metadata: authors: 0: author: Dailami, Mansoor
1: author: Leipziger, Danny
count: World
docna: 0: docna: Infrastructure project finance and capital
            flows : a new perspective
docty: Policy Research Working Paper
subtopic: Investment and Investment Climate,Financial Crisis Management & Restructuring,Capital Markets and Capital Flows,Capital Flows,Inflation,Financial Structures
teratopic: Conflict and Development,Finance and Financial Sector Development,Environment,Public Sector Development,Macroeconomics and Economic Growth
abstracts: cdata!: The success with which middle-income
            indebted developing countries have gained access to private
            international finance in the 1990s is a tribute to their own
            domestic economic performance, international policy in
            dealing with the debt crisis of the 1980s, and innovation in
            international financial markets.  Emphasizing the role of
            private infrastructure investment as a vehicle for
            attracting foreign capital to developing countries in the
            1990s, the authors develop an analysis model to examine what
            determines the credit-risk premium on infrastructure
            projects in the country-risk environment of developing
            countries.  They also provide tentative quantitative
            evidence of the importance of macroeconomic and
            project-specific attributes of project risk.  Their key
            finding is that the market seems to impose a high-risk
            premium on loans to countries with high inflation and to
            projects in the road sector.
repnme: repnme: Infrastructure project finance and capital
            flows : a new perspective
display_title: Infrastructure project finance and
            capital flows : a new perspective
listing_relative_url: /research/1997/12/693854/infrastructure-project-finance-capital-flows-new-perspective
topicv3: Financial Infrastructure and Remittances
            m1326532 350,Inflation m1326709 0870F4727ACED1CF8525815C00471347,Capital Markets m1326967 332,Investment Entry m1504647 2544,Credit Risk m1505083 3885
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Conflict and Development,Finance and Financial Sector Development,Environment,Public Sector Development,Macroeconomics and Economic Growth
origu: Finance & Private Sector Dev Div (WBIFP)
no_of_pages: 36
model_extractions: | POLIcY RESEARCH WORKING PAPER 1861

# Summary findings

The success with which middle-income indebted developing countries have gained access to private international finance in the 1990s is a tribute to their own domestic economic performance, international policy in dealing with the debt crisis of the 1980s, and innovations in international financial markets.

Emphasizing the role of private infrastructure investment as a vehicle for attracting foreign capital to developing countries in the 1990s, Dailami and Leipziger develop an analytical model to examine what determines the credit-risk premium on infrastructure projects in the country-risk environment of developing countries. They also provide tentative quantitative evidence of the importance of macroeconomic and project-specific attributes of project risk. Their key finding: the market seems to impose a high-risk premium on loans to countries with high inflation and to projects in the road sector.

This paper - a product of the Regulatory Reform and Private Enterprise Division, Economic Development Institute - is part of a larger effort in the institute to expand best practice, knowledge, and learning in the infrastructure finance area. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Mansoor Dailami, room G2-071,telephone 202-473-2130, fax 202-334-8350, Internetaddress mdailami@worldbank. org. December 1997. (30 pages) _The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent._ Produced by the Policy Research Dissemination Center
# Infrastructure Project Finance and Capital Flows: A new perspective

Mansoor Dailami and Danny Leipziger

## Economic Development Institute

## World Bank

## Presented at the Conference

on Financial Flow and World Development, The University of Birmingham, United Kingdom September 7-8, 1997 The authors are Principal Financial Economist and Manager, respectively, of the Regulatory Reform and Private Enterprise Division, Economic Development Institute, World Bank.
I
**Infrastructure Project Finance and Capital Flows:** A **New Perspective**

# **Mansoor Dailami and Danny Leipziger**

# **World Bank**

# **Washington, DC, USA**

The success with which middle income indebted developing countries have gained access to private international finance in the 1990s is a tribute to their own domestic economic performance, international policy in dealing with the debt crisis of the 1980s, and innovations in international financial markets. This paper emphasizes the role of private infrastructure investment as a vehicle for attracting foreign capital to developing countries in the 1 990s. The paper examines the determination of credit risk premium on infrastructure projects in the country risk environment of developing countries, and provides tentative quantitative evidence of the importance of macroeconomic and project-specific attributes of project risk. The key finding is that the market seems to impose a high risk premium on loans to countries with high inflation, and to projects in the road sector.

# I. **Introduction**

Recent debate on the causes of the upsurge in capital flows to developing countries in the 1990s has offered three different perspectives. First, it is argued that the main factors motivating capital flows have been external to developing countries and have been related in particular to decline in the US interest rates (Calvo et al. 1993; Fernandez-Arias, 1994). The second line of argument is that the surge in capital flows has been the result of domestic economic reforms, including privatization of public enterprises, liberalization of currency and capital accounts, and that these trends, along with macroeconomic stabilization, have improved creditworthiness and have expanded investment opportunities (Chuhan et al. 1994; and et al. 1996, U. Haque). Third, it is observed that financial innovations, including the securitization of creditor commercial bank loans by conversion into bonds, with partial multilateral guarantees, under the Brady Plan, were critical in lifting the "debt overhang," and stimulating investment and growth in debtor developing countries. (Claessens, et al. 1996; Dornbusch and Werner, 1994).

