such conditions, investors tend to hesitate when confronted with regulations forcing them to join forces with a specific domestic partner. Potential investors in Zimbabwe, for example, are concerned about the effects of the government's "indigenization policy", and the lack of a concise description and definition of this policy does not help to improve investor confidence. Popular Resistance to High Returns and Market Pricing:Many governments in the region are concerned about the tariffs for services that would be provided by private entities. Pricing at commercial rates often conflictswith existing policies of subsidized tariffs, and governments tend to suspect that these prices are the result of excessively high rates of return demanded by private operators. Investors, on the other hand, believe that this perception results from an insufficient understanding by government officials of underlying market forces, which require these profit margins as well as take pricing market in order to attract partners and lenders to these projects. Weaknessof Domestic FinancialInstitutions: Most infrastructure investors send their bills in domestic currency, and such projects are hence most sensibly financed in domestic currency. The

16

sort of long-term finance they require is typically difficult to arrange domestically, however. In many countries the banking system is facing grave difficulties because government borrowing has pushed up interest rates and banks with cash to spare have a limited appetite for longterm project finance. The domestic interest in bond issues is also limited, although there are indications that it is growing. Pension funds and insurance companies, which would seem to be logical sources for term finance, are often either under-funded or prohibited by government regulation from project lending. EnsuringConvertibilityand Transferability: Foreign investors need assurance that they will be able to convert project revenues into foreign exchange that they can repatriate. Mainly due to balanceof-payments concerns, several countries in the region still impose limitations on profit repatriation, and even in countries where legal restrictions do not exist, actual conversion of funds is often difficult. Investors also face the danger of large exchange rate fluctuations, jeopardizing the adequacy of the project's cash flow in hard currency. Thus, many investors are hesitant to engage in projects where transferability and convertibility remain uncertain. The government of Tanzania, for example, has wanted to involve the private sector in the Songo-Songo project since the discovery of the natural gas field in 1974. However, major difficulties arose in trying to create an acceptable framework for currency transferability and convertibility. At present, the project is being developed with the help of the World Bank and may be concluded soon through the innovative use of World Bank guarantees and the creation of an escrow account abroad. However, not many investors would be as patient as in this particular case if a reasonable solution cannot be found promptly. UnclearRegulatoryFrameworksfor Service Provision:A primary concern for any investor in infrastructure projects is the extent to which the future business environment will be reasonably predictable. Investors want a well-developed and reliable framework of regulations. However, countries in Southern and Eastern Africa do not have a strong history of regulation and enforcement. Regulatory agencies often do not exist, and when they do exist they tend to suffer from a severe lack of qualified manpower and expertise. The future environment for projects is thus

uncertain, especially with respect to tariff adjustments over time. While some of these problems can be solved by incorporating solutions in project-specific contracts and concession agreements, the lack of an overall framework is disconcerting to many potential investors. Concernsover the Adequacyof the LegalFramework: Many investors have doubts about the efficacyof the current legal framework in most of the countries in the region. Concession laws that spell out the rules for private participation, including the definition of the responsible government agency, rules for project bidding and tendering, and a

description of the circumstances under which concessions can be modified or canceled, often do not exist. In Uganda, for example, potential investors in the power sector are concerned that it is unclear whether private operations are actually possible under the existing legal regime. The definition of rights and guarantees, including the ownership of land and assets, is also of key importance. Disputes can arise even under the best contractual and regulatory setup, and legal recourse is therefore important to all parties involved. Investors often doubt the neutrality and independence of the local judicial system and press for international rules of arbitration.

