Patricio Mansilla - Zamyn Uud an invitation for PPP in mongolia
Economic Policy Reform and Zamiin Uud Logistics Park An invitation for a Public- Private Partnership January 2009 Ulaanbaatar, MongoliaThis publication was produced for review by the United States Agency for International Development. The viewsexpressed in this publication do not necessarily reflect the views of the United States Agency for InternationalDevelopment or the United States Government.
Project: Mongolia Economic Policy Reform and Competitiveness Project (EPRC)Report Title: Zamiin Uud Logistics Park - An invitation for a Public Private PartnershipMain Author: Patricio MansillaContract No. 438-C-00-03-00021-00Submitted by: EPRC Project/Chemonics International Inc., Tavan Bogd Plaza, Second Floor, Eronhii Said Amar Street. Sukhbaatar District, Ulaanbaatar, MongoliaTelephone and fax: (976-11) 32 13 75 Fax: (976-11) 32 78 25Contact: Fernando Bertoli, Chief of PartyE-mail address: firstname.lastname@example.org
ABBREVIATIONS AND ACRONYMSADB Asian Development BankANTT Terrestrial Transport National Agency-BrazilBBO Buy-Build-OperateBDR Bangladesh RiflesBDO Build-Develop-OperateBLOT Build-Lease-Operate and TransferBOM Bank of MongoliaBOT Build-Operate-TransferBOO Build- Own- OperateBOOT Build-Own-Operate and TransferBROT Build-Rent- Own and TransferBSBK Bangladesh Sthala Bandar KartripakshaBTO Build-Transfer-OperateCCPPP Canadian Council for Public Private PartnershipsCDS Credit Default SwapDBOT Design-Build-Operate-TransferDBFO Design-Build-Finance-OperateDCMF Design-Construct-Manage-FinanceEPRC Economic Reform and Competitiveness ProjectFRC Financial Regulatory CommissionGoM Government of MongoliaIADB Inter American Development BankIFC International Finance CorporationIMF International Monetary FundLDO Lease-Develop-OperateLPDC Logistics Park Development CorporationLPLA Land Port Los Andes-ChileMFFA Mongolian Freight Forwarders AssociationMIF Multilateral Investment Fund- FOMIN of IADBMIK Mongolian Mortgage CorporationMOP Ministry of Public Works-ChileMNT Mongolian Togrog
PFI Private Finance InitiativePIMAC Private Management Center-KoreaPICOM Private Infrastructure CommitteePRC People´s Republic of ChinaPPP Public Private PartnershipPV Partnerships VictoriaSEW Single Electronic WindowUBTZ Ulaanbaatar RailwayUNDP United Nations Development ProgrammeUSD United States DollarWAA Wrap around AdditionWBI World Bank Institute
TABLE OF CONTENTABBREVIATIONS AND ACRONYMS ........................................................................................ iEXECUTIVE SUMMARY ........................................................................................................... i A. Public Private Partnerships in Mongolia ............................................................................ i B. Zamiin Uud Logistics Park – Public Private Partnership.................................................... iiSECTION I: UNDERSTANDING PPP FOR A SUCCESSFUL APPLICATION IN MONGOLIA 1 1. Understanding Public Private Partnerships (PPP) ............................................................ 1 2. Main reasons to use PPP ................................................................................................. 2 3. Main PPP models applied in the world.............................................................................. 6SECTION II: PRESENT AND FUTURE OF PPP IN MONGOLIA ............................................. 9 1. Mongolian experience in PPP projects ............................................................................. 9 2. New Mongolian Government structure: The platform for a PPP Structure ..................... 10 3. Macroeconomic Factors to be considered in a Potential PPP Program in Mongolia ...... 13 4. Mongolian financial market ............................................................................................. 17 5. Foreign investment in Mongolia ...................................................................................... 19 6. Recommendations .......................................................................................................... 21SECTION III: ZAMIIN UUD LOGISTIC PARK PPP BUSINESS MODEL ............................... 27 1. Main reasons to start the project Zamiin Uud Logistic Park ............................................ 27 2. Objectives ....................................................................................................................... 28 3. Legal framework for the project....................................................................................... 29 4. Preliminary project description ........................................................................................ 30 5. Investment cost ............................................................................................................... 32 6. Demand .......................................................................................................................... 32 8. Main services and potential revenues ............................................................................. 33 9. Business model ............................................................................................................... 33 10. Corporate Governance ................................................................................................. 35 11. Business regulation ....................................................................................................... 36 12. Financial management .................................................................................................. 36 13. Feasibility studies and public agencies coordination .................................................... 37 14. A comparison with Land Port Los Andes-Chile PPP Project ........................................ 37ANNEX A: LAND PORT LOS ANDES-CHILE ........................................................................ 43ANNEX B: ACTIVITIES OF THE CONSULTANCY ................................................................ 53ANNEX C: EPRC MEETINGS IN ULAANBAATAR ................................................................ 57ANNEX D: LOWER AND UPPER MIDDLE INCOME COUNTRIES ....................................... 61ANNEX E: LIST OF WORKSHOP PARTICIPANTS/“LAND PORT LOS ANDES-CHILE ANDZAMIIN UUD LOGISTICS PARK-MONGOLIA: TWO INNOVATIVE PROJECTS .................. 65ANNEX F: LIST OF WORKSHOP PARTICIPANTS/“INCENTIVES, STRUCTURE ANDREGULATION OF PUBLIC PRIVATE PARTNERSHIPS IN MIDDLE INCOME COUNTRIES”................................................................................................................................................. 69ANNEX G: LIST OF THE MULTILATERAL INVESTMENT FUND (MIF) PROJECTS INPUBLIC-PRIVATE PARTNERSHIPS IN LATIN AMERICA .................................................... 73ANNEX H: BANGLADESH BOT PROGRAM OF LAND PORTS............................................ 77
EXECUTIVE SUMMARYA. Public Private Partnerships in MongoliaMongolia’s strong economic performance in the last decade must be sustainable in the longrun. One public policy that can contribute to increased economic stability and also attractforeign investment, generate employment, spur economic growth and increase the wealth ofMongolian citizens is to invite the private sector to develop public facilities and services withthe public sector.It is the right moment for Mongolia to consider extending a special invitation to the privatesector to contribute funds, expertise and know how to create a new industry that can acceleratethe achievement of the current Action Plan and Millennium Development Goals of Mongolia.Currently, Mongolia has a significant number of projects requiring urgent developmentprincipally in transportation, energy, water and sanitation, hospitals and schools. However, thepublic budget is not sufficient to complete all of these projects within the period set forth bythe government in the 2008-2012 Action Plan. There is substantial opportunity for the privatesector to bring value added and to complement public funds to build and operate such projectsover a long period of time.International and local investors must recognize in Mongolia a serious group of publicagencies and a clear legal system to allow them to comfortably innovate and create businessopportunities in public private partnerships (PPP). The field for implementing PPP must beleveled for the private and public sector with a fair share of risks and profits.In order to have the field leveled for the PPP participation, two important steps needs to bedeveloped in 2009, the design and implementation of the legal framework and the creation ofthe institutional structure to deal with PPP projects. It is crucial that Mongolian authoritiesstudy and understand the successes and failures of PPPs in middle income countries in whichthe experiences and issues to address may be similar to the challenges facing Mongolia.To better understand the PPP concept, models and applications, Mongolia can use theexpertise of Multilateral Agencies or donors like World Bank, Asian Development Bank,USAID and others, to create a specific PPP support program for Mongolia.Once the legal and institutional framework is ready, it will be necessary to advance to the nextstep, which could be the generation of a PPP Program that will select project candidates from apool of several potential PPP projects. Selected projects must be socioeconomically viable andfinancially attractive for the private sector. Starting with a group of PPP projects with adequatedesign and strong feasibility studies is the right way for Mongolia to realize the best valuefrom PPPs for investors and their citizens.The PPP bidding process in Mongolia must be conducted seriously, ensuring transparency andencouraging competition. Encouraging competition for projects is the best way to simulate ex-ante a competitive market for projects that normally are categorized as monopolies.Given that the vast majority of PPP projects are considered monopolies, Mongolia mustestablish a clear regulatory contractual scheme which motivates the private sector to deliver ahigh level of service associated with fair tariffs and enforcement measures to assure that theuser must always be well served.It is crucial to have the support of the financial world to assure funding for a PPP project.Therefore, it is important for Mongolia to send the appropriate signals to financial institutionsand investors to increase the attractiveness and reduce the cost of credit for PPP in Mongolia.