These perspectives have important implications for the sustainability of capital flows and hence for policy design both at the national and international level. Thus, if the surge in capital flows has been driven mostly by lower international (US) interest rates, as is argued by some researchers, then a reversal in such rates would threaten the 1
sustainability of capital flows.I By contrast, if the magnet for capital flows has been the process of domestic economic reform and stabilization in the developing countries themselves, sustainability would then be a function of the continuation of such reforms. However, if the key to the successful return to creditworthiness of indebted (middle income) developing countries and their ability to access international private finance in the 1990s has been the policy-induced financial innovation and engineering under the Brady Plan, there exists ground for official intervention in the credit relationship between developed and developing countries. Such interventions could address specific agency problems related to the asymmetry of information, market overreaction, and coordination failure in international finance and/or transitional problems as developing countries move to forge closer integration into global capital markets.<sup>2</sup> In this paper we offer a new perspective, emphasizing the role of private infrastructure investments in developing countries as a vehicle for attracting foreign capital. Our motivations are two. First, infrastructure investment has been the fastest growing component of capital flows to developing countries, increasing from $1.3 billion in 1986 to $27 billion in 1996 (see Table 1). Though the volume of such flows remains small (12% of total'external gross flows in 1996), the potential for future growth is substantial.<sup>3</sup> Second, we draw on certain characteristics of infrastructure investments, including their complex risk profile, long pay-off period, and sensitivity to policy and the regulatory climate, to establish links between capital flows to infrastructure and the behavior of international interest rates, domestic reforms and liberalization, and financial innovation. In essence, the financing of infrastructure in capital markets captures the key elements of the above three explanations of capital flows.

Our treatment of infrastructure finance as a vehicle of capital flows to developing countries assigns a central role to financial evaluation of foreign investment projects in the country risk environment of developing countries. With a few exceptions, most developing countries are still rated as "non-investment grade" by major credit rating agencies (See Annex I). And while many countries have made substantial progress in macroeconomic stabilization by reducing inflation and government deficits dramatically, especially in high-inflation Latin American countries (see Annex I), and moved to

- I This interpretation places the burden of management of international capital flows on the shoulders of industrial countries' monetary authorities in promoting policies conducive to low inflation and low interest rates.

- 2The case for official intervention in the event of financial distress by borrowing countries along these lines is elaborated by Eichengreen and Portes (1994), and Portes (1996).

- 3Estimates of developing countries' infrastructure financing needs are huge, although precise magnitudes are difficult to establish. For East Asia and Latin America, however, average annual investment requirements for infrastructure are estimated to be in the neighborhood of $150 billion and $70 billion, respectively, from the mid-1990's to 2005, of which 25 to 40% is expected to come from foreign sources. In India, for example, a government- appointed commission has estimated total infrastructure investment requirements of about US$115 to 130 billion over the next five years, rising to US$215 billion in the following five years.

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liberalize their capital accounts, they still remain vulnerable to speculative attacks on their currency or foreign exchange reserves once policies go off course. As demonstrated by the experience of Mexico in 1994 and the South East Asian countries in recent months, exposure to such currency crises has its roots in part in the dramatic increase in the volatility of capital flows and speed of reaction of emerging market investors. While international support through, for instance, the recently approved IMF's Emerging Financial Mechanisms, provides some assurance in limiting the disruptive impact of a financial crisis, the damage to the creditworthiness of private entities with foreign currency debt obligations could be serious. Their creditworthiness is likely to be undermined, not only because of deterioration in business environment i.e. rising domestic interest rates, falling stock market prices, and economic recession which seems to characteristically follow a financial crisis, (see Calvo, 1996, Mishkin; 1997), but also because of a higher likelihood of governments intervening in foreign exchange markets, and imposing controls on currency convertibility and transferability. Such a risk, moreover, is compounded by a lack of certain forms of risk insurance and hedging instruments for managing interest and exchange rate risks.<sup>4</sup> The existing literature on the determinants of country creditworthiness is vast. This literature, whether in its traditional debt-service capacity approach (Feder and Uy, 1994; Lee, 1993; see also McDonald, 1992 for a survey of the literature), or in its most recent strategic and bargaining framework (Eaton and Gersovitz, 1981; Eaton, 1989; Bulow and Rogoff, 1989; Ketzer, 1989; Gennotte, Kharas, and Sadeq, 1987; and Schwartz and Zurita, 1992) has treated country risk at an aggregate level, with no distinction between the entity receiving foreign capital and the broader country/sovereign risk considerations. The focus of attention has been on whether a country is able or willing to service its foreign debt obligations, or on the incentives for loan renegotiation or repudiation under distress. The basic underlying assumption has been that the public sector is the main borrower in foreign capital markets, which seems to have been valid in the 1970s and 1980s. In the 1990s, however, when the borrowing entity is likely to be the private sector, we must rethink this assumption.<sup>5</sup> Indeed, in contrast to the general obligation borrowing public sector and publicly guaranteed type which dominated commercial external finance in the 1970s, recent capital flows have been to private entities, raised to meet specific project or corporate