17

Conclusion

While private investment in infrastructure projects is booming across the globe, it is lagging in Southern and Eastern Africa. The riskiness of the business environment, combined with legal, regulatory, and procedural impediments, have frequently made it difficult for investors to develop specific infrastructure projects. Conditions are improving, however, and an increasing number of countries are looking for private sector solutions. To facilitate private investments in infrastructure, the countries in the region clearly need to improve their policy environment. The challenge of the imperative also presents opportunities for

Figure 4: The Virtuous Circle *Infrastructure

Privatization

*Deeper

Domesitic

_

*

_

*Accessto

Capital Markets

Foreign Capital&

i * Stronger Consumer Report

~~~~Expertise

*

Investor

*Improved Quality, Efficiency& Competitiveness

18

^

Perceptions

the country: governments can use private infrastructure projects as an integral, highly visible element of their overall development process. The demonstration effect of a successful project can improve not only infrastructure but also investor perceptions of the country as a whole. Those countries that manage to jump on the "virtuous circle" offered by a commitment to infrastructure privatization (see Figure 4) may achieve rapid improvements in other areas important to the development of the private sector, including a strengthening of capital markets, improved access to international finance and expertise, and the strengthening of the legal and institutional framework for their businesses.

Notes

1. EconomistiAssociati, "Eastern Africa-Survey of Foreign Investors", The World Bank, Washington, D.C., September 1994.

4. Based on the "World Bank Infrastructure Project Database". 5. Every six montns, institutionai investor asks 100

2. For some projects, cost information is simply not available. In other cases, project costs might actually be negligibly small or even zero because the arrangement does not involve initial investments from the private investor or operator.

international banks to score almost every country in the world from 1 to 100, according to the perceived likelihood of the country's default on its debts. While this index only reflects one particular angle on the business environment in a country, it is a useful index of country risk.

3. These estimates exclude South Africa.

19

Annex I Infrastructure Indicators for Southern and Eastern Africa Table A. Telecommunications

Country

Telephonemainlines Callcompletion Faultsper 100 per 100 persons rate(% of localcalls) mainlinesperyear (1994data) (1992data) (1993/4data)

Mainlines peremployee (1993data)

Angola Botswana

0.53 3.1

52.0 n/a

150.0 55.0

25.0 27.0

Eritrea Ethiopia Kenya Lesotho Madagascar Malawi Mozambique Namibia South Africa Swaziland Tanzania Uganda Zambia Zimbabwe

0.59 0.26 0.85 0.64 0.27 0.35 0.37 4.5 9.0 2.0 0.31 0.12 0.91 1.2

n/a 50.0 57.0 89.0 35.0 62.0 n/a n/a 61.0 63.0 82.0 45.0 n/a n/a

n/a 74.0 n/a n/a 78.0 n/a 90.0 78.0 n/a 238.0 n/a 380.0 33.0 254.0

n/a 25.0 16.0 13.0 14.0 8.0 25.0 36.0 61.0 31.0 18.0 17.0 25.0 25.0

SEA Average

0 .5 3a

59.6

143.0

24.4

55.4

88.3

Middle Income Country Average

11.0

9 8.0b

Notes:a: excludes Botswana,South Africa, Namibia and Swaziland; b: high income country average; n/a-data not available. Sources:WorldDevelopmentReport1995,International TelecommunicationsUnion, and World Bankstaff members.

20

TableB. Electricty Electricity productionkWh/cap (1992data)

Country

Systemlosses% of totaloutput (1992data)

Angola Botswana Ethiopia Kenya Lesotho Madagascar Malawi Mozambique Namibia South Africa Swaziland Tanzania Uganda Zambia Zimbabwe

194 390c 2 5a 130 n/a 47c 8 5c 24 n/a 4,329 n/a 66 46c 900 790

6 3a 16 1 2d 17 19 24 n/a 7 10 b 12 40 11 7

98 955 18 148 168 47 54 60 1,256 3,901 842 66 n/a 937 863

SEAAverage

585

14.4

672

2,144

11.8

n/a

Middle-Income Country Average

18 C

Electricity consumption kWh/cap(1991data)

Notes:a:includesEritrea;b: 1991;c: 1990;d: 1988

TableC. Transportation

Country

Roaddensity Roadsin good %of road Maintenance km pavedroads condition budget Shortfall% permillion % of going to actual persons pavedroads maintenance Irequired (1993data) (1989data) (1991-92data) (1991-92data)

% of roads that are paved (1992-93 data)

% of main roadsthat arepaved (1992-93 data)

Railways: dieselsin use% of diesel inventory (1993data)

Angola Botswana Ethiopiaa Kenya Lesotho Madagascar Malawi Mozambique Namibia South Africa Swaziland Tanzania Uganda Zambia Zimbabwe

816 2,022 75 334 315 366 277 277 2,722 1,433 765 129 120 744 1,360

n/a 94 47 32 53 56 56 19 n/a n/ae 35 39 10 40 70

n/a n/a n/a 25 n/a 15 n/a n/a n/a n/a n/a 42.5 13.4 32.6 36.3

n/a n/a n/a 22 n/a 29 n/a n/a n/a n/a n/a 41 33 12 73

n/a 13 . 3 c 15 13.3a 15 15.4 18.6c n/a 10 . 7b 3 0 .4 a 58.6 4.2 8.5 17.6 16

50.2 15.8 29.3 13.6 25.6 31.0 25.3 34.6 n/a 91.9 25.0 12.0 26.0 30.8 44.8

n/a n/a 60 52 n/a n/a 70 n/a 88 83 n/a 52 64 71 80

SEAAverage

784

46

27.5

35

18.1

32.5

60

2,881

45.7

Middle Income Country Average

n/a

n/a

9 1 .7 d

9 8d

69

Notes:a: 1991;b:1990; c: 1988;d:WesternEuropeanAverage;e: 5%areconsidered"poor";n/a -data notavailable. Sources:WorldDevelopmentReport1995, WorldRoadStatistics1989-93,and World Bankstaff members.