Economic Policy Reform and Competitiveness ProjectThe recommendation is for the country to pursue macroeconomic and political stability,enabling Mongolia to increase its country risk rating - given by the most important ratingagencies - and to change its current condition of a non investment grade country (BB-) to ainvestment grade country (BBB-).An imperative public policy is to accelerate the development of dynamic capital markets inMongolia, increasing the number and size of new institutional investors, available toparticipate in the PPP financial side. The creation of an industry related to individualcapitalization funds where several private companies manage the portfolio of retirementpension funds could be a good opportunity to attract new institutional investors to the capitalmarket system.Financial institutions and private companies participating in PPP around the world faceuncertainty originating from the delay of public agencies in transferring assets and land for theconstruction and operation of the PPP .Thus, it is recommended for Mongolia to clearly definethat land registration and title registration to mitigate future misunderstandings with the privatesector.B. Zamiin Uud Logistics Park – Public Private PartnershipOnly few land port projects in the world have the potential to be the bridge for two largecountries and economies, Russia and China. This is the case of the Land Port Project ZamiinUud in Mongolia, which has access to a potential market representing 22% of the total worldpopulation (approximately 1,500,000,000 from China and Russia) and a potential 10% of thetotal world economic production (China and Russia).A preliminary study prepared by USAID/EPRC 1 showed that investing in the Zamiin UudLogistic Park Project, located on the Mongolian side of the border with China, will bring hugeeconomic net benefits. The economic net benefits will be realized by addressing the lack ofadequate infrastructure, which requires cargo (principally imported goods) coming fromNorthern China in the direction of Russia and Mongolia to wait many hours and in some casesdays to unload from the rail or trucks and to load onto the railways for the trip from ZamiinUud across Mongolia and on to Russia.The necessity of cargo transshipment in Zamiin Uud is twofold: firstly because of theincompatibility between the Mongolian Gauge (follows the Russian Wide Gauge of 1520 mmgauge) and Chinese Standard Gauge (1435 mm gauge), and secondly because of the absenceof a paved road connecting Mongolia with Russia in the northern side of Mongolia.In addition, Zamiin Uud urgently requires investment in at least a new 200 m. road-railtransshipment yard located in the north west of the yard adjacent to the railway, mechanizedtransshipment facilities and equipment to support the process. It is necessary that the newinvestment plan considers services required for trucks and for all of the people working in thislogistics center.USAID estimates the Economic Internal Rate of Return for this project to be between 18% and43%. Main economic benefits emerge from savings of vehicle (trucks) operating costs, freightinventory costs and the reduction of the time spent in the transshipment process. Total savingsper lorry are estimated in USD 43.74 per day.The project would solve the lack of a proper road connection to the Russian border, poormaintenance of the vehicle yard, lack of load unitization, use of manual transshipment and1 Pre-Feasibility Analysis to Establish Logistics Facilities in Zamiin Uud in Mongolia. April, 2008 USAID-EPRC Executive summary Page ii Zamiin Uud Logistics Park – An invitation for a Public-Private Partnership
Economic Policy Reform and Competitiveness Projectshortage of mechanical lifting equipment. Given the project’s considerable social benefits, it ishighly recommendable to start the implementation process as soon as possible.As the Mongolian Government will be working all year on the design of the PPP law and thestructure for the main public agencies dealing with PPP, it implies that a Build-Operate-Transfer (BOT) process for Zamiin Uud Logistics Park would take at least two more years.The urgency of this project necessitates the creation of a PPP company with participation fromMongolian Freight Forwarders, UBTZ (Ulanbaatar railway), Mongolian Government(Ministry of Finance and Ministry of Roads, Transportation, Construction and UrbanDevelopment) and private shareholders, in lieu of waiting for two more years to beginimplementation.Once the company is created, shareholders will design the feasibility studies to present theproject to the financial sector and raise funds to start project construction and operation. Themain studies must be the engineering and architectural project and demand and financial study.From these studies the company will understand the estimated investment amount required andthe operational and maintenance costs, which will assist in deciding on the appropriatestructure for project implementation.Logistics Park Development Corporation (LPDC) will initially be created to act as a facilitiesdeveloper and at the same time could offer some non-essential or non-core business services.For example, it is possible to identify a road to rail, road to road operation and in the future railto rail operations that will require a specialized operator. This operator also could have theresponsibility of the warehouse facilities business. Thus, LPDC could prepare a biddingprocess to choose the best operator and this operator could be selected based on the highestlevel of fees proposed to the LPDC given a set of adequate and accessible tariffs for the users.This operator also could be in charge of the parking service.On the other side, LPDC could have another private company working in the commercialservices area. LPDC could establish a rental tariff for each m2 and/or collecting a percentageof gross revenues from operations in the commercial services area. Finally, LPDC could startan additional area of business related to several real estate opportunities.Zamiin Uud Logistics Park – An invitation for a Public-Private Executive summary Page iiiPartnership
SECTION I: UNDERSTANDING PPP FOR A SUCCESSFUL APPLICATION INMONGOLIA1. Understanding Public Private Partnerships (PPP)The Public Private Partnership (PPP) concept is currently used to describe many types ofprivate participation to develop infrastructure, to deliver services or to assume the risks andbenefits of projects on behalf of the public sector and other activities where the private sectorcould be more efficient than the government.There is neither a unique definition of Public Private Partnerships nor a unique Model. Toillustrate this point, the following definitions are used by different agencies working on PPP.A. European UnionAccording to the European Union, a public-private partnership (PPP) is a contractualagreement between the public and the private sectors, whereby the private operator providesservices that have traditionally been executed or financed by a public institution. The ultimategoal of PPPs is to obtain more “value for money” than traditional public procurement optionswould deliver.Although the ex ante assessment of expected value for money is often extremely complex, ingeneral a PPP can be said to generate value improvements whenever it produces/achieves thefollowing advantages: reduced life-cycle costs, more efficient allocation of risk, fasterimplementation, improved service quality, and additional revenue.B. World Bank/PPIAF (Public-Private Infrastructure Advisory Facility)A public-private partnership (PPP) according to the PPIAF/World Bank web page involves theprivate sector in aspects of the provision of infrastructure assets of new or existinginfrastructure services that have traditionally been provided by the government. However, theWorld Bank does not have an official definition for PPP.C. The Canadian Council for Public-Private Partnerships (CCPPP)The definition used by The Canadian Council for Public-Private Partnerships is the following: A cooperative venture between the public and private sectors, built on the expertise of each partner that best meets clearly defined public needs through the appropriate allocation of resources, risks and rewards.The term "public-private partnership" carries a specific meaning in the Canadian context. First,it relates to the provision of public services or public infrastructure. Second, it necessitates thetransfer of risk between partners. Arrangements that do not include these two concepts are nottechnically "public-private partnerships" and do not fall within the scope of the work beingdone by CCPPP.The following graph shows the main differences between direct public investment and PPPinvestment.