- The necessary capital and Forex market institutions that should underpin integrating into global capital markets, have not developed sufficiently in many developing countries. For instance, with the exceptions of Malaysia, Brazil, and Mexico, where currency swap and forward markets have grown in the past two years, exchange markets in developing countries suffer from a number of institutional shortcomings, including illiquidity in the spot and forward markets and a lack of derivative instruments to hedge exchange rate risk beyond a short-term horizon afforded by forward cover.

- S It is also useful to distinguish between the steady-state and crisis situations. In the latter (e.g. Argentina in the post-Maquila environment) the private sector exited quickly, despite its longer-term exposure, by refusing to honor past commitments or renew credit lines, and it fell to the public sector to restore confidence in international markets (see Caprio et. al. 1996).

3
financing needs. In 1996, for example, total private net capital flows to developing countries amounted to $244 billion,<sup>6</sup> which represents a five-fold increase since 1990, and accounts for 86% of total aggregate net long-term flows (see Figure 1). In such a situation, should there be a currency crisis, the private sector is likely to be rationed out and its demand for foreign exchange subordinated to that of the public sector.

The remainder of the paper proceeds as follows: Section II elaborates on reasons that capital flows to infrastructure have grown so quickly in recent years, despite the perceived high risk of such transactions. Section III develops an analytical framework for valuation of foreign investment projects, incorporating explicitly both project and country risk. Section IV presents the empirical results of an econometric analysis of the credit risk premium associated with foreign loans extended to a sample of infrastructure projects. Finally, Section V provides some policy recommendations.

Table 1. Infrastructure financing raised by developing countries 1986-95

|Typeofborrowerand<br>instrument|1986|1987|1988|1989|1990|1991|1992|<br>1993|<br>1994|<br>1995|
|---|---|---|---|---|---|---|---|---|---|---|
|Total|1,351|2,543|910|3,503|2,641|6,312|8,835|18,027|23,314|22,297|
|Public sector|1,251|2,378|773|2,586|<br>639|2,803|3,079|5,760|7,580|6,690|
|Private sector|100|<br>165|137|<br>917|2,002|3,509|5,756|12,267|15,734|15,607|
|Loans|100|<br>165|137|<br>767|1,380|<br>126|1,536|6,271|6,007|11,086|
|Bonds|0|<br>0|0|<br>150|<br>500|<br>740|1,155|3,867|5,810|3,262|
|Equity|0|<br>0|0|<br>0|121|2,643|3,065|2,130|3,918|1,259|

_Source: World Bank, Global Development Finance_

# **II. Reasons for increases in capital flows to infrastructure**

At first glance, infrastructure finance does not seem to be a viable vehicle for attracting foreign capital to developing countries. First, exposure to currency risk, which for foreign investment in export-oriented manufacturing industries is of a relatively minor concern, is a critical feature of infrastructure project investment. Project revenues are often generated in local currencies, while servicing of foreign capital, whether debt or equity, involves payment in foreign currency. Fluctuations in the exchange rate of the

> 6 According to World Bank estimnates (Global Development Finance, 1997).

4
domestic currency, as well as capital controls limiting currency convertibility and transferability, pose a particularly difficult problem for foreign investors and financiers.

Secondly, infrastructure investments are typically up-front, with a high degree of asset specificity (although the extent of sunk investment varies from sector to sector) and risky revenue streams stretching many years into the future. As recognized in the recent literature on specific investments (Dasgupta and Sengupta, 1993; and Elden and Reichstein, 1996), investors are hesitant to make investments in such circumstances without adequate contractual protection. Once the investment is sunk, the incentive system and the bargaining power of contracting parties change vis-a-vis each other. This leads to special contracting and risk sharing problems, perhaps best exemplified by the dominant use of BOT and BOO arrangements in international infrastructure project finance transactions. A typical BOT structure is made up of a number of agreements set forth in the concession agreement concluded between the host government and the project company, formed often by a consortium of major international developers, contractors, equipment supplier and engineering companies.

Third, the scope for divesting equity holdings in infrastructure projects through IPOs is limited in many developing countries. As a result, project promoters would be 7 locked in their investments for several years.