21

TableD. Water

Country

% ofpopulation % of households with access with houseconnection tosafewater towatersupply (1991data) (urban1992data)

Angola Botswana Ethiopia Kenya Lesotho Madagascar Malawi Mozambique Namibia South Africa Swaziland Tanzania Uganda Zambia Zimbabwe

40 89 17 49 46 21 53 22 37 50-74 n/a 52 15 59 36

SEAAverage

44.9

SSAAverage

56

Middle-Income Country Average

79.3

% waterloss of total provision (1986data)

30 90 n/a 18 n/a n/a n/a n/a n/a n/a n/a n/a 20 n/a n/a

n/a 25 46 n/a n/a 33 n/a n/a 25 n/a n/a n/a n/a n/a 16

22 87 n/a n/a n/a n/a 15 n/a 13 n/a n/a n/a 57 40 n/a

n/a

n/a

43.8

n/a

42

50 n/a

1 8-20 a

Notes: a: estimateof averagefor high-incomecountries;n/a-data not available;SSA-Sub-SaharanAfrica.

22

% of population with sanitation (1990data)

n/a

Annex II Policy Obstacles to Foreign Direct Investment in Infrastructure in Developing Countries (by Gary Bond, CorporatePlanning Department, IFC)

Introduction The purpose of this annex is to review the experience of the International Finance Corporation (IFC) and the Foreign Investment Advisory Service (FIAS)with respect to the main policy issues which have affected the pace of foreign direct investment in infrastructure in developing countries. The focus is on those issues that have emerged as barriers to foreign investment, particularly during the early phases when a country is opening up to private infrastructure for the first time. The annex draws in part upon the operational experience of the IFC in financing private infrastructure projects, a summary of which is presented in the IFC publication Financing Private Infrastructure(1996). This annex also draws upon the advisory experience of FIAS in promoting policy and regulatory reform for foreign direct investment in infrastructure in Africa, Asia, and Central Europe. Part of the discussion is based upon contributions made by participants at previous FIAS Infrastructure Roundtables in Bangkok (1993), Beijing (1994), Hanoi (1995),Vienna (1996),and Entebbe (1996).These participants included representatives of project development companies, commercial lenders, legal advisors, and government officials.

Most difficulties in implementing private infrastructure investments arise out of policy and regulatory weaknesses in the host country, and experiences show that the potential sources of trouble can be many. Foreign investment in infrastructure usually involves more complex undertakings than in traditional activities such as manufacturing. The policy and regulatory barriers faced by infrastructure investors are therefore typically over and above those of more traditional investors. This is one reason why some countries have been able to achieve success in attracting foreign investment into their industrial or commercial sectors, but not into infrastructure. The complexity of private infrastructure investment is reflected in the large number of contractual undertakings that are required, involving government agencies as well as other private businesses. Policy weaknesses that affect implementation or enforcement of just one of these contracts may impede the progress of a whole project. While no two countries are approaching private infrastructure provision in exactly the same way, there are common elements in the overall policy and regulatory requirements for enabling FDI in infrastructure to work. The following sections provide an overview of the main issues which have been encountered to date.

23

Meeting the Requirementsof ProjectFinancing FDI is often thought of as consisting purely of equity financing, and for many smaller projects this is correct. For private infrastructure projects, however, investor equity is usually either insufficient or too expensive to meet total project costs, and typically a mixture of debt and equity funding is required. In power projects, for example, debt might contribute as much as 75 percent of project costs. Where equity and debt are being supplied on an "at risk" basis, project implementation depends on adequate arrangements in place to satisfy the risk-return requirements of both investors and lenders. In most situations, it is a country's policy framework, at both macroeconomic and sector levels, that determines whether the risk-return levels are acceptable. Under limited recourse project financing, there are several ways in which policies and regulations can affect the bankability of a project. As discussed below, policy considerations operate at both the country level (the issues include country risk, the ability to take security over assets, and the enforceability of contracts) as well as at the project-specific level (here the issues concern concession arrangements, government agency obligations, and approval and clearance procedures). Policy weaknesses at any stage in the implementation process can delay a project, particularly where the security requirements of lenders are in doubt. The inability of policy and regulatory frameworks to meet lenders' requirements is the most frequent cause of project delay and, in some cases, abandonment.

