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Complimenting
Economic Advances
     in India
  A New Approach to Financing In"astructure
                  Projects
     ...
Research
Background
   Dr. Chen, distinguished
 finance professor, began this
 research theme in the early
            2000...
The India
Context
✤   Inadequate infrastructure was emerging as a
    key obstacle to growth, in spite of a terrific
    te...
The India
    Context
✤   Cases of corruption and political and
    economic risk deterred investors. Eg. Enron’s
    $2.9...
Backdrop of Infrastructure
      Approaches
✤   Presence of infrastructure and FDI synergistically related, also
    provi...
Problems with Current
Approaches
✤   Bidding process can be inefficient. The influence of politicians, and
    possible brib...
Problems with
Current Approaches
✤   The plums story repeats itself
    world-wide. Many cases of cost
    overruns likely...
Problems with Current
Approaches

✤   Policy and political risk, that project contracts can be unenforceable
    or nullifi...
An Innovative
Approach

✤   An approach is needed that:

    ✤   Levels the competitive playing field;

    ✤   Deters poli...
Bring in the Markets

✤   Using a “market finance” approach over “contract” finance
    approaches can create diversification...
Bring in the Markets

✤   Ensures greater efficiency and liquidity for future cash flow claims.

✤   Managerial incentives m...
More Particulars

✤   Projects with natural monopoly characteristics (like water and power)
    can still have a public se...
Implications
✤   Under a market-based PPP, enhanced project values bring benefits to
    the community and economy at large...
Real
Development
✤   Infrastructure funds of all types —by
    sector, country, region—are growing
    rapidly. Even an In...
New Research Ahead:
Greater Resource Efficiency for China

✤   New research about the capital market approach and how it c...
Water & Energy

✤   To meet electricity demand, China needs $2.74 trillion to 2030; in
    power generation, China consume...
Water and China

✤   Per capita water availability is one-quarter of global averages; India’s
    is worse, and worsening....
More on Water


✤   Water managers in UK, US, Germany, Bangladesh, Australia
    considering climate change in planning.

...
Sustainable and Responsible

✤   Infrastructure projects or projects linked by theme, sector or region
    can use PS or I...
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Infrastructure in India research, plus China

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Presented to Iraqi city leaders. Based on research regarding infrastructure development in India, and its financing. Includes preview of new research about China's need for green infrastructure and how to finance it.

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Infrastructure in India research, plus China