Fourth, infrastructure investments are distinguished by the pattern according to which project risks are resolved over time.8 The combination of a high concentration of project risks in the early phase of the project life cycle, i.e. the pre-completion phase, and relatively identifiable sources of risk once the project is completed, e.g. credit risk under off-take agreements in power projects or market risk with telecom and toll road projects, gives substantial value to early information. Thus, information about governments' policies, strategies, and political stability, as well as project parameters and benchmarks such as tariff rates, prices, and cost of capital, possesses tremendous economic value. There is also a premium on name recognition and reputation in the field which explains why in the power sector, for example, large, well-known companies such as Hopewell, Seimens, ABB, and Enron dominate the market for independent power producers.

Against this background we rely on two sets of factors to explain the increase in capital flows to infrastructure in developing countries. The worldwide move towards private participation in providing and financing infrastructure services; and the capacity of international capital markets to supply long-term debt capital, which is critical for the financing of infrastructure projects with long-term assets whose costs may take 10 to 30 years to recoup.

This contrasts with the normal corporate finance situation in which firms shift their business risks to the general public through the issuance of securities.

This phenomenon is generally referred to in the literature as "the sequential resolution of risks" (see Wilson, 1982).

_5_
# _A. Private Participation_

The commitment to private sector participation in infrastructure services is a common policy objective in countries as diverse as China, India, Indonesia, Australia, UK, Colombia, Chile, and Argentina. Driven by fiscal austerity and widespread disenchantment with the performance of state-owned utilities, many governments are turning to the private sector to build, operate, finance, own, and transfer new power plants, toll roads, telecommunication facilities, ports, and airports. In the developed countries the trend is toward restructuring or unbundling integrated industry structures, introducing competition and choice, particularly in the electricity and telecommunications industries, and regulating those sectors where elements of natural monopoly, associated with the increasing return to scale, exist. In developing countries the picture is mixed, presenting a diverse portrait of different levels of achievements in institutional, regulatory, and policy developments.

Private investors have been hesitant to invest unless supported by host governments through tax incentives, direct financing and guarantees intended to improve the project's cash flow or reduce risk. Such supports have varied in scale and mix from country to country and from project to project. Four distinct types of government support emerge from a cursory review of recent infrastructure projects closed or negotiated: direct financing, guarantees, tax incentives, and subsidies. Direct financing refers to government or government agency equity contribution to the project through a joint venture participation (as was most common in China, before the most recent liberalization changes), or provision of a local currency term loan<sup>9</sup> , often provided in the form subordinated loans to other creditors, and as an inducement to foreign banks, as in the case of the Bangkok Second Stage Expressway project in Thailand. Tax incentives provided to private infrastructure projects include most frequently favorable tax treatment of income, special depreciation allowances, and lowering/ exemption of import duties on imported machinery and equipment. Such incentives have been provided either as part of government's strategy of promoting foreign direct investment (subject to the applicable tax codes and provisions, most notably in Indonesia, China, and Mexico), or specifically designed to promote private investment and financing in infrastructure,as in India and the Philippines.

Guarantees are the most important form of government support to private infrastructure projects. They are intended to mitigate risks faced by creditors and project promoters, ranging from the commercial risk of non-payment of government entities to - policy and regulatory risks. Guarantees have been particularly prominent in power

- 9 The largest number of projects with government equity participation are in China, where until recently, 100% foreign ownership in the power sector, for instance, was not allowed. An example here would be the Rhizao Power Project in China, where Shandong Power invested US$1 0Om in the project. Also, strategic consideration as in the case of Paguthan power in India, where the Gujarat Power Corporation invested US$23 million equivalent, accounting for 12% in the project.

_6_
projects in developing countries. In reality, governments have relied on a range of explicit guarantees, comfort letters, and other forms of insurance, encompassing a broad range of characteristics in the extent of coverage provided, types of events guaranteed, the nature of the underlying risk, and whether such guarantees are explicitly incorporated in contractual arrangements or are implicit, with no contractual basis defining the government's liability (Dailami and Klein, 1997).

Table 2 provides a classification of guarantees offered by developing country governments to private projects. Salient examples include Pakistan's practice of providing a full guarantee of state-owned power purchasers and fuel suppliers in power projects, as well as a universal fixed tariff rate (at US 6.5 cents per kWh for the first 10 years and US 5.9 cents averaged over the life of the plant); India's practice of guaranteeing the payment obligations of state electricity boards, as well as a guaranteed, dollar-denominated rate of return; and Indonesia's partial indexation of power tariffs, where the Indonesian state power company, PLN, assumes part of the exchange rate risk of electricity tariffs. In Colombia, protection against currency risk is incorporated into the project documents and contractual agreements, as in the case of the Mamonal Private Power Project, which stipulates an inflation-index clause in the power purchase agreement. To the extent that changes in the value of the local currency vis-A-vis foreign currencies are related to domestic inflation, foreign creditors/investors will be covered, even if project revenues are in local currency.