Some other countries have encountered difficulties in achieving foreign participation in infrastructure without first having a clear concession framework. In China, for instance, a large number of agreements were signed in the early 1990s between various government agencies and foreign investors to undertake infrastructure projects (notably power generation) on a joint venture basis. Very few projects have been able to proceed, however, mainly because of uncertainties over which agencies have responsibility for certain key approvals, and which approval criteria should be applied. China is now in the process of developing a concession framework aimed at overcoming these difficulties. Detailed implementing rules and regulations are an essential companion to the laws that govern private participation in infrastructure. Investors need to know which government agencies are authorized to negotiate and award concessions, and they need to know the procedures for obtaining approvals and clearances, as well as the criteria for approval. The absence of published implementing rules and regulations can create confusion among both investors and govermnent officials, and may result in arrangements that are not necessarily within the provisions of the law. Vietnam, for instance, has experienced a number of implementation difficulties since publishing a BOT Law in 1993, partly due to the inadequate specification of implementing rules and regulations. These difficulties have contributed to the very slow pace of private infrastructure investment in Vietnam. Foreign ExchangeConvertibility

Concession Arrangements Most countries that have been successful with private infrastructure programs have introduced specific legal frameworks that provide for private (and foreign) participation either in the form of ownership (such as BOO or privatization arrangements) or fixed-term contracting arrangements (such as BOT). Pakistan (with BOO or privatization) and the Philippines (with BOT)are examples of countries that have prepared comprehensive legal frameworks for private infrastructure as a first step in the development program. While the approaches taken by these countries are different, they have in common a clear legal basis for approval and award of concessions, plus detailed implementing rules and regulations which specify the procedures to be followed.

24

Most infrastructure projects generate earnings denominated in local currency, which must then be converted into hard currency to meet the obligations of foreign investors and lenders. Although there are exceptions, such as ports that charge for services to foreign vessels, power that is exported to a neighboring country, or toll roads which rely on foreign traffic, most cash flows from infrastructure projects are not in hard currency, and the ability of project investors to make the necessary conversion on a timely basis can be a major concern. Few developing countries have currencies that are freely convertible on both current and capital account transactions. Most have administrative arrangements that operate through the central bank for allocating hard currency among

comDeting demands, both public and private. The main concern of foreign companies is whether the country's foreign reserves will be sufficient to meet their conversion requirements in the years to come and whether the arrangements for foreign exchange allocation will work in their favor or against them. Some countries have been able to make special arrangements through offshore escrow accounts for payment of infrastructure fees in foreign currency; this arrangement has been used by the Philippines to implement private power projects. Other countries have provided guarantees of foreign exchange convertibility, issued through the central bank or ministry of finance. However, in some emerging markets, investors are uncertain of the meaning of such guarantees and doubt whether they will ensure that conversion takes place in a timely manner. The latter issue is particularly important to foreign lenders, who require strict adherence to loan repayment schedules (in hard currency). Countries can do much to improve investors' foreign exchange perceptions by putting in place a credible strategy for balance-of-payments management. The most credible strategies involve controls over excessive public sector borrowing (mainly through fiscal reform measures) and the promotion of external competitiveness (particularly through removal of anti-export biases in the trade regime). For many investors, foreign exchange concerns are ultimately a measure of faith in a government's ability to manage the balance-of-payments situation, and credible fiscal and trade policies can have an important, if indirect, effect on promoting investments in infrastructure. Investors are also aware that while infrastructure projects may not add directly to a country's net export earnings, they can help overcome export bottlenecks. For this to happen, however, a credible export-oriented strategy must also be in place. Ownership Requirements Investment opportunities for foreign investors in infrastructure vary from 100 percent foreignowned and operated enterprises to legally-mandated minority stakes in joint ventures with local firms. In some countries, the foreign investor's local partner is a state-owned utility, which may act as business partner, regulator, and offtaker (in the case of electric power). While foreign investors have found ways to implement projects