Economic Policy Reform and Competitiveness Project Public Investment / PPP Public Investment Public Agency PPP Investment Ministry Investment Public Company Public Agency Ministry Public Company PPP Contract Special Purpose Vehicle 3 potential Financial Structure 2 potential subcontracts contracts Public Financing Private Operation Public Budget Financing Construction Service Multilateral 70%-80% Debt Construction Operation Delivery Agency Loan Public Financing 20%-30% Equity Service Delivery Donors Banks Bond Issue Bridge Loan National or And International Refinancing Capital Market Capital MarketIn the case of a Public investment, a Public Agency, a Ministry or a Public Company can signthree separate contracts for specific activities. For example, the public sector can invite theprivate sector to build a road or to operate a specific service for a given period of time, so theprivate sector has normally a fix bounded business with a certain level of risk.One public company could recover costs from the users and normally the financing is a publicresponsibility coming from the public budget, loans from multilateral agencies, banks loans orfinancial resources from donors.In the case of a PPP investment, there are three main differences in comparison with publicinvestment. Firstly the creation of a new company or Special Purpose Vehicle (SPV) with thespecific objective to fulfill the rights and obligations established in the PPP contract or in thelegal documents that created the company. Thus, it allows the risks faced by the PPP companyto be treated separately, not involving the performance of the original firm. Creation of a SPVis very useful for project finance purposes because financial institutions can perform duediligence on the strengths and weaknesses of the PPP company.Secondly, the PPP contract signed between the public agency and private sector companieswill establish the investment, construction, operation and financial responsibilities, so the SPVcould sign subcontracts for every activity or otherwise perform any of these activities throughthe same SPV. Normally, in BOT projects, the SPV signs a subcontract with the constructioncompany and prepares a financial structure through banks, local capital markets orinternational capital markets.2. Main reasons to use PPPThere are several reasons for the public sector to invite the private sector to participate in theprovision of infrastructure or public services. The most important are the following:Section I Page 2 Zamiin Uud Logistics Park – An invitation for a Public-Private Partnership
Economic Policy Reform and Competitiveness ProjectA. Demand • Excess of demand for the facility, product or service, managed by the public sector.As a result of a country’s economic growth and therefore the increase in disposable income ofcitizens, a public facility can face excess of demand. This phenomenon also could be triggeredjust from the vegetative growth of a population, generating shortage of services or even lowquality services. • Potential increase in demand in the short/medium term for the facility, product or service.Public authorities and Ministries normally have a planning period where they can review thenecessities of investment for the next year of couple of years. In this process they can identifypotential increase of demand, which could require expansion of infrastructure or a highernumber of products or beter quality of services per unit of demand.B. Supply/public sector • Lack of financial resources to increase the level of investments to decrease the excess of demandWhether or not the public sector recognizes the necessity to improve the capacity of a publicservice to meet existing demand, the public sector might not have enough financial resourcesto accomplish the objective. • Low public sector capacity to increase the level of investments to close excess demand.In some cases the public sector may have the financial resources to invest in improvements toa service, however, the value added or marginal efficiency can sometimes be too low so it maybe beneficial to invite the private sector to participate and generate more value added per MNTinvested.The authorities also can have administrative problems filling the gap in cases where demand isdynamic and requires flexible decisions to adapt the supply of the service. • Public companies can suffer from absence of commercial orientationIn the study “Public Investment and Fiscal Policy” (2004) the International Monetary Fund(IMF) established 9 criteria to evaluate public companies in 8 developing pilot countriescommercial enterprises.The criteria include: managerial independence (pricing and employment policies), relationwith the government (subsidies, transfers and regulatory and tax regimes), financial conditions(profitability and creditworthiness) and governance structure (stock listing, outside audits andannual reports) and shareholders rights.The result of the study was that three out of 115 public companies 2 , met several criteria to beconsidered commercially run. It shows that the private participation in those public companiescan bring most of the nine criteria considered by the IMF study.C. User benefits • Fast way to receive a better and sustainable service in the long run2 The study considered eight pilot countries and for the commercially run survey were used 6 out of eightcountries. Zamiin Uud Logistics Park - An invitation for a Public Private Section I Page 3 Partnership
Economic Policy Reform and Competitiveness ProjectPublic services are strongly dependent on the public budget. Normally public budgets areadjusted after every new presidential election, which does not assure the stability of a publicservice or its quality in the long run. Attracting private investment can be considered a“bridge” to enhance stability and avoid the uncertainty of public resources, service andmanagement of the public company or ministries in periods of presidential transitions ofpower. • Increased capacity to apply commercial policies and match the level of use with payment.In a PPP scheme users that do not use a service do not pay for it and those who use more of aservice, pay more. PPP companies can apply several commercial policies to encourage usageof services and also to mitigate potential externalities like congestion in the service.D. Social benefits • Fast way to achieve Social Responsibility/ Accountability in the allocation of resourcesGiven that public and private sector interests are different, it is necessary to create regulatorymechanisms through contracts, requests for proposals and others documents to assure that theprivate sector can earn a fair level of profits and the users can obtain an adequate service at afair price.The existence of regulatory documents, regulatory agencies and more than one public agencyinvolved in the PPP program creates accountability for the allocation of public resources. • Sustainability of the serviceShortage, congestion, black out and other problems are all consequences of inefficientservices. PPP encourage continuity of services because of the focus on the core of the privatesector business and on the regulatory system that needs to be achieved by a PPP company. PPPprovides society with enhanced assurance that the service will be available almost all of thetime for users. • Cost recoveryPPP is associated with the concept of No Free Lunch. It means that the service has a cost andthe citizen must to pay for it. In the regulatory process, the Government can establish certaindiscounts, subsidies or vouchers for people who need a basic service but cannot afford the totalprice of the service.E. Economic growth • Creation of a new industry, a new formal sector in the economy.In the last fifteen years Chile, a South American country with a GDP of around USD 150billion, experience with PPP and new industry has invested around USD 8 billion in ports,airports, railways, roads, dam, jails, sport arena, and urban projects.The industry in Chile is composed by the most important European companies and alsocompanies coming from Canada and United States.The following table shows the most important concessionaire/PPP companies in infrastructureaccording to the Public Works Financing magazine.Section I Page 4 Zamiin Uud Logistics Park – An invitation for a Public-Private Partnership
Economic Policy Reform and Competitiveness Project PPP Infrastructure Construction/Operation Active Proposals Company Projects 1. Macquarie (Australia) 51 14 2. ACS Dragados/Iridium (Spain) 45 22 3. Ferrovial/Cintra (Spain) 44 34 4. Sacyr Vallehermoso (Spain) 29 19 5. FCC (Spain) 27 20 6. Abertis/La Caixa (Spain) 24 2 7. Vinci/Cofiroute (France) 21 26 8. Hochtief (Germany) 19 16 9. OHL (Spain) 17 10 10. Cheung Kong Infrastructure 17 4 (China) Source: Public Works FinancingIn the case of Peru, a South American country that received the support of USAID to developa PPP Program in transport infrastructure through the Poverty Reduction Alleviation (PRA)Project managed by Chemonics International the country has created the industry mostly withSouth American companies coming from Brazil, Ecuador and Peru in the road sector. Thefollowing table shows the companies operating in Peru. It does not include Dubai Ports(company from Arabs Emirates United) that adjudicated the Callao Port and OHL (companyfrom Spain) that recently won a road concession in the north of Peru. Gross Profits Company (Million US$) year 2006 Odebrecht (Brazil) 1.133,9 Andrade y Gutierrez (Brazil) 827,5 Camargo y Correa (Brazil) 808,7 Construtora Queiroz Galvao 699,3 (Brazil) Graña y Montero (Perú) 86,5 Gross Profits Hidalgo-Hidalgo (Ecuador) N.I • Foster employment, wealth and economic growthPPP projects have the ability to promote a virtuous cycle generating employment in thedifferent phases of the projects, in several professional and non professional areas and inseveral geographic locations. Economic growth is promoted by the use of the facilities orservices, which generates several crowding in effects in other economic development sectors.PPP business creates wealth for a country. This wealth is shared between the private sector andthe public sector and can be reinvested in the same project assuring the continuity of theservice level in long periods of time. • Encourages private sector financing (institutional investors) and financial markets efficiencyZamiin Uud Logistics Park - An invitation for a Public Private Section I Page 5Partnership