# Table 2: Types of Government Guarantees to Private Infrastructure Projects

## **1. Contractual Obligations of Government Entities**

- r* Guarantee of off-take in power projects

- Birecik Hydro Power Plant, Turkey

- v Electricidad de Cortes, Honduras

- Paguthan & Dabhol Power Plants, India

- Mt. Apo Geothermal Plant, Philippines

- ' Guarantee of fuel supply in power projects

- Termopaipa Power Plant, Colombia

- Lal Pir Power, Pakistan

## **II. Policy/Political Risk**

- Guarantee of currency convertibility and transferability

- Lal Pir Power, Pakistan

- Guarantee in case of changes of law or regulatory regime

- Rousch Power, Pakistan

- Izmit Su Water Treatment Plant and Pipeline, Turkey

## **III. Financial Market Disruption/Fluctuations**

7
* Guarantee of interest rate

* North-South Expressway, Malaysia

* Guarantee of exchange rate

- North-South Expressway, Malaysia

- Debt Guarantee

- 4 Toll Roads, Mexico

- Termopaipa Power Plant, Colombia

# IV. **Market Risk**

- Guarantee of tariff rate / Sales risk guarantee

- Don Muang Tollway, Thailand

- Western Harbour Tunnel, Hong Kong

- Buga-Tulua Highway, Colombia

- Mexico Toll Roads (Leon-Aguascalientes, Mazatlan-Culiacan, Mexico City-Toluca)

- **c>** Revenue guarantee

- South Access to Concepcion, Chile

M5 Motorway, Hungary ...... .............................................................................................................................................................

## _B. Supply of long-term debt capital_

A major requirement of infrastructure project financiability is the availability of sufficiently long-term debt capital. The basic intuition behind this proposition is the casual industry practice of "matching maturities," i.e., that long-term assets should be funded through long-term debt, and short-term assets through short-term debt. Theoretically, the validity of this proposition rests on various manifestations of capital market imperfections in the form of taxes, agency costs, and asymmetry of information that result in conflicts of interest between shareholders and creditors.'<sup>0</sup> Generally speaking, longer maturities reduce the risk that cash flows may fall short of required amounts to service debt obligations when such payments come due. In the particular case of project financing, where loans would have to be paid from a project's cash flows, and where creditors have no or limited recourse to the assets of the sponsoring company, loan maturity plays an important role in ensuring project financiability. To illustrate this point, Figure 1 below plots the probability of loan default against project risk (as measured by the standard deviation of cash flows) for two alternative loan maturities and terms. These scenarios are: (i) a loan with a maturity of 5 years and interest rate of 7% per year; and Under perfect market conditions, debt maturity is irrelevant, as shown in a seminar paper by Stiglitz (1974). For a detailed review of literature on choice of debt maturity in corporate finance, see Ravid (1996).

8
_(ii)_ a loan with a maturity of 15 years and interest rate of 8% per year. As expected, the probability of default increases with the project risk. But it is interesting to note that the probability of default is almost twice as high with a 5- year loan maturity than with a 15 year loan maturity, eventhough the latter carries a higher interest rate.

In practice, most private infrastructure projects closed or under preparation in developing countries are financed with a sizable amount of foreign capital. A typical financing mix consists of 20% to 40% (see Table 3) equity provided by project promoters and the rest raised in the form of debt in a combination of syndicated commercial bank loans, bond issues, bridge and backup facilities, and multilateral and export credit agency loans and guarantees. Within debt category, bank loans, principally in the form of floating rate loans priced off a particular benchmark, such as the U.S. treasuries or LIBOR, account for the bulk of debt financing. Thus, in 1995, about 60% of total cross boarder infrastructure finance was in the form of bank loans, 20% bonds, and the rest in the form of equity capital.

The underdeveloped state of local bond markets in emerging market economies has been an important motivating factor behind the recourse to international financial markets for infrastructure finance. Compared to the size and depth of local equity markets, debt markets are much smaller, less liquid, and have a narrower investor base. The bulk of trade and transactions are centered on government papers, and corporate issues tend to be of short maturity, perhaps five to seven years. Historically, the development of local bond markets and infrastructure have reinforced each other -- for instance, in the U.S., the need to finance rail roads and canals in the 19th century helped create the U.S. debt market. With the entry of foreign institutional investors and liberalization of domestic interest rates, debt markets in most Asian and Latin American countries have witnessed considerable growth in recent years. Recent estimates put the total size of Asian local markets at about US$477 billion compared to US$7429 billion in the U.S. and US$366 billion in the United Kingdom.

Generally speaking, efforts to improve local bond markets' liquidity and lengthen their maturity profile would require actions on three fronts: first, removal of the various policy, regulatory and tax constraints that have impeded development of secondary trading in private debt instruments; secondly, development of bond insurance mechanisms to enhance the attractiveness of local currency bonds to a wider range of investors, including foreign investors; and thirdly, upgrading the infrastructure of markets through the establishment of efficient securities clearing, settlement, and depository systems with scripless book-entry trading.