under each of these arrangements, ownership restrictions typically add to implementation difficulties. Laws or rules requiring minority foreign ownership in a joint venture are usually aimed at promoting local capabilities and ownership, but such an arrangement is not always the most efficient from the viewpoint of project management and financing. The local partner's capabilities and record of business management may influence the desirability of the venture. The foreign partner may be reluctant to cede management control to the local partner, and may not be willing to transfer technologically advanced equipment. Financiers, who look to the project's efficient management and operation as the basis for loan repayment, may also have reservations regarding the managerial capabilities of the local partner. Restrictions on foreign ownership can give rise to other types of financing problems. In joint ventures where equity is contributed in proportion to ownership, the local partner may not alw^ays have access to sufficient investment funds for the project's equity requirements. The local partner may then seek to borrow to make up the equity contribution, or advocate an increase in the debt portion of project funding, or scale down the project size to a level that suits the limited equity availability. In many cases these attempts to alter the financing structure or project size to fit a predetermined ownership arrangement can be detrimental to the soundness of the undertaking. In some countries the law may provide for 100 percent foreign ownership, but in practice the government agency authorized to negotiate the project concession may insist on a joint venture arrangement with the state utility. Such a case can happen where there is no functional separation between the implementing agency and the state utility, or where the implementing rules and regulations are not clear regarding the preferred ownership structure. In some countries (e.g., Pakistan), a separate agency has been established to award concessions to private investors; contractual negotiations of elements such as power purchase and fuel supply are carried out separately with the relevant state agencies. In situations where the foreign investor establishes a joint venture with a local entity, it is important that the relevant company laws provide adequate protections. The law should provide for freely transferable ownership rights, not

25

subject to government approval. The law should also ensure that equity can be effectively voted. In Vietnam, for instance, the implementation of joint ventures has been delayed because majority equity in a joint venture company does not mean that the foreign investor will have effective management control; certain decisions of the management board of the company require unanimous approval, including decision on production, business, budget, and financing plans. Hence, the local board members may have effective veto power over all business decisions in spite of a foreign investor's majority equity. Vietnam is, however, in the process of revising this provision. The Pricing of InfrastructureServices Low or subsidized prices for key infrastructure services such as power and water present major obstacles to foreign investors in many countries. Consumer prices that are below economic costs deter private investors in several ways. First, in the absence of comprehensive sector price reform, project developers are reluctant to supply services at economic prices for fear of a backlash aimed at them. Second, low prices impair the creditworthiness of existing state-owned utilities and this limit their ability to enter into contractual commitments without some type of government backup. Third, government transfers to utilities to cover revenue shortfalls may bring political objections against foreign power generators or water providers. Hence, in a number of countries, especially in Eastern Europe and sub-Saharan Africa, pricing is one of the main issues holding up private investment in power and water. Governments have been slow to implement reforms of water and power tariffs due to concern over people's abilities to pay market prices. In addition, in countries with extensive state enterprise sectors, there is the related concern that higher tariffs may mean higher subsidy payments to industrial firms. Some governments have nevertheless realized the wastefulness of subsidized tariffs and have sought to phase in tariff increases over a period of years. Others have also recognized that the significant portions of the population who have no access to water or power receive no benefit from these subsidies, and that by inhibiting investment, subsidies may actually be working against these people's interests. Several countries are currently in the process of implementing tariff reform in water

26