  1. 1. Complimenting Economic Advances in India A New Approach to Financing In"astructure Projects by Dr. Andrew Chen & Jennifer Warren Published in Journal of Structured Finance, Summer 2007; adapted for Far Eastern Economic Review, Mar 2008 Co!ins Center SMU Cox August 2010
  2. 2. Research Background Dr. Chen, distinguished finance professor, began this research theme in the early 2000s. Dr. Chen and Jennifer Warren teamed up in 2006 to see how this new approach would look within country contexts, first in Africa, then India, and now in China. Co!ins Center SMU Cox August 2010
  3. 3. The India Context ✤ Inadequate infrastructure was emerging as a key obstacle to growth, in spite of a terrific technology and innovation story. ✤ Indian government wanted to attract $500 billion of private capital by 2012 to bring infrastructure spending (from 5% to 9%) in line with its economic growth trajectory. ✤ In India, 7% of the $51.4 billion spent on private participation projects were cancelled or distressed. India was also attracting lower levels of private investment vs. China, for example. Co!ins Center SMU Cox August 2010
  4. 4. The India Context ✤ Cases of corruption and political and economic risk deterred investors. Eg. Enron’s $2.9 billion Dahbol power plant with construction halted in 2001 after being four- fifths complete. ✤ Policy risk—that government changes laws, regulations or contracts—is a problem for investors. Numerous water and power projects met with public contention. ✤ Problems with PPPs ranged from high tariffs with poor service to lack of transparency about the process and goals. ✤ India’s bureaucratic red tape is ✤ Infrastructure spending particularly politicized, especially in lagging regions. legend.
  5. 5. Backdrop of Infrastructure Approaches ✤ Presence of infrastructure and FDI synergistically related, also providing increased standard of living for people. ✤ BOT (Build-Operate-Transfer) and PPP (Public-Private Partnerships) approaches have led to substantial losses and reveal flaws. ✤ Infrastructure projects are inherently risky with large capital outlays, long completion times and regulatory and political risk. ✤ Of $786 billion spent on PPP projects globally (1990-2003), India attracted only 4%. Co!ins Center SMU Cox August 2010
  6. 6. Problems with Current Approaches ✤ Bidding process can be inefficient. The influence of politicians, and possible bribery and corruption, may weigh heavily in the bidding process. (The Enron case got off to a bad start with a lack of competitive bidding.) ✤ These contract finance approaches reveal inefficiencies in negotiations and bidding processes, often requiring lengthy efforts and completion times. (Managalore Power Co. project held up 7 years before given clearance to execute project.) ✤ Bidding process suffers the “plums” problem. The bidding firm (buyer) may have more knowledge about the projects costs and its economic value. This gives rise to corruption, game playing and waste. Co!ins Center SMU Cox August 2010
  7. 7. Problems with Current Approaches ✤ The plums story repeats itself world-wide. Many cases of cost overruns likely the result of low bids to secure projects. ✤ In India, of 837 central government sponsored projects, 23% had cost overruns (at an average of 43%). ✤ World Bank cites bad negotiations in PPP and BOT projects as source of billions lost during Asian financial crisis (Indonesia at $10 billion and Philippines, $6 billion).
  8. 8. Problems with Current Approaches ✤ Policy and political risk, that project contracts can be unenforceable or nullified. New political agendas can overturn projects at critical stages. ✤ Lack of diversification and liquidity in project’s finances. Project sponsors bear equity concentration risk financially and political risk, given small number of lenders and/or sponsors. ✤ Post-contract opportunism can cut both ways. Project companies can engage in managerial misdeeds in absence of proper incentives. Co!ins Center SMU Cox August 2010
  9. 9. An Innovative Approach ✤ An approach is needed that: ✤ Levels the competitive playing field; ✤ Deters political and policy risk; ✤ Develops more transparent market mechanisms; ✤ And, most importantly, unshackles that which constrains the economy and standard of living— a lack of proper infrastructure.
  10. 10. Bring in the Markets ✤ Using a “market finance” approach over “contract” finance approaches can create diversification, increase liquidity, and eliminate the plums problem existing in BOT and PPP. ✤ Use of project securitizations (PS) or initial public offerings (IPOs) via capital markets for large-scale projects can: ✤ Ensure ample funding, bring awareness of project, with strong interest globally; ✤ Greater community interest can be generated using domestic capital markets to avoid “mood swings” of public opinion. Co!ins Center SMU Cox August 2010
  11. 11. Bring in the Markets ✤ Ensures greater efficiency and liquidity for future cash flow claims. ✤ Managerial incentives more aligned with productivity. ✤ Government at local, state and central levels can be allocated PS to achieve true public-private partnership. ✤ Financial innovations can be used in security design as a deterrent and incentive (eg., puttable stocks, tax-free status project bonds or with event-risk provisions for earthquakes, terrorist attacks, or oil price shocks). ✤ Event-risk covenants can deter politicians’ attempts to make undesirable policy changes.
  12. 12. More Particulars ✤ Projects with natural monopoly characteristics (like water and power) can still have a public service commission to set price and allow for fair return. ✤ To align incentives, construction workers and project operation employees can be granted stock options. ✤ Approach can be applied to a consortia of small-scale projects linked by sector or region. (Eg.,Aqua Siempre Corridor) ✤ Research showed that inefficiencies in India’s public sector led to losses of 1.4% of GDP; power sector losses and subsidies amounted to 1.3% of GDP and unpaid electricity liabilities a further 1.1% of GDP.
  13. 13. Implications ✤ Under a market-based PPP, enhanced project values bring benefits to the community and economy at large, and stakeholders’ awareness must be elevated through communication about the gains. ✤ For politically-sensitive, important, large-scale projects, complete communication is needed among community stakeholders, project companies, and financial architects. ✤ Use of capital markets can jump-start projects that stand on a more solid, transparent foundation from proper due diligence and communication to civil society. ✤ This type of public-private partnership allows for community assets which help stabilize polarizations common to lagging regions (in the case of India). Co!ins Center SMU Cox August 2010
  14. 14. Real Development ✤ Infrastructure funds of all types —by sector, country, region—are growing rapidly. Even an India infrastructure exchange-traded fund (ETF) was created recently. ✤ More pension funds world-wide are investing in infrastructure to hold ‘real assets’ post-financial crisis. ✤ Return prospects are more realistic than in years past, giving more opportunities for bankable projects. ✤ Since this paper, infrastructure investing has become more popular and sophisticated.
  15. 15. New Research Ahead: Greater Resource Efficiency for China ✤ New research about the capital market approach and how it can facilitate greener infrastructure, especially in power and water projects, for China. (Forthcoming in The Chinese Economy) ✤ China needs to bring the private sector into infrastructure projects to accomplish its economic growth and development goals. ✤ China especially needs more clean energy and efficient water infrastructure to combat air and water pollution, alongside the impacts of climate change as China becomes more water-stressed in the coming years. Co!ins Center SMU Cox August 2010
  16. 16. Water & Energy ✤ To meet electricity demand, China needs $2.74 trillion to 2030; in power generation, China consumes 24% of world demand (2005-2030). ✤ Water infrastructure tends to attract less private capital owing to policy risk in developing countries. ✤ Climate change expected to worsen water problems: increasing frequency of floods and droughts. ✤ Water issues impact important policy areas: energy, health, food, and environment. Co!ins Center SMU Cox August 2010
  17. 17. Water and China ✤ Per capita water availability is one-quarter of global averages; India’s is worse, and worsening. (India loses more to climate change than China even.) ✤ World Banks says China is water-stressed by 2010, at 2000m3 / person. ✤ Focusing on efficiencies in energy adds to China’s water and energy savings. ✤ Yunnan province studied temperature from 1950-2003 to understand drought effects. Increases of 0.2 celcius recorded per decade. Cost to agriculture was $1.5 billion. Now to begin drought-related infrastructure undertakings. Co!ins Center SMU Cox August 2010
  18. 18. More on Water ✤ Water managers in UK, US, Germany, Bangladesh, Australia considering climate change in planning. ✤ To bring in private sector, tariffs being raised throughout many Chinese cities. Eg., Shenzhen raising 30% households, 60% businesses. ✤ Same story of flaws repeats itself in BOT and PPP projects: Many wastewater treatment plants with private participation are BOT, but investors have grown weary. Co!ins Center SMU Cox August 2010
  19. 19. Sustainable and Responsible ✤ Infrastructure projects or projects linked by theme, sector or region can use PS or IPO approach. Theme could be “green” like a biomass power plant, a solar plant and a super-efficient water utility. ✤ With water a delicate public issue, citizens can participate as shareholders and stakeholders, with governance and oversight roles. ✤ Government needs to pave the way however with consistent policies. ✤ Goal of sustainability —in financing and resource implications— should guide analyses of policies that deter clean energy and water infrastructure development. Co!ins Center SMU Cox August 2010

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