9
Figure 1: Loan Maturity and Project Risk <!-- Start of picture text --> 0.45<br>0.40<br>035<br>0.30<br>0.25<br>0.20 -<br>010-<br>015 --- ~~~~~~~~~~N= 5<br>Prot(p~I i-N1<br>0.00 _ __<br>0 50 100 150 200 250<br>Project nisk (standard deviation)<br><!-- End of picture text -->

**Parameter assumptions are:** i) Initial investment =$ 1000, financed with a mix of $200 equity and $800, debt; ii) Loan payment = end-of-period equal amount; iii) Rate of return on the project = 25%; iv) Distribution of project revenues, net of all non-capital production expenses, assumed to be normal with mean = 250 and with standard deviation that is assumed to vary from 12.5 to 250 with an increment of 12.5; and v) Debt service ratio= 1.1.

10
Table 3

|**Leverage Ratio of Private Infrastructure**<br>**Projects**<br>**(by sector)**|
|---|
|Sector<br>Mean<br>Sample Size<br>(standard deviation)|
|Power<br>73.07<br>28<br>(8.15)|
|Roads<br>63.07<br>15<br>(15.43)|
|Transport<br>77.86<br>7<br>(8.09)|
|Telecoms<br>61.25<br>4<br>(2.50)|
|Waste/Water<br>75.00<br>4<br>(12.25)|
|Gas<br>67.00<br>1|

* Percentage ratio of total debt (book value) to a project's investment cost

Source: Authors' estimates based on a sample of infrastructure projects closed between 1994 and 1996 (see below).

# **III. Analytical Framework**

To motivate the discussion of determinants of the risk premia on private foreign currency loans, we begin with a highly simplified model of bank lending with exogenously specified probability of country default, or financial distress. The key factor that distinguishes a foreign loan from a domestic one is the presence of country risk. The importance of country risk in internationally-funded infrastructure projects is highlighted by the fact that even if a project is commercially viable, its ability to service its foreign debt or equity depends on broader governmental policies regarding capital mobility and currency convertibility, which are beyond the control of the project entity. Technically, consider the required return to creditors, or cost of debt capital, from a particular project in a given country. This required rate of return is denoted by i and can be expressed as: _i= r_ + _s,_ where r is the risk-free rate of interest, and _s_ is a variable reflecting the market's combined assessment of country and project risk. In what follows, we develop a simple model of how _s_ is determined as a function of specific project and country risk factors.

Assessment of a country risk premium can rely on ratings assigned by credit rating agencies to the country's foreign currency debt obligations, andlor information on secondary market trading of sovereign bond issues, if available. In assigning such ratings, agencies are known to take into account numerous economic, social, and political factors. In a study of the behavior of two US credit agencies, the Moody's and Standard and Poor's, Cantor and Packer (1996) found that six factors appear to play an important role 11
in determining a country's rating: per capita income, GDP growth, inflation, external debt, level of economic development, and default history. The authors also found evidence of a strong relationship between ratings and market-determined credit spreads of sovereign bond issues. Furthermore, as demonstrated by Ul Haque (1996) a close correlation exists between country credit ratings and capital flows across all country groupings, including heavily indebted countries." In its most general form, the risk premium demanded by creditors from an infrastructure project is a function of their own risk perception, availability of third-party guarantees, and other contractual arrangements contained in the loan security package, as well as broader country risk factors. To disentangle the influence of country and project risk, we postulate the conditions under which the project and or the country runs into financial distress. For the project, we adopt the standard corporate finance practice in defining default as the condition in which the project's revenues are less than the face value of its outstanding debt obligations. The definition of financial distress at the country level is not straightforward, however. The existing literature has focused on either "country credit risk" or on risks associated with the volatility of capital flows. In the first strand, the nature of risk relates to the country's ability or willingness to service its external debt obligations in a timely manner. The basic financial contractual relationship is one of fixed debt obligation, with the government as the main borrower. In the second strand, the focus has shifted to the elaboration of circumstances and factors contributing to a country's vulnerability to speculative attacks on its foreign exchange reserves or currency.

We use financial distress as a general term which includes not only default in the traditional country credit risk sense<sup>12</sup> , but also speculative attack on the host country's reserves as elaborated by McKinnon and Pill (1997) and Obstfeld (1995). This broader definition seems to be more relevant in describing the exposure of private entities to broader country risk attributes.'<sup>3</sup> Factors and circumstances which bear upon the creditworthiness of private entities relate to direct or indirect measures adopted by the

- Country ratings by major rating agencie **s** how a consistent overall improvements increditworthiness. This improvement has been particularly marked over the past four years: the average country risk in the Euromoney's ranking has increased from 43.56 in March 1993, to 50. 72 in March 1996, and the ratings of 16 countries in Asia, LAC, and Eastern Europe were upgraded between September 1994, and December 1996, at least by one of the two US major agencies, Moody's and Standard & Poor's.

- 12 For an insightful discussion of the concept of loan default in international credit markets, see Eaton, Gersovitz, and Stiglitz, 1986.