and power as a prelude to attracting significantly increased volumes of foreign investment in these sectors. Enforcementof Contractsand Dispute Settlement Infrastructure projects are contract-intensive arrangements, often involving explicit undertakings between the foreign investor and local companies, including state enterprises. Because contractual undertakings form the basis of a project's ability to generate cash flow and service debt, it is essential that all contracts be enforceable under law. It is also important that mechanisms for settling disputes among contracting parties be in place. Dispute settlement mechanisms should aim to resolve differences in a timely manner and without prejudice to the ongoing operation of the project. Contract enforceability is usually most evident in countries with established business legal frameworks and with a history of private sector growth and development. It is in these countries that the necessary integration of specific laws governing BOT, BOO, or privatization concessions with laws relating to contracts and other commercial activities has been achieved most readily. By contrast, in countries that have only recently given prominence to private sector development issues, there are more likely to be questions over the legal basis of contract enforceability and the provisions for dispute settlement. Project negotiations in countries currently undergoing transition to the market (including China and Vietnam) have been delayed over these issues, especially in relation to contracts involving state-owned entities. Countries need to ensure that disputes involving local and foreign joint venture partners do not jeopardize the integrity of the project. Some countries have passed regulations enabling disputes to be referred to a domestic arbitration body or to an arbitration body of another country. However, such provisions need to be backed by domestic laws on the recognition and enactment of foreign arbitral awards. It is also important for foreign investors to know the position that local courts will take regarding enforcement of awards against local parties. In some countries, there have been occasions when state enterprise partners in a joint venture have called upon other arms of government to help resolve a dispute in their favor. Clearly, countries sometimes

need to make a special effort to overcome the conflict of interest that is inherent whenever state agencies act as both an arm of government and as a joint venture business partner. Lenders' Requirements Few private infrastructure projects are financed on the basis of equity finance alone, and in most cases a project's viability depends on whether or not it can attract term debt. Under situations of limited recourse project financing, where debt repayment is not guaranteed, lenders will impose stringent conditions in order to protect themselves against the risk of default. These conditions, which are also referred to as lenders' requirements, apply to virtually every element of the project that may impact upon the project's cash flow and asset value. A number of developing countries have difficulty attracting term debt for project financing because of country risk factors. Commercial banks and other lenders will typically set limits to their involvement with risky countries, either in the amount of loans outstanding or in the maximum term of loans. For the least creditworthy countries, these limits are often too low for infrastructure projects, which typically involve repayment terms of six to eight years (at least) and loan volumes in the tens (or hundreds) of millions of dollars. While agencies such as the IFC can help to overcome risk barriers for individual projects, the priority strategy is to seek an improvement in country risk status through appropriate policy reform. Beyond the limitations imposed by country risk factors, there are also project-level impediments to the mobilization of term debt. Under limited recourse financing, a lender's primary concern is the project's cash flow and the ability of the project sponsors to service debt out of that cash flow. Such an assessment requires detailed appraisal, but in some countries, lenders have found it difficult to properly appraise a project because the terms and conditions of the contract or concession have not been finalized at the time finance is requested. This problem arises because licensing procedures in these countries require the foreign partner to be quite specific about the sources and terms of finance, something that few project developers can know with certainty in advance. Such requirements only add to the complexities of project negotiation and may delay or jeopardize the implementation process.

Inadequate accounting practices and a lack of audit requirements add to the difficulties of lenders. In projects involving joint ventures with local partners or important local contractual arrangements, lenders will want to carry out proper credit analysis to ensure their ability to meet commitments. In several countries, this task has proved difficult due to poor accounting and auditing standards. Creditworthiness concerns also arise where government entities enter into contractual arrangements such as power purchase agreements. Timely payment for power generated by a private power company is essential if the company is to meet debt service obligations, and lenders are reluctant to provide at-risk finance when the creditworthiness of the power purchaser is in doubt. In a number of countries, project implementation has been