Financing Constraints

5.3 Smaller projects appear to have a host of financing and structuring issues. The public entity in almost all the projects examined had to play a proactive role in facilitating financing. The projects also needed substantial government support in order to become bankable.

5.4 Local bodies undertaking small-scale PPP projects are frequently characterized by inadequate fiscal resources. Most projects out of the sample of ten small-scale PPP projects examined were net cost projects for government; i.e., the government needs to pay a substantial proportion of the costs through availability or output based payments. In some of the cases examined, the local body did not have the financial capacity to make the payments on its own and needed help from sources external to its routine budget, such as from the GPOBA and VGF.

5.5 Issues of credit-worthiness also plague local bodies. The lack of credit-worthiness of the local body affects the availability of finance for PPP projects sponsored by it. The guarantee of a local body or even termination payment provisions in contracts where the local body is the contracting authority does not amount to much if its fiscal position is doubtful. In the late 1990s the Government of India had, with assistance from a USAID project, worked on an exercise of developing a credit rating methodology for municipal bodies, and an initiative for rating these institutions was undertaken by the Ministry of Urban Development. The exercise helped several local bodies adopt better financial management systems and to issue bonds for infrastructure.

5.6 There is a shortage/ non-existence of financing from local debt markets for small-scale projects. While bond financing is somewhat forthcoming in recent times for some of the larger PPP projects of national importance, commercial bank financing is frequently the only source of financing for small-scale projects. In addition, there is no true project finance in countries, with the investors having to produce collateral that may be equal to or higher than the debt issued.

5.7 Bankers do not understand small-scale projects due to a lack of experience with similar projects, and a lack of frameworks or standard documents that are well known to them. With each small project coming with its own distinct and different contract and risk characteristics, and with there being a lack of sufficient numbers of projects, bankers are also averse to building appraisal and due diligence skills for such projects. Often, bankers may not have a lending product for a sector or particular type of small-scale project. For example, in the case of small-scale energy efficiency projects in India such as street-lighting projects, only one financier with the required lending product exists; this entity has equity participation by IFC.14 The Government of India is now trying to create a project financing market for such projects through the use of a Bureau of Energy Efficiency (BEE) partial risk guarantee instrument, which takes the first loss in the case of default.

5.8 Single and group borrower limits have created constraints in financing projects, large and small alike, but often smaller projects are affected more as the investors are small or medium net worth firms with smaller borrowing limits. In most cases, private developers need to approach a number of banks in order to get financing even for a small project. In some cases, this has led to full equity financing for projects, such as in the case of the Bhubaneswar street lighting project and small water projects in Indonesia.

5.9 While lease financing can help in bringing finance and implementation together by leveraging the different capacities and skills available in the market, there could be impediments to the use of such platforms in some countries. Lease financing is widely used in Mexico and other countries in the Latin America region. Lease financing can enable the long-term financing and implementation of several smaller projects more easily and at lower cost than traditional commercial bank lending. Countries like India face regulatory constraints in the use of lease financing and rely mostly on a trust fund structure. Practitioners have cited the existence of a large untapped potential market for lease financing in India that can be encouraged by easing some of the associated regulatory constraints.

5.10 The costs involved in retaining transaction advisors to assist in the preparation of projects at subnational levels are relatively high and sometimes unaffordable. This is especially so in the case of municipal entities since these are already constrained financially in most cases. In the projects examined where IFC acted as transaction advisor, it was observed that several projects obtained initial project development funding from DevCo or from bilateral or other funding agencies. India has the India Infrastructure Project Development Facility (IIPDF) implemented by the Department of Economic Affairs in the Government of India, which is a fund designed to help in financing transaction advisory costs and can be utilized by national as well as subnational levels of government. Similar is the case with Pakistan where the Project Development Facility (PDF) and VGF can be used by projects irrespective of the total value of the project. South Africa has a PDF to assist in project development and that has been usable by municipalities since 2006 to defray the costs of project development and feasibility studies. Prior to the PDF in South Africa a similar function to assist municipalities was being performed by the Municipal Infrastructure Investment Unit (MIIU).

5.11 While it is essential to make project development funding accessible, it is important to note that often small projects also have proportionately higher development and procurement costs that may reduce value for money of these projects. In the United Kingdom, £20 million have been identified as the floor below which authorities intending to bid out projects are required to ensure that the VfM exercise considers appropriately the proportionately higher costs of development and procurement of these projects in terms of time as well as money.

5.12 Small projects are likely to show a proportionately larger viability gap due to the higher costs of technical and financial documentation needed as well as the higher risk profile of projects. As observed in earlier paragraphs, the cost of bidding and preparation of technical, legal, and financial documentation for small projects is often cumbersome and time consuming leading to proportionately higher costs for small projects, further leading to a larger viability gap in proportion to the total capital cost of the project. The nature of services related to most small projects is such that it is not feasible for governments, politically as well as from the point of view of affordability, to increase tariffs sufficiently to cover the viability gap. In addition, investors also add a premium for their higher risk perception.