Economic Policy Reform and Competitiveness ProjectChile has large and successful experience with the participation of the national andinternational financial system, pension funds and others institutional investors in the PPPsystem.Thus, in the last fifteen years and according to the Ministry of Public Works in Chile, theinfrastructure PPP projects in Chile have secured financing of around USD 6 billion. Bankloans are responsible for USD1.2 billion, bonds issued in the international capital marketsUSD 0.9 billion and bonds issued in the local capital markets USD 4 billion.Chile created the capitalized pension system in the 1980s replacing the old pay as you gosystem. It allows the money from pension funds of Chilean citizens to be invested in the localcapital markets and also in the international capital markets. Pension funds and insurancecompanies as institutional investors in Chile have also been buying infrastructure bonds.The Chilean government has been working with rating agencies to get a project shadow ratingbefore launching the tender process. The shadow rating gives the government the opportunityto improve the business and offer the private sector an adequate risk-profit sharingcombination.3. Main PPP models applied in the world 3Every country working in the arena of PPP has several different models to incorporate theprivate sector in a particular project. We know that there is neither an exact definition for PPPnor a limit to the PPP models applied in the world. We know that the models can move frommanagement, operation and services contracts to full divestiture or privatization. However, thePPP models continue to grow in number and also in the level of innovation in every country.We could have a sequence of PPP models by municipal level or by country, but it is practicallyimpossible to include in just one definition the broad variety of models that any country coulduse in several areas of application, ports, airports, roads, water, energy, hospitals, etc.The different PPP models presented above can be flexibly selected and tailored according tothe sector of application. Some areas are better suited for risk transfer to the private party thanothers, as the different models imply various degrees of control by the public party.In general, the private sector proved to be a better manager of construction risk and qualitystandard risk, while regulatory risk is more appropriately borne by the public sector.The term "privatization" is used in the case of full divestiture or when a specific function isturned over to the private sector and regulatory control remains a public sector responsibility.In Canada "privatization" refers to the furthest point on the PPP spectrum, where most or allassets are held by the private sector. This Canadian definition more closely resembles theterminology used in countries other than the USA.This section describes the main PPP models applied in the world based on the EuropeanCommission (2003) and IMF (2004).Section I Page 6 Zamiin Uud Logistics Park – An invitation for a Public-Private Partnership
Economic Policy Reform and Competitiveness Project Operation and Management Contracts Service Leasing Contracts PPP BOT Partial DBOT (DBFOT) Divestiture BOOa) Service contracts are agreements between a public agency and the private sectorparticularly suited for simple, short-term operational requirements. It is a very limited form ofPPP, where the private party procures, operates and maintains an asset for a short period oftime. Management and investment responsibilities remain with the public sector, which bearsthe financial risk and residual value risk, but benefits from the technical expertise of theprivate operator and obtains some cost savings, without transferring control over the quality ofoutputs. Service contracts are commonly used for toll collection services, for the provision andmaintenance of vehicles or other technical activities.b) Operation and management contracts are agreements in which the responsibility forasset operation and management is passed on to the private sector. The duration is generallyshort but can normally be extended. The private party is remunerated on a fixed fee basis or onan incentive basis with premiums linked to specific performance targets. The public party stillbears the investment risk and the financial risk. This type of contract allows significantefficiency gains and investment in technological sophistication, as the private operator has astrong interest in improving service quality to reduce both overall costs and the demand riskduring the operational stage.c) Leasing agreements. The private party purchases the income streams generated by publiclyowned assets in exchange for a fixed lease payment and the obligation to operate and maintainthe asset. Since the commercial risk and the demand risk are transferred to the private sector,the private agent has an incentive to achieve operational efficiency. The private party indeedprofits only if it manages to reduce operating costs while meeting the designated service level.On the other hand, the public party bears the risks related to construction, capitalimprovements and financing. Leasing is particularly suited for infrastructures that generateindependent revenue streams, as occurs in the case of public transport. Leasing includes Buy-build-operate (BBO) and Lease-develop-operate (LDO).d) Build-Operate-Transfer (BOT) is an integrated type of partnership in which the privateparty bears the responsibility of designing, constructing and operating the asset. Thecombination of these different responsibilities under a single entity fosters greater efficiencygains and removes important maintenance issues from the public budget. Since the ownershipof the asset generally remains with the public party, the specification of quality outputs isZamiin Uud Logistics Park - An invitation for a Public Private Section I Page 7Partnership
Economic Policy Reform and Competitiveness Projectessential for achieving the desired results. The BOT scheme can be designed in a number ofvariants (BOOT, BROT, BLOT, and BTO) according to the specific project needs.e) Design-Build Finance-Operate (DBFO) In this scheme the private partner designs theservice or the asset according to the requirements set by the public entity, ensures and financesthe construction/implementation of the asset/service following the design phase, and finallyoperates the facility. At the end of the PPP contract, the service or asset can be granted back tothe public sector under the terms of the original PPP agreement; in alternative, the agreementis renegotiated. The most common model is the DBFO concession where the private investordesigns, finances, constructs and operates a revenue-generating infrastructure in exchange forthe right to collect the revenues for a specified period of time, generally for 25-30 years.Ownership of the asset remains with the public sector. This model is particularly suited forroads, water and waste projects and generally for services where user charges can be applied.f) Partial divestiture. In this scheme, the asset is partially or entirely sold to the private sector,while the government only maintains a regulatory role aimed at protecting consumers frommonopolistic prices and output restrictions. The divestiture can also be partial, if thegovernment maintains the ownership of some portion of the asset to ensure a certain standardof service while transferring a substantial share of overall costs to the private partner.The following table present a summary of different schemes used as a PPP model Schemes Modalities Service contracts The private procures, operates and maintains an asset for a short period of time. The public sector bears financial and management risks. Operation and management contracts The private sector operates and manages a public owned asset. Revenues for the private party are linked to performance targets. The public sector bears financial and investment risks. Leasing-type contracts The private sector buys or leases an existing • Buy-Build-Operate (BBO) asset from the government, renovates, • Lease-Develop-Operate (LDO) modernizes, and/or expands it, and then • Wrap-around addition (WAA) operates the asset, again with no obligation to transfer ownership back to the government. Build-Operate-Transfer The private sector designs and builds an asset, • Build-own-operate-transfer operates it, and then transfers it to the (BOOT) government when the operating contract ends, • Build-rent-own-transfer (BROT) or at some other pre-specified time. The • Build-lease-operate-transfer private partner may subsequently rent or lease (BLOT) the asset from the government • Build-transfer-operate (BTO) Design-Build-Finance-Operate (DBFO) The private sector designs, builds, owns, • Build-Own-Operate (BOO) develops, operates and manages an asset with • Build-develop-operate (BDO) no obligation to transfer ownership to the • Design-Construct-Manage-Finace government. These are variants of design, (DCMF) build, finance and operate (DBFO) schemesSource: IMF (2004) and European Commission (2003)Section I Page 8 Zamiin Uud Logistics Park – An invitation for a Public-Private Partnership
SECTION II: PRESENT AND FUTURE OF PPP IN MONGOLIA1. Mongolian experience in PPP projectsMongolia does not have experience in PPP. In the last ten years Mongolia has been trying toprepare some projects in the road, energy and health sectors but it has not done so as part of aPPP program.Energy in Mongolia is a relevant sector where five coal-fired cogeneration power plants aremanaged by a central power system, but it is necessary to prepare more projects in urban citiesand rural areas that have diesel generators. One interesting project in development is the CHP5project which anticipates to implement a build, own and operate model for a cogenerationpower plant and the modification of the existing sub stations to produce electricity and heatenergy for Ulan Bator. The capacity of the plant must be 300 MW for power and 700 Gcal forheat energy. It is estimated that this project will be adjudicated this month after the Mongoliangovernment decides if the proposal submitted by a Chinese corporation is technically andfinancially acceptable.Despite lacking experience in PPP, the privatization process completed through internationaltenders was successful. For example, the Mongolia Privatization Program supported byUSAID between 2000 - 2004 utilized a Sealed- Bid Auction 4 for the process of privatizingMost Valued Companies. The project also included a public information and investorawareness component. Through Sealed- Bid auction, Mongolia’s State Property Committeesold 47 enterprises raising USD15,4 million for the GoM. The program included theprivatization of 4 Most Value Companies, Trade and Development Bank, Agricultural Bank,Mongol Daatgal (insurance company) and NIC JSC (Oil & Gas Distribution), sold at USD33.38 million with additional committed investments of USD 58 million 5 .Currently the GoM is preparing a draft law on a BOT and PPP law that is supposed to beapproved by the Parliament this year. Along with the preparation of the law the GoM will needto decide on the best institutional organization for the PPP system.The new GoM action plan (2008-2012) established the main guidelines to use PPP and itfocuses especially on infrastructure and urban planning. The large projects mentioned in theaction plan are: • the international airport Hösig Valley of Töw Province and the roads to connect the airport to Ulan Bator, • renovation of five hundred buses and two thousand taxis for Ulan Bator, • renovation of the technology and equipment of the Mongolian railroad, • construction of a speed road between Zamiin Uud-Ulan Bator- Altanbulag, Yarant Howd-Ölgiy-Ulan Bator • New sources of heating and power • Program on development infrastructure in the southern desert region • Terminal facilities and logistics centers in Ulan Bator and regionsMongolia has around 49.077 kms of roads with only 8% being paved and 92% in badcondition. These statistics represent a huge opportunity to involve the private sector in roaddevelopment.4 An bid- auction in which bidders simultaneously submit bids to the auctioneer without knowledge of the amountbid by other participants. Usually, the highest bidder is declared the winner.5 A Guide to Privatization Tenders. The Mongolian Privatization Experience. USAID/Bearing Point. ZhivkoNenov and Teresa Fabiano. March 2004.
