Policies of MDBs in Promoting Private Finance for Local Government Infrastructure

1. Second International Conference onFINANCING MUNICIPALITIES & SUB-NATIONAL GOVERNMENTS The Role of Specialized Local Funds and Financial Intermediaries(30 September – 1 October 2004, Washington, D.C.) Policies of MDBs in Promoting Private Finance for Local Government Infrastructure The Asian Development Bank Alfredo E. Pascual Director, Private Sector Operations

2. Decentralization trends in Asia • Decentralization is happening in a number of Asian countries, e.g.: • Philippines (1991): Local Government Code • India (1992): Nagarpalika (Decentralization) Act • PRC (1994): separation taxing powers between the central Government and the local governments • Thailand (1999): Decentralization Law • Indonesia (1999): Local Government Autonomy Law and Central-Local Balance Financial Fund Law • Pakistan (2000): devolution of authority and grant of autonomy to lower-level government units • Devolution of responsibility for delivering basic services and providing physical infrastructure to local governments is not always matched with corresponding fiscal transfers from the center. 2

3. Need for private finance • Asian cities cannot finance the infrastructure investments they need without accessing private domestic savings. • With decentralized governance, domestic credit markets must be capable of generating long-term financing for cities and their infrastructure agencies. • Private sector financing modalities (e.g., bank loans, bond issues) can enable local governments to access markets reliably for the long run. • Private sector participation in infrastructure can facilitate access to private finance. 3

4. But local governments are generally not ready to access private finance. • The challenge for MDBs is to help prepare local governments through institutional reform and capacity building. This preparation is hard work in a tough environment. The process can take time (1-2 years). • Reform areas have to be defined and financed. Among these are the following: • Rebalancing the books: better tax raising powers, cost recovery strategies, tariff setting procedures. • Setting up accounting, budgeting and financial reporting systems to enable performance evaluation and rating. • Building capacity for project preparation, design and execution. • incorporation of private sector participation in key services. 4

5. Other enabling conditions are needed. • Legal framework for security arrangements for local government debt and enforcement mechanisms. • Financial sector reform to deepen domestic capital markets for debt. • Establishment of appropriate capital market institutions: rating agencies with capability to rate municipal risk, credit guarantee companies. • Strengthening of sector governance (e.g., in water): regulatory framework, regulatory body. • Leveling the playing field between government-sponsored lending programs and commercial institutions in the local credit markets. 5

6. Pilot projects and model financing structures are needed, too. • Local government leaders sometimes lack confidence in their execution capability. Development of a small number of pilot projects that are successfully debt financed and executed can help in confidence building. • Financing structures (e.g., specialized financial intermediaries, pooled finance schemes) can facilitate access to private finance. • Initial participation of or credit enhancement by trusted partners such as MDBs can catalyze commitments from commercial lenders and investors to fund projects or intermediaries. 6

7. The Asian Development Bank (ADB) • ADB is a multilateral development finance institution dedicated to reducing poverty in Asia and the Pacific. • Established in 1966, we are now owned by 63 member countries, mostly from the region. • Headquartered in Manila, with 24 other offices around the world, including one in Washington, DC. • Support for local governments, particularly in the provision of basic services, is important in the pursuit of ADB’s poverty reduction objective. 7

8. ADB is in a good position to promote private finance for local government infrastructure • ADB’s sovereign lending, technical assistance work and non-sovereign investment operations are under one roof. • Synergy is possible between policy and advisory work and support for non-sovereign financing transactions. • ADB can dialogue with governments on policy and institutional reform to create enabling conditions. • ADB can catalyze private finance transactions by direct participation and through risk mitigation. • ADB has a broad range of instruments for policy dialogue, advisory and project preparatory work, direct financing and risk mitigation to help promote private finance for local government infrastructure. 8

9. ADB instruments • Technical assistance and other knowledge products to support and finance capacity building efforts. • Sovereign loans to support policy and institutional reform. • Equity investments to help launch credit and bond market institutions such rating agencies and credit guarantee companies. • Loans without sovereign guarantees to co-finance projects, funds and needed financial intermediaries. • Partial credit guarantees (PCG) and political risk guarantee (PRG) for credit enhancement and risk mitigation to facilitate private finance. 9

10. Development and financing of a pioneer municipal-level BOT water treatment plant • Through the use of technical assistance, ADB helped establish the first municipal-level BOT water project in PRC. This was in Chengdu, province of Sichuan. • The ADB technical assistance supported the preparation of the project, drafting of contracts (take-or-pay) and other legal documents, study of the project’s environmental impact, evaluation of bids and selection of the project sponsor (a joint venture between Vivendi and Marubeni). • ADB provided the project company with a direct loan and a lender-of-record facility to encourage co-financing by international banks. 10

11. Investment in a guarantee company • ADB has recently approved an equity investment in the LGU Guarantee Company to help increase its capacity to credit enhance bank loans and bond issues of local government units in the Philippines. • Established in 1998, LGU Guarantee Corporation has insured a total of 12 bond issues by 10 local government units. • No underwriting losses have been incurred to date. 11

12. Initiatives in local currency financing • Local government financing requires local currency. • ADB can issue its own local currency denominated bonds to generate local currency funds for onlending to borrowers in the host country. (India already done; PRC, Philippines and Thailand to follow). • ADB can also generate local currency via cross currency swaps in the market or with the host government. (e.g., $200 million swap and financing facility approved for the Philippines: fixed-rate long-term peso to be lent to banks for onlending to infrastructure projects and other borrowers). • ADB partial credit guarantee is available to credit enhance local currency borrowings or bond issues by clients. 12