29 operation and with a total present<sup>value of payments of $7 million (at a 21 percent discount</sup> rate). On an undiscounted basis,<sup>the total supplemental payments are estimated at just over $10</sup> million.

In contrast, if the net cash<sup>flow stream is guaranteed to investors, a 50 percent initial</sup> shortfall would require government<sup>payments every year, with a net present value of $78</sup> million for this liability. Of<sup>course, such guarantees could be structured in many ways -such as</sup> guaranteeing a percentage<sup>of the base case forecast, or a minimum monetary amount per year.</sup> (Guaranteeing a specific dollar<sup>amount is similar to providing a debt service guarantee.) In</sup> general, though, with a 60<sup>percent debt structure, revenue shortfalls would have to be about 1/3</sup> for debt service guarantees<sup>to be activated.</sup> Overall, the changed financial<sup>environment has implications for designing government</sup> participation in infrastructure<sup>concessions. Rather than direct investment being a substitute for</sup> guarantees, it now serves to<sup>replace portfolio sources of equity. On the other hand, guarantees</sup> are still helpful in attracting<sup>debt capital on better terms. However, the level of revenue</sup> guarantees required to generate<sup>the much-higher expected equity returns is likely to be</sup> extremely costly to the government.<sup>Given this environment, a composite approach of debt</sup> guarantees and supplemental<sup>government investment on the equity side may provide the least-</sup> cost approach. This could be<sup>implemented by offering debt service guarantees and then asking</sup> prospective bidders to bid<sup>the minimum government investment required.22</sup>

# **The Future of Project Finance**<sup>**in Transport**</sup>

Recent developments in emerging<sup>financial markets have dramatically changed the</sup> appetite for and terms of transport<sup>infrastructure projects. The effects of defaults in Asia and</sup> Russia, and the devaluations<sup>in Asia, Russia, and Brazil, have resulted in dramatic increases inGiven the large needs for sovereign debt</sup> political and currency/exchange<sup>risk premia.23</sup> financing, infrastructure project<sup>finance will be seeking guarantees at the same time</sup> governments are issuing primary<sup>securities. Large portfolio outflows in emerging market funds</sup> mean that the sources of both<sup>equity and debt capital that became available in the mid-1990s</sup> are drying up for all but the<sup>most creditworthy projects.</sup> Moreover, any real economic<sup>effects from these financial events have particular</sup> consequences for the transport<sup>sector. Since transport is a derived demand, any decline in real</sup> economic activity will be quickly<sup>felt in traffic levels and revenues. These effects vary by</sup> sector, especially over the medium<sup>to longer term. Currency devaluations that help spur exports</sup> may generate higher volumes<sup>for seaports and air cargo activity.</sup> By contrast, declines in real<sup>economic activity could be make matters especially</sup> difficult for toll roads. Auto<sup>ownership rates are very sensitive to taxes and tariffs, both ofIn addition, trip generation is</sup> which are likely to come under<sup>pressure for budgetary reasons.24</sup> highly income sensitive. Declines<sup>in economic activity tend have large effects on auto traffic on</sup> toll roads, as drivers shift to<sup>free alternatives and also reduce the number of trips taken.</sup>

> 22 This approach was considered<sup>by Peru's Special Committee on Toll Roads in December 1998.</sup>

> **23** Oxford Analytica (December<sup>1998) reports that spreads for sovereign debt over ten year US Treasuries reached</sup> 900-1400 basis points in September<sup>before abating prior to Brazil devaluation in January 1999.</sup> **24** The IMF is forecasting<sup>large regional current account deficits for Latin America, which increase pressures to</sup> reduce import volumes through<sup>tariffs and taxes.</sup>