5.13 Government support mechanisms exist in several countries for providing viability gap and other forms of support, but these are not specifically designed to cater to small projects. In Indonesia, for example, the VGF has a threshold of $100 million for any project to be considered for assistance. In India, while the VGF caters to projects irrespective of size, it has a cap of 20%, which is often not sufficient for smaller projects in some sectors such as solid waste and water. Urban Infrastructure Development Funds are an increasingly common phenomenon in countries with some of these providing various instruments of support including credit enhancement as well as senior and subordinate debt at lower than commercial rates of interest. Among the projects examined, the Berhampur Solid Waste Management Project is financed partly by a loan from the Orissa Urban Infrastructure Development Fund (OUIDF). GPOBA has partially financed the Palestine Solid Waste Management Project.

5.14 The Government of Korea has included clauses in its legislation to enable small and medium enterprises (SMEs) to participate in the PPP process. The PPP Act of Korea promotes SME participation in projects at local government level through Article 11, which mandates the sponsoring authority to give proper consideration to small and medium enterprises during the process of selection, and also through Article 34, which mandates that SMEs with weak security capacities shall be given priority in the provision of credit guarantees from the Infrastructure Credit Guarantee Fund. Where projects are local government sponsored projects, the PPP Basic Plan Article 124 (3) allows the adoption of preferential measures in evaluating project plans with regard to the ratio of investment by business firms in the local area, the number of investors and the ratio of local small and medium business firms participating in the project at the stage of construction. In addition, the government also has specific caps based on the type of facility for provision of subsidy to PPPs in the environmental sector, which are in Table 2 below. Variations in subsidy amounts incorporated into the policy based on project subcategory help in creating the required support for such projects. While environment PPP projects are not specifically small PPPs, many of these tend to be below $50 million. Currently, there are 307 local projects with a total cost of $14 billion, suggesting an average cost of below $50 million.

Table 2: Caps in Subsidies for Environmental PPPs

Source: Korea Development Institute

5.15 A specific constraint associated with several small projects is the high credit risk perception by commercial banks as well as investors and developers. Revenue recoveries in small projects are associated with a high level of risk due to affordability as well as political economy issues. In most of the projects examined, the payment mechanism consists of availability payments or includes a minimum demand and price guarantee, which should normally take care of this risk perception; however, it is observed that availability based payment mechanisms that take care of the revenue risk do not adequately cover the credit risk (for banks) and payment risk (for the PPP SPV) due to the weak financial position of municipalities. For example, in South Africa, many municipalities spend 85-90% of their revenues on staff salaries. To give a live example of the problems associated with the risk perception of investors: the governments of the provinces of Sindh and Punjab in Pakistan floated tenders for silo projects a couple of years ago with some enthusiasm shown by the investors at pre-qualification stage. None of the pre-qualified bidders, however, submitted proposals. The reason cited for not doing so: the cost of the silo project was too high and the firms feared that the governments involved would not be able to pay the estimated availability payments. Such perceptions of high payment risk could affect the financial feasibility of the project as the case of the Pakistani silo projects shows. In some of the small projects examined, escrow mechanisms have been used to cover the credit and payment risks with at least 3-4 months' worth of reserves being maintained in the accounts, and automatic release followed at designated times; in addition comfort letters from the government have been utilized. However, there are costs to escrow mechanisms-especially opportunity cost issues to keeping money in advance in escrow accounts apart from the fact that the escrow arrangement itself might not be fulfilled in the case of a weak public entity.

5.16 In order to increase the impact of development financing, several bilateral and multilateral entities seem to be increasingly inclined to invest in projects not singly but through funds that invest in individual projects. For example, KfW invests in urban infrastructure funds among others, one example in our review of ten small-scale projects being the OUIDF. This holding fund model has been used in energy efficiency financing in Europe widely and holds the key to successfully scaling up financing focused towards specific types of sustainable development.15 Another interesting example of the wholesale approach is the Social Innovation Fund (SIF) on which the IDB is working. The concept involves the IDB, bilateral and/or multilateral organizations pooling together funding to invest in country specific SIFs that could further bring in financing from private sources for investing in social impact public private partnership projects through reimbursable and non-reimbursable financing instruments such as grants, loans, and guarantees.16 While these examples are promising, the requirement for such funds is largely unfulfilled in the countries examined for the purpose of this review.

5.17 Practitioners also highlighted the need for building specific structures for contract management as well as for management of fiscal commitments and contingent liabilities arising out of small projects. Small projects on the face of it seem relatively less likely to cause large fiscal commitments and contingent liabilities to governments because of lower values; however, if seen in aggregate and given the higher risk profile of the public entity as well as the private partner, these projects could result in higher than obvious contingent liabilities; given this, the probability that they will fail could be higher than for the typical large transport and energy projects. There were frameworks for contract management embedded in the contracts of the projects examined; there were no frameworks for monitoring or managing the fiscal commitments and contingent liabilities.

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14 Tata Cleantech Capital Limited (TCCL) is a JV of the Tata Capital Limited and the IFC. It provides financing products for energy efficiency projects in India.

15 JESSICA and JEREMIE represent these models and are an initiative of the European Commission in partnership with the European Investment Bank and the Council of Europe Development Bank.

16 JESSICA Guaipatín, Carlos. 2013. How to Promote High-Impact Innovations through Social Innovation Funds: A Call for Public- Private Partnerships. Discussion Paper No. IDB-DP-319. Washington, DC: Inter-American Development Bank. http://publications.iadb.org/bitstream/handle/11319/6396/CTI%20DP%20How%20To%20Promote%20High- Impact%20Innovations%20through%20SIF.pdf