- 3 The traditional approach of country risk assessment has focused on country credit/default risk. In this new scenario, the traditional concept of country risk or sovereign risk arising primarily from the possibility of default on government extemal debt obligation, is no longer relevant. A more relevant concept would need to encompass types of extemal financial crisis, as experienced by Mexico in 1994, or East Asian countries in recent years.

12
governments in response to a situation of financial distress such as contractionary macroeconomic measures and or intervening directly in the foreign exchange markets, resulting in controls on currency convertibility or transferability.

Technically, our analysis is based on a simple two-period model of bank lending with no taxes, transaction cost, and third party guarantee and focuses only on default risk. Thus, consider a bank extending a foreign currency denominated loan to a company to finance an investment project. The loan is contracted in the first period with the face value D dollars to be paid back in the next period. The investment project yields an uncertain cash flow X dollars (in foreign currency equivalence) in the second period. We define X to include liquidation value of assets but net of operating costs. The promised payment to debt, i.e. interest plus principal needs to be serviced entirely from the project's cash flows i.e. no recourse to the credit of project promoters. To incorporate country risk, we assume that the project is domiciled in a country with a risk of financial distress represented by a random variable z. The random variable z is assumed, for simplicity, to take two alternative values of z=l, with the probabilityp, indicating that the project's host country is in financial distress at the time of loan maturity and value z=O with the probability I-p. In the event of financial distress, the project's ability to service its foreign currency loan obligation in a timely manner is adversely affected. Two events are important: (i) a general deterioration in business and economic environment associated with country financial distress, and (ii) imposition of government control and interference with access to foreign exchange. In either cases, the outcome is less than 100% loan recovery, even if the project itself is financially viable. In the case of default, let the fraction of the project's loan repayment that can be recovered be denoted by the parameter _a_ where 0 S<cx 1. For a value of a=1, the loan can be recovered totally and for _a=O,_ the loan value is totally lost.

In the case of no country default, the pay-off to foreign creditor is determined solely by the project's own financial viability, in the sense that whether its cash flows are sufficient and adequate to meet its contracted loan repayment obligations. In view of the above discussion, and bearing in mind that a debt contract is a fixed obligation which does not entitle debt investors, beyond a certain point, to the success of the project, the return, or pay-off to the creditor _Y,_ will be a function of both project and country risk, i.e., _Y_ = _7C(z,_ X), which can be succinctly expressed as: ) 13
where The expected value of _Y_ can be expressed as: where f(x) is the density probability function of X.

Under the assumption that creditors are risk-neutral, the market value of the loan V, is the present value of _E(Y_ ),discounted at the risk free rate of interest, r. That is Given that the loan has a maturity of one year with a promised value D, and market value V, its expected market rate of return, i, is given: From equations 3,4, and 5, it is possible to derive an expression for the risk premium on the loan, i-r, which can be shown to equal where X and L are defined as: 14
_L= Yf|(D X)f(x)dx_ (8) 0

Equation (6) describes the risk premium on a foreign currency loan to a project as a function of both project and country risk attributes. Country risk is captured through the parameters, a and p, and project risk through _L._ In the case that there is no country risk, i.e. X = 1, which can happen when eitherp =0 or a=1, then i - r = _L._ On the other hand, if there is no project risk, i.e., _L =_ 0, which could happen if the loan was fully guaranteed by a third party, then i - r = _r)(1 2) 2_ In equation (8), _L_ defines the average loan loss on the project which will be zero for full pay-off outcomes and positive in the case of default. Figure 3 demonstrates a simulated value of L for various specifications of project riskiness (standard deviation of project return). The simulation is undertaken based on the following assumed parameter values: we take an initial investment of $100, leverage ratio of 0.8, contracted loan value of $88 and assume that _Xis_ normally distributed with mean of $125 and standard deviation raging from 20 to 35 with an increment of 0.5 to reflect projects with different degrees of risk. As shown in figure 3, the higher the riskiness of the project, the higher the average expected loss. Thus, for a risky investment, i.e. standard deviation equal to 35, the corresponding value of L would be 4%. Figure 4 demonstrates a simulated value of _i_ - r for various project risk values, and a (the share of foreign currency loan paid back in the case of country default) set to 80% of the amount due. As expected, the risk premium increases with project risk. It is also interesting to note how highly sensitive _i_ - _r_ is with regard to the variation with the probability of country default. Raising p, the probability of country default from 5% to 10% will result in an upward shift in i - r by about 150 bps.

Finally, the role of risk-free rate of interest, r, in the determination of the credit risk premium, i-r, deserves attention. From equation (6), it is evident that, i-r, depends positively on r, implying a second-order influence of variation in the level of risk-free interest rates on the cost of borrowing to the projects. Given the dominance of U.S. dollars in international loan markets, a good proxy for r would be a particular U.S. Treasury rate (short-term Treasury bill rate). This second-order effect stems from the fact that as international interest rates decline, the market value of outstanding dollars denominated loans increases. Thus, when international rates, i.e. U.S. rates increase, the cost of capital to projects increases both directly and indirectly through higher credit spreads.