Economic Policy Reform and Competitiveness Project On the other hand, the railways sector is crucial for Mongolian development and it transport of crude oil, timber, wood products, fertilizers and machineries that must cross Russian and Chinese borders with Mongolia. In the last year MFFA and authorities from the GoM started the creation of a Public-Private company to manage the Zamiin Uud Logistics Park. This PPP company could attract private operators to invest in transshipment services, warehouse services and commercial services for the logistics park. Another opportunity to involve the private sector is the Program on development infrastructure in the southern desert region. According to the Action Plan this Program will allow the opening of mines and new factories. It considers building a new railway, a heating power plant with capacity larger than 300 MW and twin aerial cable to provide 220 kw electricity in Mandalgowi-Tawan Tolgoy. The Program also includes a road between Tawan Tolgoy and Oyuu. Mongolia has a National Transport and Trade Facilitation Committee that was established in 2007 by a Mongolian Government Resolution. The Committee has 25 members or representatives from relevant Ministries, government agencies and Mongolia’s private sector. The “Transit Mongolia” program includes the following projects that could also be part of a future PPP Program: - Construction of a secondary railway line - Railway electrification project - Construction of Asian Highway Routes in Mongolia - Facilitation of Transit transport through Mongolian territory - Construction transport and trade logistics and terminals It is evident that Mongolia has a critical mass of potential projects that could create substantial benefits if implemented through a PPP. 2. New Mongolian Government structure: The platform for a PPP Structure It is interesting to review the new structure of the GoM to understand under which institutional context the PPP program and its system can be created. Government Coordination Government Implementation Portfolio Agency AgencyPrime Minister 1. General Intelligence Office 2. National Development and Reform Committee 3. Agency for Nuclear Energy 4. State Property Committee 5. Information, Postal, Communications and Technology AgencyFirst Deputy Minister 6. Agency for Fair Competition 1. Agency for Intellectual and Customers Property 7. Standardization and 2. State Registration Office Measurement AgencyDeputy Prime Minister 8. General Office of Specialized 3. Agency for Children Inspection 9. National Emergency Management AgencyChairwoman of 4. Management Academy Section II Page 10 Zamiin Uud Logistics Park – An invitation for a Public-Private Partnership
Economic Policy Reform and Competitiveness ProjectGovernment Cabinet 5. Agency for State andSecretariat Governmental ServicesMinister of Foreign 6. Agency for Services ofRelations Diplomatic Organizations 7. Foreign Investment and Foreign Trade AgencyMinister of Finance 8. General Customs Office 9. National Taxation AdministrationMinister of Justice and 10. General Police Office 10. General archives officeInternal Affairs 11. General Authority for Border 11. General office for the Protection Implementation of Court Decisions 12. Office of Immigration, Naturalization and Foreign CitizensMinister of 13. Forest AuthorityEnvironment and 14. Water AuthorityTourism 15. Agency for Meteorology and Environment MonitoringMinister of Defense 12. General Staff of Armed ForcesMinister of Education, 16. Culture and Arts CommitteeCulture and SciencesMinister of Road, 17. Civil Aviation AuthorityTransport, Construction 18. Railway Authorityand Urban 19. Transport Services CenterDevelopment 20. Auto road Agency 21. Administration of Land Affairs, Geodesy and CartographyMinister of Social 22. General Authority for SocialWelfare and Labour Insurance 23. Labour and Welfare Services AgencyMinister of Food, 24. Agency for Small andAgriculture and Light Medium EnterprisesIndustries 25. Agency for Veterinary Hospital and ReproductionMinister of Minerals 26. Mineral Resourcesand Energy Authority 27. Petroleum Authority 28. Energy AgencyMinister of Health 29. State Committee for Physical Culture and Sports 30. Health Authority Zamiin Uud Logistics Park - An invitation for a Public Private Section II Page 11 Partnership
Economic Policy Reform and Competitiveness ProjectIn order to establish a public structure for the PPP system in Mongolia, internationalexperience shows several types of possible organizations that can be summarized in at leastfour models for Middle Income Countries 6 .a) Chile: The Ministry of Public Works (MOP) is the competent authority representing thegovernment to prepare all the PPP process, the elaboration of the feasibility studies, the designof the business model, the contract, the adjudication process and also the regulation. Normallythe other of Ministries signed an MOU with MOP to bid on their behalf for any infrastructurebusiness. The Chilean system is totally integrated. A similar concept is applied in Mexico,Costa Rica and Colombia under the Secretary of Transport and Communication in Mexico,the Ministry of Public Works in Costa Rica and the Ministry of Transport in Colombia.b) South Africa: The National Treasury (Ministry of Finance) is the authority withresponsibility of PPPs through a special PPP unit. This unit has developed thepolicy/regulatory framework for PPPs –and has prepared guidelines and manuals on theregulatory requirements (National Treasury PPP Manual and Companion manual onstandardized provisions of PPP/agreements). At the same time this unit has established aProject Development Fund to improve the quality of PPP. Kazakhstan also recently hasestablished the same system in which the ministries and local governments submit theirprojects to the PPP Unit located in the Treasury to start with the feasibility studies and thetender process. In the case of India, the PPP Unit is in the Ministry of Finance but there is alsoa special PPP centre in regions, for example Gujarat (Gujarat Infrastructure DevelopmentBoard).c) Peru: This country has a special agency which deals with PPP projects calledPROINVERSION. The agency prepares the feasibility studies with the ministry involved inthe concession. PROINVERSION designs the contract and business model until theadjudication process. Once finished WITH its responsibility, the adjudicated project issupervised and controlled by the Ministry of Transport and the regulation agency, OSITRAN.The Peruvian System worked over the concept of special separated agencies, where eachpublic agency is responsible for a stage of the PPP processd) Brazil: This country is good example for the countries with two levels of administration,Federal and States, both of which can prepare concessions or PPPs. In Brazil Federalconcessions have historically been prepared by the ANTT (Terrestrial Transport NationalAgency). The new PPP Law enacted in December 2004 allows Municipal, State and Federalinstitutions to prepare PPPs for a period of 35 years. The Federal PPP Program is prepared andmanaged by the CGP (Comité Gestor de Parceria Público-Privada), a council composed ofMinisters of Planning, Finance and the President Chief of Staff. In addition, there is anExecutive Secretary in the Ministry of Planning where economic advisors work under the PPPUnit of the Ministry of Planning based in Brazilia. The Russian Federation’s recentexperience is close to the Brazilian institutional experience. Russia created the Federal LawNo. 115 of July 21, 2005 “On concession Agreements”. Saint Petersburg City also designed alaw “On Participation of Saint Petersburg in PPP” dated December 20th, 2006 and amended onApril 9th 2008. The authorizing body involved in the process at the federal level are theGovernment Council in Competitiveness and the Expert Council for PPP of Ministry ofTransport. In the case of Saint Petersburg, the City Agency for Strategic Investments is theauthorizing body.6 Annex D Shows the list of Middle Income Countries and Upper Middle Income Countries according to theWorld Bank classification Section II Page 12 Zamiin Uud Logistics Park – An invitation for a Public-Private Partnership
Economic Policy Reform and Competitiveness ProjectFinally, a couple of Middle Income Country examples consist of a combination of differentauthorities participating in PPP programs and multisystems of Units working on PPPs. Such isthe case in Bulgaria, Indonesia (National Committee for the Acceleration of InfrastructureProvision Policy (KKPPI) and Ministries), Philippines (BOT Center and others) andPanama.In the case of High Income Countries, like United Kingdom, Australia and Korea it isnormal to use public-private agencies to evaluate and design feasibility studies and participatein tender processes. The agencies are Partnerships UK (51% private and 49% Government),Partnerships Victoria (PV) and Public and Private Management Center (PIMAC).The most famous model used in high income countries is the United Kingdom model ofPrivate Finance Initiative (PFI) which is also applied in Canada and Australia. The PFI modelis characterized by the payment from public sector to the concessionaire to build and operatethe infrastructure.The HM Treasure 7 of the UK is the manager of the system designing methodologies andguidelines for project appraisal and approval. Each public agency prepares a project with thesupport of Partnerships UK which is a public-private institution. Most of the projects in theadjudication process go through a negotiation process to assure that the public sector will haveaccess to the highest quality. The negotiation step is called Invitation to Negotiate. If there isno agreement with the first company selected, the process continues with the second rankingcompany and so on.The UK uses a methodology called Public Sector Comparator to estimate Value for Moneyfrom a private initiative compared with the same project through