able to proceed only through the provision of counterguarantees on the state utility's obligations, either by the government or through agencies such as the World Bank.Avoidance of the government counterguarantee prob'LEl's occurred oruy where the utility that is purchasing the service is demonstrably creditworthy or already in private hands. In addition to seeking minimization of cash flow risk, lenders will also protect their interests by taking collateral security over project assets, usually in the form of a mortgage. In many developing countries, there are well-established procedures for drawing up and registering mortgages over land and fixed assets, but this is not always the case. China, for instance, has only recently established a national security law authorizing mortgages. In other countries, such as Vietnam, the problem involves legal uncertainty over the assignability of land use rights and the ability of foreigners to establish claims on land. ProjectSelection, Negotiation, and Approval Processes There is much variation in the ways that countries select projects for FDI, the transparency of the negotiation process, and in speed of approvals. These differences have had a major impact on the rate of project implementation. In some countries, the selection of eligible BOT projects appears to be unrelated in many cases to their commercial potential, and difficulties thus arise in the government-to-business relationships

27

from the very start. This relationship is particularly important in sectors such as transport, where doubts over traffic volumes and willingness to pay economic tolls will make foreign investors very cautious in their commitments. In the power sector also, projects need to have strong business underpinnings, which are reflected in arrangements for fuel type and supply, cost pass-through provisions, take-or-pay provisions, grid connections, etc. In some countries investors have not being able to determine easily which projects are up for BOT investment and which are not; often when governments are developing public sector projects in parallel with BOT projects, but have not drawn a clear line between them. Problems arise when a project is offered as a BOTopportunity, but is subsequently withdrawn and implemented on a public sector basis, as has happened for example in the Czech Republic. Although such changes may happen for valid reasons of urgency, they do not promote investor confidence in the government's commitment to private infrastructure. In several developing countries, there is still a perception that the government regards private infrastructure not as a priority, but as a last resort. Private infrastructure projects involve a large amount of business-to-government negotiation, both in the form of the concession arrangements that define the investor's rights to own and/or operate an infrastructure facility as a business, and in various contractual undertakings with government firms, including power purchase agreements, fuel supply agreements, and construction works agreements. Both the concession arrangements and the contractual undertakings involve government in new types of commitments that, in many cases, would not be necessary if everything were to be done by state enterprises. Hence, the introduction of private

28

investors to infrastructure poses a great challenge to government officials in the fulfillment of their responsibilities. When countries are in the initial phases of a private infrastructure program, few officials will have any depth of experience with the practices that underlie project concessions and financing. The lack of experience sometimes results in misinterpretations and may also account for the resistance to foreign investment that is still encountered in some countries. Incentive structures within the ministries responsible for infrastructure may also be a problem. Ministries will probably continue to have close relationships with their counterpart utilities and may not welcome the concept of dealing with them through arms-length regulations. Furthermore, they may fail to see the importance of providing evenhanded treatment to all parties concerned. As a result of these imbalances, many of the difficulties faced by foreign investors occur at the initiation or negotiation phases of project implementation. An overall lack of familiarity with large-scale foreign investment is said to be one reason that government officials will proceed very cautiously-and slowly-at the initial stages Indeed, negotiations leading up to the granting of a license can sometimes take up to two years and involve considerable legal fees and other costs for the foreign investor. At the project negofiation phase, officials are still trying to find out how in practice project risks are managed and how this management in turn affects negotiating strategies. Officials are often concerned that there be an equitable sharing of risks in BOT projects, but it is not clear whether they are talking about the sharing of risks within the joint venture or betweenthe joint ventureand consumers.Clarification of this key regulatory issue will be central to any future improvements in project negotiation and approval.

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