Washington DC Development Forum
Brown Bag Lunch Series No. 239
Tuesday, February 25, 2014
JICA Office

DEVELOPMENT FINANCE IN ASIA
AND PUBLIC-PRIVATEPARTNERSHIPS (PPPs)
Toshiro NISHIZAWA, Professor
Graduate School of Public Policy
The University of Tokyo

Asian economies have shown a relatively
robust growth performance.

%

141210864
20-2-4-6

Developing Asia

Emerging market anddeveloping economies
Advanced economies

Source: IMF, WEO
Database.
February 25, 2014

Toshiro Nishizawa

2Per capita income grew as well.
12,000Int'ldollars

10,000Thailand

8,000China6,000

Indonesia

4,000

Vietnam

2,000
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012

0

February 25, 2014

Toshiro Nishizawa

Source: IMF, WEO
Database.

3However, there are signs of slowing
economic growth in Asia ....
Developing Asia

Emerging market anddeveloping economies
Advanced economies

February 25, 2014

Toshiro Nishizawa

2016

2013

2010

2007

2004

2001

1998

1995

1992

1989

1986

1983

Projections
after 2014
1980

%

14
12
10
8
6
4
2
0-2-4
-6

Source: IMF, WEO
Database.

4

Concerns about the middle-income trap areemerging.

(An excerpt from the concept note prepared by the Government of Indonesia
for the international seminar "Avoiding the Middle-Income Trap" organized on
December 11-13 in Nusa Dua, Bali)
February 25, 2014

Toshiro Nishizawa

5How should we interpret a change in thesavings-investment balance after the Asian
Financial Crisis?
Gross national savings indeveloping Asia
Investment in developing Asia

February 25, 2014

2013

2010

2007

2004

2001

1998

1995

1992

1989

1986

1983

Gross national savings inemerging market anddeveloping economies
Investment in emerging
market and developingeconomies
1980% ofGDP

50454035302520151050Toshiro Nishizawa

Source: IMF, WEO
Database.

6Is investment in "capital" sufficient?
Probably not, but why?
 Domestic financial intermediaries are still not welldeveloped for longer term investments.
 Perhaps not only in physical capital, but also inhuman capital to strengthen institutions.
Therefore, How to enhance "development finance" remains achallenge.
February 25, 2014

Toshiro Nishizawa

7

How could we define "development finance"?
"financing from domestic and externalsources, both public and private, forinvestment serving development purposes
in developing countries"

February 25, 2014

Toshiro Nishizawa

8

How could we define "development finance"?
(continued)
investment in hard infrastructure with risks difficult for theprivate sector to bear alone
 investment in soft infrastructure (e.g., technology transfer,
institutional capacity building), not likely feasible without
public sector involvement
 investment in hard and soft infrastructure (hybrid type)
"investment in developing countries with a public
good nature"
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Toshiro Nishizawa

9Changing sources and nature of development
finance in AsiaThe excess of savings over investment is adistinctive feature of the Asian economies during
the last decade.
 In this setting, policymakers should find ways tomobilize domestic savings for investment within
the national boundaries.
February 25, 2014

Toshiro Nishizawa

10Changing sources and nature of development finance in Asia (continued)

What about external sources ...
 the continued dominance of foreign direct
investment (FDI)
 the volatile and procyclical nature of portfolio
flows and bank lending a relatively small share of official flows

February 25, 2014Toshiro Nishizawa

11

Changing sources and nature of development finance in Asia (continued)

400
300
200
1000Billions-100ofdollars -200-300
-400
-500
-600-700

Direct investment, net
Private portfolio flows,net
Other private financialflows, net
Official flows, net

February 25, 2014

2013

2010

2007

2004

2001

1998

1995

1992

1989

1986

1983

1980

Change in reserves

Toshiro Nishizawa

Source: IMF, WEO
Database.

12Changing sources and nature of development finance in Asia (continued)

8
7
6
5
4
3
2
10Source: World Bank
Open Data.

1961
1964
1967
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
200320062009%

Net ODA received in percent ofgross capital formation, 1961-2011
East Asia & Pacific (developing countries)

February 25, 2014

Toshiro Nishizawa

13

Changing sources and nature of development finance in Asia (continued)

Most evident in East Asia and the Pacific are:
 the mainstreaming of private sources of finance fromabroad a diminishing share of official financial flows fromabroadand, AGAIN, the emergence of domestic resources potentiallyavailable for development purposes
February 25, 2014

Toshiro Nishizawa

14

Changing sources and nature of development finance in Asia (continued)

As a consequence, one of the policy challenges in developing Asia now is
the effective use of public sources of finance, both
domestic and external,
as a catalyst for mobilizing private sources of financeinto investment for development purposes.

February 25, 2014

Toshiro Nishizawa

15

A key question would be ...
What are the respective roles of the public andprivate sectors for enhancing the effectivenessof development finance in Asia?

the key to success is ...
"incentive design and risk mitigation"
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Toshiro Nishizawa

16

Public-Private Partnerships (PPPs)
as a typical example

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17

Why are governments willing to promote PPPs?

to seek efficiency gains
 to fill public sector funding gaps
Despite the improved fiscal conditions,for longer-term public investments,
the public sector is faced with institutional or
structural constraints,
resulting in a limited share of investment
spending.
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Toshiro Nishizawa

18

Nature and potential benefitsof PPPs

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Toshiro Nishizawa

19

What is the basic nature of PPPs?

PPPs are a long-term contractual arrangement
between a public sector procurer and privateparties,
typically by means of the project company
created by private sector equity investors toundertake the activity defined in the contract.