public sector.In the case of Australia, Partnership Victoria (PV) develops policy and guidelines, promotesimplementation of best practices and provides specific advice for public institutions, but thePPP projects are developed by each Ministry or Public department. The PV unit is locatedwithin the Commercial, Infrastructure & Risk Management Group in the Commercial Divisionof the Treasury, therefore the Treasury is the institution responsible for developing andcontrolling the work of PV.It is recommended to conduct a study to determine the best institutional structure forMongolia’s PPP system, given the current GoM structure, the type of projects Mongolia isconsidering to implement and international best practices weighing the strengths andweaknesses of each model.3. Macroeconomic Factors to be considered in a Potential PPP Program in MongoliaEvery country has macroeconomic strengths and weaknesses that serve as a platform fordomestic and international investors once a PPP program is established. Liquidity and depth ofthe capital markets, economic growth, increase in the wealth of the citizens, prudent fiscalmanagement and country risk are important factors to back a PPP Program.Mongolia has had positive economic growth over the past six years averaging around 7%. Theeconomy has been prudently managed promoting stability and reducing vulnerability andinternational risk exposure. It is important to highlight that privatization and fiscal reform havecontributed to the existing macroeconomic stability.Fiscal reform has focused on the new mining law, VAT, personal and income tax laws,intending to provide a clear regulatory frame of reference.7 Her Majesty´s Treasury Zamiin Uud Logistics Park - An invitation for a Public Private Section II Page 13 Partnership
Economic Policy Reform and Competitiveness ProjectHowever, the Mongolian economy is still small with around USD 2,200 per capita and a totalGDP of around USD 4 billion. The economy is also small in terms of population, whichaccording to the last estimations is close to 3 million inhabitants.Those two disadvantages small economy and small population could be largely compensatedwith the fact that Mongolia is the potential bridge for two large countries and economies,Russia and China, both countries represents 22% of the total world population (approximately1,500,000,000 from China and Russia) and 10% of the total world economic production(China and Russia).At the same time, Mongolia has large copper and gold deposits in Mongolia in addition to thecountry’s proximity to Russia and China, the largest countries in the region with high exportpotential for Mongolia.In the last couple of years Mongolia has successfully created a special fund for fiscal savings.The Development Fund raises money from the revenues of the mining sector, principally goldand copper, which is the main revenue of the GoM. The resources allocated in the Fund arespent in the following manner: one third for the children and families allowances, one third forcapital expenditures and the remaining one third is saved.However, as a result of the international financial crisis, the price of copper is decreasingaffecting Mongolia’s 2009 budget forecast, which estimated the copper price to be 50% higherthan the actual current price of copper. These commodities, along with gold and cashmere,suffer from time to time due to the volatilities of their prices, which impact the economythrough the flexible exchange rate of MNT.Unfortunately and although Mongolia is implementing the correct policies to follow themarket efficiencies, the Mongolian investment grade over Long Term Foreign Currency givenby the rating agency Standard & Poors did not improve and it is still BB- ( non investmentgrade).It is important to note that when countries reach a stable investment grade they become moreattractive to investors who perceive a country with a stable investment grade as a less riskyinvestment, therefore reducing the opportunity cost of the money invested in the country.The following table displays a useful comparison of several developing countries, which areinteresting to consider in the world of PPP for different reasons.In our currently competitive world every country desires to send a strong signal to potentialinvestors through the positive evaluation prepared by credit rating agencies like Standard &Poor, Fitch Rating and Moody´s. Ratings and evaluations allow potential investors to makeinformed choices about countries in which they can invest their money profitably and safely.The investment grade is the capacity of a country to meet its payments and liabilities. Forinstance, Chile is a country in Latin America which is a symbol of success in the economicarea and political stability. Transparent public policies and strong institutional systems haveallowed Chile to reach the highest level of investment grade for a Latin American country,A+. 8The successful case of Chile in PPP occurred in tandem with political and economic stabilityrecognized by the international community with investment grade (BBB). This investmentgrade coincided with the start up of a PPP program and enhanced the program’s probability of8 In Latin America just Chile, Peru, Mexico and Brazil have investment grade according to Standard & Poorrating agency. Section II Page 14 Zamiin Uud Logistics Park – An invitation for a Public-Private Partnership
Economic Policy Reform and Competitiveness Projectsuccess. In the last fifteen years, Chile has increased three notches from its original rankingunderpinning the PPP program.An example of the positive impact of such established stability was recently displayed when inJanuary 2009 a public Chilean mining company, Codelco, became the first company in LatinAmerica to issue a bond in New York, nevermind this occurred in the midst of a globalfinancial crisis. The bond value was USD 600 million with a term of 10 years. The demand forthe bond was twice the original amount expected and the interest rate was 7.5%.Brazil and Kazakhstan have recently been enjoying a high investment grade rating but thesetwo countries have different experiences in PPP. Brazil also started the Program in the 1990sand Kazakhstan has been working with PPP especially in railways and energy projects in thelast decade.In Mexico’s case, the country faced PPP program design problems in the 1990s and nowMexico can take advantage of this investment grade because it is launching a comprehensivePPP program with the support of the Interamerican Development Bank through a specialagency called PIAPPEM.Finally, the case of Peru is interesting because in the 1990s Peru approved the PPP law butPPP development was slow since the approval of the law. Peru received a BBB- investmentgrade just 6 months ago, but still managed to attract USD 3 billion in private investment overthe last decade, creating confidence among the investors with the assistance of partial creditrisk guarantees from multilateral agencies and subsidies for the projects.As we can see in the table, Mongolia is just one notch below the starting point rating given toPeru in the nineties 9 , when Peru started its PPP program. For Mongolia to attract investors itwill be necessary to create a PPP program that includes special protection for investorsassuring return on their long term investments. Investment Grade (Long Term Foreign Countries Currency) Chile A+ Malaysia A Mexico BBB+ Thailand BBB+ Kazakhstan BBB- Brazil BBB- Peru BBB- Mongolia BB- Philippines BB- Indonesia BB-Source: Standard & Poor´sThe investment grade of Mongolia will increase if the country is able to: • Improve the ability to meet debt obligations or improve creditworthiness with strong fiscal policies to reduce the current levels of debt. • Reduce the sensitivity of the economy to external shocks. Some countries establish specific funds to reduce sensitivity in volatile areas of the economy.9 Peru had a BB investment grade when this country started the PPP program in th nineties Zamiin Uud Logistics Park - An invitation for a Public Private Section II Page 15 Partnership
Economic Policy Reform and Competitiveness Project • Develop the capital markets, generating new financial instruments to deepen capital markets and to create the possibility of lengthening the period of investment in long term domestic bonds. The correct design of a PPP infrastructure program can facilitate the creation of new financial instruments and create the possibility of offering infrastructure bonds over long term periods. Pension system reform allowing the recognition of the individual capitalization system could also help to develop Mongolia’s capital markets.Although the macroeconomic situation in Mongolia has been improving over the last ten yearsit is still a small economy and it will be necessary for the private sector and donors tocollaborate with the GoM to help the country to achieve the expected economic results in the2008-2012 Action Plan.The Action Plan describes some expected economic results for the end of the current GoM. Itis possible to achieve some of the results related to areas where the private sector couldpossibly participate in infrastructure projects and other areas of development as is shown in thetable. Situation at the end Estimated Result Measurement 2007 and first half of Achievement by 2012 2008Supply of electricity Availability to all 70% 90% householdShare of Population Percentage 66% 68%supplied with drinkingwaterAmount of GDP per USD 1288.8 USD 5000 USDcapitaReduction of poverty percentage 32.2% 25%levelLength of paved auto kilometers 2120 6320roads 285National roadsRegional roadsReduction in duration The period of 30- 35 Within 40-45 minutes Within 20 minutesof traffic jams km/h ride from the Eastern crossroad to the western at 12 o´clock in business daysSource: GoM Action Plan 2008-2012GoM requires around 33 trillion of MNT to reach the results of the Action Plan. GoM isexpecting to contribute 9.4 trillions MNT (30%) and to bring 19.9 trillions MNT (63%) indomestic and international private investment. The GoM is also counting on foreign loans anddonors for 2.2 trillion MNT (7%).Government funds are not enough to achieve the Action Plan results, therefore providingmotivation to attract funds to Mongolia. In 2008, the GoM studied the possibility of signing anagreement to create a fund with the Kazakhstani institution Kazyna Capital Management(KCM) JSC. The fund would be initially capitalized with USD 100 million to be used forprojects and industries principally in the energy, transport and logistics, financial market,telecommunications, tourism, metal and mining industry (geological exploration for gold,Section II Page 16 Zamiin Uud Logistics Park – An invitation for a Public-Private Partnership
