_26_ _Why Infrastructure Financing Facilities Often Fall Short of Their Objectives_ 70. The concept of the fund was based on the assumption that the lack of long-term financing was the binding constraint to increasing private investment in the power sector.<sup>3 8</sup> While Pakistan's domestic financial markets did indeed lack long term capital resources, it is unclear whether the lack of long-term finance was the main obstacle to attracting private investment (on a commercial basis).<sup>3 9</sup> The 1994 private power policy program was very successful in bringing **IPP** to financial closure (19 EPPs were brought to financial closure), although this was achieved at a cost. The Government was only able to bring projects to financial closure by offering subsidized financing or other types of government guarantees and other financial and non-financial advantages to project sponsors such as tax exemptions, an advantageous tariff structure, and noncompetitive bidding process. Subsequent to the initial drafting of the report, the government asked for renegotiations of the deals indicating that significant deficiencies in the regulatory and policy framework exists that hamper the efficient use of private and government resources in this area.40 71. While the facility attracted on average four additional dollar in equity and loans in funding, the direct funding instruments offered by the fund expose the government (fundlfacility) to commercial risk without having control over the management of that risk.<sup>41</sup> Similarly, while the government shares in the downside risks of a project, it is unable to take advantage of any upside potential. Moreover, direct funding instruments may be successful in attracting equity investment, but they may reduce project sponsors' incentives to manage risk adequately, if it is provided on an unconditional basis as they are somewhat protected. They may even tempt project sponsors to misbehave and pursue riskier projects.<sup>42</sup> Finally, while the fund was supposed to act as a catalyst for initiating private sector investment in infrastructure with a limited time horizon, it appeared that it created a situation where private sector investment may have become dependent on government backed finance as the existence of the fund may have taken the pressure off the government to improve the regulatory framework to such a degree that government backing was needed to a lesser degree to attract private financing.

> 38 It should also be noted here that the provision of long-term financing resources was hampered by an unstable macro-environment.

39 In this context, a demand survey may have helped the government to identify obstacles to private participation and may have given important input in the designing the financing facility.

40 This policy was meant to be transitional. The bulk tariff structure under the policy was intended to be transitional and GOP was to reform its policy creating a competitive bidding structure and adjusting tax exemptions and incentives provided. Nevertheless the Government did not undertake these sector reforms (which it had agreed to in a parallel project with the World Bank. The current problems are a result of a number of factors including the stalled reforms in the sector, a sharp economic downturn that substantially reduced the demand for power and the government had overestimated power needs which resulted in an oversupply.

41 Commercia **l** enders use loan convenants to exert control over management or require them to behave in a fashion that is in line with the borrowers interest of repayment of the loan. NDFC has tried to mitigate this risks by being presented on the boards of all projects it finances. 42 See for a detailed discussion: Klein (1997).