February 25, 2014

Toshiro Nishizawa

20

What is the basic nature of PPPs? (continued)

This arrangement also involves:contracts with subcontractors to build, operate,
and maintain the facility, andcredit agreements with lenders to finance a PPP
project (or project bonds, still to a limited extent).

February 25, 2014

Toshiro Nishizawa

21

Why do PPPs need many contracts between
various parties?
The core task of structuring a PPP project is toreconcile the interests of various parties from theprivate and public sectors (i.e., investors, lenders,contractors, the government and other relatedentities), or in other words,
 PPPs are a risk sharing arrangement among variousparties from the private and public sectors.
 Agreements creating enforceable obligations areneeded.
February 25, 2014

Toshiro Nishizawa

22

How and why are risks shared among private andpublic parties?
In a PPP project, the public authority specifies therequirements of public services to be provided by
the facility, but leaves the private sector to decide
how to meet these specific requirements.
 Therefore, risks are transferred to the privateparties.
 One of the potential benefits of PPPs isencouraging the public sector to identify projectrisks and consider risk transfer.
February 25, 2014

Toshiro Nishizawa

23

How and why are risks shared among private and publicparties? (continued)

Private sector investors and lenders involved in a PPP
project have capital at risk, and therefore a greaterfinancial incentive to ensure that the service isprovided as required in the contract.
 Moreover, lenders may provide benefits throughindependent due diligence in order to ensure that theproject is viable and that all obligations in a contract
can be safely fulfilled.
February 25, 2014

Toshiro Nishizawa

24

But, are they always in conformity with each other?

Public interests versus
private interests, andinevitable contingencies

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Toshiro Nishizawa

25

Could the inherent conflict between public andprivate sector interests be compromised, mostnotably in price setting?
The government under political and socialpressures tends to prefer reduced prices.
 On the other hand, private sector investors
pursue sufficient cash flows by setting prices highenough to ensure that the project is commercially
viable and to secure higher equity returns.
February 25, 2014

Toshiro Nishizawa

26

How could they fill the gap?

Subsidies, financing, or guarantee provided
by the government are likely options.

February 25, 2014

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27

Are private sector parties always comfortable withgovernment action?
Private sector parties may not be certain thatthe government is financially capable of andcommitted to ensuring the soundness of public
utilities or maintaining conducive policy andregulatory environments.

political risk
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Toshiro Nishizawa

28

Are private sector parties always comfortable withgovernment action? (continued)

If perceived risks are large, private sector parties
ask for additional premium for taking such risks.
 Therefore, the commercial viability of PPP projects
depends, to a large extent, on government capacity,commitment, and policy.
 But, in reality, “PPPs may be promoted for shortterm political advantage” without firmly establishinggovernment capacity, commitment, and policy.
February 25, 2014

Toshiro Nishizawa

29

Could a risk be borne by the party who canmanage that particular risk with least cost?
A PPP contract, as a typical “incomplete contract,”cannot provide for all possible future eventualities,
and even worse with infrastructure investment
because the longer the term of the contract, themore difficult to provide for unforeseeable
circumstances.

February 25, 2014

Toshiro Nishizawa

30

What would be the likely consequences?

The inherent conflict between the public andprivate sectors as well as the inevitable
contingencies could entail risks for thegovernment to assume excessive fiscal burden
through subsidies or in the form of contingent
liabilities.
 Ironically though, the growing popularity of PPPs
is due to public sector fiscal constraints.
February 25, 2014

Toshiro Nishizawa

31

What are the pitfalls?
For financing PPPs, the bigger the perceived risks forthe private sector, the higher the costs incurred on
the government or eventually on taxpayers.
 Mitigation measures can help reduce perceived risks.
However, without removing the root causes of risks
perceived by the private sector, either thegovernment or users will eventually have to bear thecost that private sector parties require for their risk
assumption.
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February 25, 2014
Toshiro Nishizawa
What are the pitfalls? (continued)

Also important is the management of government
contingent liabilities. PPPs may entail significant
fiscal risks arising from bypassing spending controls
and moving public investment off the budget anddebt off the government balance sheet.

February 25, 2014

Toshiro Nishizawa

33

Are PPPs a panacea?

PPPs sound promising, but are in reality very
complex and most likely costly.
 Risk allocations are challenging because of thepublic nature of infrastructure services provisionand inherent uncertainties over the long term.
PPPs are clearly not a panacea.

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Toshiro Nishizawa

34

Then, how could we make the most of PPPs?

Incentive design andrisk mitigation

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Toshiro Nishizawa

35

How could we attract private sources of financefor infrastructure investment?
In an effort to attract private financing forinfrastructure investment, we should avoid what is
generally appealing, but not commercially viable.
 The key to success is interim risk mitigation
measures and incentive design more
fundamentally, rather than heralding elusive
benefits brought about by private sector
participation.
February 25, 2014

Toshiro Nishizawa

36

How could we attract private sources of finance for
infrastructure investment? (continued)

Private sector parties need to be convinced that thegovernment is financially capable of and committed toensuring the soundness of public utilities ormaintaining conducive policy and regulatoryenvironments.
 Another caveat is that risk mitigation or any public
support to correct market failure should be designed
to avoid moral hazard on both the public and private
sector sides.
February 25, 2014

Toshiro Nishizawa

37

Washington DC Development ForumBrown Bag Lunch Series No. 239
DEVELOPMENT FINANCE IN ASIA
AND PUBLIC-PRIVATE PARTNERSHIPS (PPPs)

Thank you.

Toshiro NISHIZAWA, Professor
Graduate School of Public Policy
The University of Tokyotnishizawa@pp.u-tokyo.ac.jp