Economic Policy Reform and Competitiveness Projectsilver and tungsten) sectors in Mongolia. KCM funds will be allocated mainly to geographicareas where Kazakh people are living in Mongolia.The exchange rate is an additional macroeconomic issue essential for consideration in PPPcontracts. It is crucial to define who will assume exchange rate risk or if this risk can be sharedbetween the public and private sectors. This is particularly important for Mongolia, especiallybecause of the large MNT fluctuations in the first two weeks of January 2009. For example, onDecember 1, 2008 the exchange rate was MNT 1,210 per 1 USD and in the second week ofJanuary it reached MNT 1,400 per 1 USD. The fluctuation is basically a result of the lack ofexport diversification in the Mongolian economy, speculation and also the financialinternational crisis, which impacts Mongolia through the exchange rate. Recently in January2009 the Yuang exchange is also increasing.In some concessions, the Chilean government utilized an exchange rate guarantee, whichworks in the following way: the Chilean government established two exchange rate thresholdsone for a cap and another for a floor, so the real exchange rate can fluctuate inside of theselimits. When the real exchange rate depreciates beyond the cap, the government pays thedifference to the concessionaire and the case reverses when exchange rate appreciates.The system is used under the condition that the concessionaire recognizes the value of theguarantee in reducing the risks of exchange rate and matching debt payments, which are takenin USD and the revenues while the concession is paid in Chilean pesos.4. Mongolian financial marketA new PPP program must consider the domestic banking system’s capacity to secure the loansnecessary for private sector investment in PPP projects. It is also important to understand if theMongolian Financial System allows institutional investors to participate in buying bonds orsecurities issued by a PPP company.This section presents a quick review of Mongolia’s current financial market focusing on realpossibilities for the domestic banking system and capital markets to actively participate withlong term funds for a new PPP program.The Mongolian banking system consists of 16 commercial banks and the Bank of Mongolia(BOM) or Central Bank of Mongolia, which supervises banking activities and acts as aGovernment fiscal intermediary. The BOM also formulates and implements monetary policy,issues currencies and is in charge of managing Mongolia’s foreign currency reserves.Mongolia also has a Financial Regulatory Commission (FRC) that supervises non bankfinancial institutions and the capital markets.The following table shows that the Financial System in Mongolia has 3.425 billion MNT inassets, of which 95.7% is owned by banks, principally foreign banks.The table also shows the small participation of non bank financial institutions with just 147billion MNT in assets and the most numerous institutions are the finance companies. It isexpected that insurance business will become more dynamic in the future as this sector hasonly 4 years of existence since the implementation of the Insurance Law in 2004.Zamiin Uud Logistics Park - An invitation for a Public Private Section II Page 17Partnership
Economic Policy Reform and Competitiveness Project Mongolia Financial System Institution Number Assets (bn MNT) % of total shares Banks 16 3,279 95.7 Private 16 3,279 95.7 Domestic 6 967 28.2 Foreign 10 2,312 67.5 State-Owned 0 0 0 Non Bank financial Institutions 379 147 4.3 Insurance companies 15 28 0.8 Life 0 0 0 Non-Life 15 28 0.8 Savings and Credit 192 36 1.0 Cooperatives Finance Companies 137 66 1.9 Securities firms /Brokers Firms 35 16 0.5 Total Financial System 395 3,425 100Source: IMF, Bank of Mongolia and Financial Regulatory Commission (December 2007)Given the current situation of Mongolia’s financial system it will be very useful to develop thecapital markets in anticipation of the necessities of PPP companies. In this sense, the USAID-funded Economic Policy Reform and Competitiveness (EPRC) Project supported banks in thecreation of the Mongolian Mortgage Corporation (MIK) which is the first secondary mortgagemarket company established by the Bank of Mongolia (BOM) and ten commercial banks(Anod, Golomt, Zoos, Capital, Capitron, Mongol Post, Khaan, Trade and Development,XacBank and Ulaanbaatar City Bank).Several banks have been facing liquidity limitations to expand mortgage lending. Additionallythe current mortgage market is concentrated short term loans and there is a lack of institutionalinvestors. As such, according to its Mission Statement, MIK is going to engage in “thepromotion and development of primary and secondary mortgage markets by raising medium tolong term funds on domestic and foreign capital markets through a series of capital markettools to create and ensure a smooth functioning of a long-term financing system to promoteaffordable home ownership and urban development for Mongolia’s people”.MIK is going to be the main developer of new products for the capital market. It is estimatedthat the principal products could be: • Credit Default Swaps (CDS) as a partial synthetic securitization transaction that could be used alone as a separate line of business or as an interim step to full securitization at the initial stage of MIK’s operation. • Warehousing Facility. MIK will be working with lender customers to purchase mortgage loans, pool and warehouse them until a sufficient volume for securitization is generated. • Credit-Enhanced Mortgage-Backed Securities (CE-MBS) with Standby Liquidity: MIK will work with lender customers to securitize mortgage loans into MIK CE MBS and to facilitate the purchase of mortgage loans for MIK´s mortgage portfolio. • Capital Market Transactions: MIK will issue debt securities in the capital markets to attract capital from global investors to finance mortgage lending in Mongolia.The next step in Mongolia’s capital market is to advance the enactment of an efficientMortgage and Securitization Law to regulate the main subjects related to securitization It willbe a critical step in support of PPP project finance where normally the revenues of the projectSection II Page 18 Zamiin Uud Logistics Park – An invitation for a Public-Private Partnership
Economic Policy Reform and Competitiveness Projectare the principal asset of the PPP company and they can be securitized in the capital market toobtain the money necessary to invest in the projects.For example, an urban road PPP project in Chile called Costanera Norte and adjudicated to theItalian company Impregilo, obtained USD 260 million (in local currency equivalent) fromChile’s capital markets, mainly from institutional investors (pension funds and insurancecompanies). The participation of Monoliners 10 was important to obtain triple A rated debt.Ambac assurance was the monoliner for this structure in 85% of the debt (approximately USD220 million) and the Interamerican Development Bank (IADB) provided a financial guaranteefor the remainding 15%.At the beginning of the PPP program, the Mongolian PPP companies can be funded by thebanking system for small projects or by foreign financial institutions. Recently, for example, inChile a Spanish company, Azvi, has closed a credit with DEPFA Bank (Ireland) and CreditInstitute (Spain) for around USD 26 million to build the Land Port Los Andes which will bediscussed in the next section.5. Foreign investment in MongoliaIn the last sixteen years Mongolia has received around USD1.5 billion in foreign investmentwith the creation of around 6,000 companies from 93 countries. In 2006 foreign investmentwas around 366 million as a result of tax incentives, property ownership protection andguarantees for investors. Based on the foreign investment Law Mongolia has been active in thelast years signing two agreements with around 40 countries, which includes the: “Agreementon Avoidance of Double Taxation” and “ Agreement on Mutual Protection and Promotion ofInvestment”. Mongolia is also a part of the Washington Convention on Investment DisputeSettlement of 1965 and the Seoul Convention on Investment Insurance of 1985.EPRC is supporting the GoM in the implementation of a relevant tool, known as the SingleElectronic Window (SEW) which, according to Recommendation No. 33 of the UnitedNations Centre for Trade Facilitation and Electronic business (UN/CEFACT), is described as:a facility that allows parties involved in trade and transport to lodge standardised informationand documents with a single entry point to fulfil all import, export and transit-relatedregulatory requirements. The SEW will improve the information management and the speed tocontrol and inspect cargo at the borders.With respect to Tax Preferences, the Foreign Investment Law of Mongolia includes thefollowing: 1. A business entity with foreign investment in any of the following areas shall be granted the tax preferences set forth below effective from the date of starting production activities: i) power and thermal plants and their transmission networks, highways, railways, air cargo and engineering constructions, and basic telecommunications networks shall receive 3 years of tax exemption and 50 % tax relief during the following 5 year period; ii) mining and processing of mineral resources (except precious metals), oil and coal, metallurgy, chemical production, machinery, and electronic shall receive 5 years of tax exemption and 50% tax relief during the following 5 year period;10 Monoliners or Monoline Insurance Company guaranteed the repayment of a bond principal and interest whenthe responsible institution failures to do the timely payments. Zamiin Uud Logistics Park - An invitation for a Public Private Section II Page 19 Partnership
Economic Policy Reform and Competitiveness Project 2. Should a business entity with foreign investment, which is not referred to in paragraph 1 of this Article, export more than 50% of its production, then it shall be entitled to tax exemption for 3 years and 50% tax relief in the following 5 year period. 3. A business entity with foreign investment which is not referred to in this Article may be granted tax preferences. Decisions in this matter shall be adopted by the State Great Hural on a case by case basis upon the presentation by the Government of Mongolia. 4. Should a foreign investor reinvest income due to it in the same business entity with foreign investment which produced such income, then the taxable income of the concerned business entity shall be subject to a deduction equal to the amount of such reinvestment. 5. If the activities of a business entity with foreign investment covers more than one of the areas referred to in paragraph 1 of this Article, then the tax preferences to be granted to such business entity shall be in respect to the main area of activity. 6. A business entity with foreign investment which is established by purchasing shares and securities which were previously sold by coupons under the Privatization Law of Mongolia shall not be eligible for the preferences set forth in paragraphs 1 and 2 of this Article.Respect to the Use of Land by Business Entities with Foreign Investment (article 21 of the TaxLaw) the law indicates the following: 1. Land shall be used by a business entity with foreign investment on the basis of a lease hold and subject to the conditions and procedures set forth in the land laws of Mongolia. 2. A lease shall contain the terms and duration of use and the measures to ensure the protection and restoration of the environment to its natural state, the amount of annual ground rent, and the liabilities of the lesser and lessee. 3. A lease shall be made under the procedures set forth below: i) a lease for the use of state-owned land by a wholly foreign-owned business entity shall be made between the Mongolian landowner and the foreign investor and subject to authorization by the respective local Hural of Representatives and its Presidium; ii) a lease for the use of state-owned land by a business entity with foreign investment to which a Mongolian investor is a participant shall be made between the Mongolian landowner and the head of the business entity concerned and subject to authorization by the respective local Hural of Representatives and its Presidium; iii) a lease for the use of private freehold land by a business entity with foreign investment to which a Mongolian investor is a participant shall be made between the Mongolian landowner and the head of the business entity with foreign investment and subject to authorization by the competent state authorities. 4. Responsibilities arising from a lease referred to in paragraph 3 (ii), (iii) of this Article which are contracted by the head of the business entity with foreign investment shall be borne by the Mongolian and the foreign investor in proportion to their contributions to the registered capital of the business entity. 5. The duration of any lease shall be determined by the duration of the operations of the business entity with foreign investment. The initial term of a lease shall not exceed 60 years. The lease may be extended once for a period of up to 40 years under the initial conditions of the lease.Section II Page 20 Zamiin Uud Logistics Park – An invitation for a Public-Private Partnership
Economic Policy Reform and Competitiveness Project 6. If a business entity with foreign investment is dissolved before the expiration of the lease, then the lease shall be terminated at the same time. 7. Leasehold land may be substituted or taken back for a specific state purpose. Decisions concerning this matter shall rest exclusively with the Government of Mongolia. Compensation for losses suffered by a foreign investor due to such actions shall be effected without delay. The amount of such compensation shall be determined on the basis of value at the time of such substitution or transfer. 8. If leasehold land is used to the detriment of the public health, natural environment or the interests of national security, then the lease shall be cancelled6. RecommendationsThis section includes recommendations to be considered by the appropriate Mongolianauthorities in order to establish a successful PPP program in this country. • Investment climateMongolia needs put forth the effort in increase the country’s rating to obtain an investmentgrade. It will attract more foreign and national investment because of the impact of decreasingthe long term interest rate as a result of higher confidence in the country.In order to achieve a better rating, Mongolia needs to protect the macroeconomic stability withsound fiscal and monetary policies and continue encouraging market forces with adequateregulation. • Legal frameworkMongolia needs a comprehensive law on PPP or in concessions (BOT) to foster faircompetition between private companies and to correctly establish the rights and obligations ofthe public and private sectors.The legal system also needs to specify the public agencies dealing with the PPP process andthe main steps of the tender process.In some PPP laws it is also possible to specify the main bidding mechanism that the publicagency will use in the tender process.It is highly recommended that Mongolia work in a coordinated fashion, perhaps in theformation of a working group, with the main authorities that are going to be involved in thePPP process.It is clear that the ministries dealing directly with projects and the ministries dealing withforeign investment and budget must to be present for the discussion of the draft Law. Thisincludes the following ministries: • Minerals and Energy; • Road, Transport, Construction and Urban Development; • Finance • Foreign Relations • JusticeIn addition to the aforementioned ministries, participation of the State Property Committee andthe Agency of Fair Competition and Customers would be highly desirable.This working group would need to establish a work plan to deliver the new law before the endof the second quarter 2009.Zamiin Uud Logistics Park - An invitation for a Public Private Section II Page 21Partnership
Economic Policy Reform and Competitiveness ProjectThe areas for development under PPPs which the government is considering for inclusion inthe Law are the following: a) Heat, electricity or natural gas transmission and distribution network and energy generating source; b) Centralized water supply and sewage system, their networks; c) Water facilities; d) Railway and public transportation facilities; e) Auto road and road facilities; f) Airport, civil aircraft and air navigation facilities; g) Waste treatment and disposal facilities; h) Water transports; i) Complexes used to meet general needs of citizens including health, education and sport; j) Housing units and villages for rent; k) Mining facilities for extraction and processing of all types of minerals and natural gas except those which are widespread. • Institutional organizationWhile the PPP Law is discussed between the public authorities and knowing that the Law willneed to explain clearly the Ministries or agencies involved in the process, the Ministry ofFinance should reserve and allocate financial resources for the public agency that will beworking on the PPP program.Ideally the main projects to be implemented through PPP should also be identified to assist inthe selection of the best institutional model for Mongolia. It’s anticipated that the mainprojects will likely involve the ministries of Minerals and Energy and Road, Transport,Construction and Urban Development.The initial process of designing the Law, creating the structure and building capacity amongthe professionals responsible for the projects requires strong leadership to coordinate thedifferent point of views inside of the public sector. It is recommendable to identify a couple ofhighly prepared professionals that can assume this responsibility in the near term. • Multilateral agencies and donors participationMultilateral agencies and donors could contribute to starting the PPP process in Mongolia byhiring consultants and financing study tours and workshops in the PPP area.Among the several agencies working in the world of PPP, the World Bank Institute and thePPIAF, UNDP, Asia Development Bank and USAID could assist in this process. The AsianDevelopment Bank for example, has been lending to Mongolia around USD 676.54 millionsince 1991 and 25% of these resources have been allocated to the Transport andCommunications sector, 15% in Finance and 14% in energy.Mongolia could create a Fund were the PPP Agency can receive and manage funds fromdonors and multilateral agencies. The funds could be donations in support of specific studiesor to create the PPP Agency or could be used as loans to be included in the projects orumbrella guarantees to help the PPP project finance.The extensive experience of donors and multilateral agencies will be extremely important, notonly in the start up process but also during project implementation.Section II Page 22 Zamiin Uud Logistics Park – An invitation for a Public-Private Partnership