15
Figure 3 <!-- Start of picture text --> Average percentage loan loss as a function of project risk<br>4.0%<br>3.5%<br>3.0%<br>1.5%<br>1.0%<br>0.5%<br>0.0%<br>20.0 22.0 24.0 26.0 28.0 30.0 32.0 34.0 36.0<br>Project risk (standard deviation)<br><!-- End of picture text --> Figure 4 Risk premium incorporating country and project default risks <!-- Start of picture text --> 7.0%-<br>6.0%<br>5.0%<br>4.0% - p=10o%<br>320% -<br>2.0%<br>1.0%<br>20.0 22.0 24.0 26.0 28.0 30.0 32.0 34.0 36.0<br>Project nsk (standard deviation)<br><!-- End of picture text --> 16
# IV. **Some Econometric Results:**

The pricing model developed in this article offers an intuitive perspective on the relationship between default risk premium on foreign currency loans to projects in emerging market economies and the country and project risk attributes. To provide evidence on this relationship, we compiled data on a sample of infrastructure projects having reached financial closure between 1994 and 1996 in developing countries. Out of a sample of 68 greenfield infrastructure projects, we were able to compile detailed information regarding financing mixes, terms, size, sector, and country for only 26 of them, which provide the database for our empirical analysis (for more details on the larger project database, see Dailami and Klein, 1997). This information was compiled from published industry trade sources and communication with major developers, investment banks, export credit agencies, ECAs, and multilateral financial institutions.

We measure the credit risk premium as the spread over a benchmark (e.g. LIBOR or US treasuries) of foreign currency private loans to infrastructure projects.<sup>14</sup> We focus on private dollar-denominated loans advanced to projects in the core infrastructure sectors of power, road, telecom, transport, and water in emerging market economies. Since most projects had more than one private foreign currency loan, the spread used was the weighted average of constituted loans. As summarized in Table 4, the spreads vary both across countries and projects, within a range of 100 bps to 530 bps, with higher spreads associated with loans to road projects.

We relate this measure of the risk premium to a set of macroeconomic and project-specific explanatory variables, through a simple linear regression analysis (OLS). The main macroeconomic variables include: rate of inflation, GDP per capita, and ratios of external debt to exports, short-term debt to foreign exchange reserves, and reserves to imports. On the project side, we have included project size, leverage ratio, and a set of dummy variables to distinguish projects in different sectors. Table 6 reports the main regression results under various model specifications, which we view as tentative, due to the limited number of observations.

In interpreting our regression results, the dominant role of inflation in explaining the spread on foreign loans to infrastructure projects emerges with clarity. The estimated coefficient for inflation is statistically significant in all equations. Furthermore, there is evidence that countries with domestic inflation exceeding a benchmark rate have been further penalized -- including a dummy variable for countries with domestic inflation rates higher than 50% per anum proved to be statistically significant. The estimates for other macroeconomic variable, with the exception of short-term debt to foreign exchange reserves ratio (which seems to be weakly significant), are not statistically significant. This appears to be mostly due to data limitation rather than reflecting a genuine economic phenomenon. With regard to project-specific variables, it is evident that road projects have commanded the highest risk premium, followed by power projects.

> 14 Dummy variables are included to capture differences in the magnitude of risk premia for two types of benchmarks: LIBOR and US treasuries.

17
This importance attached to inflation in determining risk premiums on foreign currency loans deserves attention. Three hypothesis could be advanced to explain this finding. First, it is conceivable that the market views inflation as a proxy for the overall fiscal and monetary policy management of governments. In the current environment of low global inflation, countries with higher than average inflation are particularly "singled out" and penalized in the international capital markets. Secondly, countries with high inflation are likely to have high domestic interest rates, thus creating an incentive for borrowing even at higher spreads.<sup>15</sup> Thirdly, higher spreads could reflect the impact of longer maturity, independent of country and project risk. While most loans in our sample are of long-term maturity, some variations exist which could be correlated with the loan spreads. Including maturity as an independent variable in the regression analysis proved not to be significant.16 There exists a trade-off involved between spreads and maturity in a loan contract. Ideally, both maturity and spread should be determined endogenously (see Leland and Toft, 1996 for a theoretical approach along this line), but this is beyond the scope of this paper.

> _5_ This demand side factor has probably been less influential in the case of infrastructure projects where project promoters are often foreign companies with access to international capital markets. Thus, it can be concluded that inflation operates mostly as a country risk variable.

> 16 It is difficult to account for the impact of maturity in a single equation regression analysis due to the problem of simultaneity, i.e., maturity is not an exogenous variable.

18
Table 4-Terms of foreign currency loans to infrastructure projects

|Country|Sector|Spread over<br>benchmark, bps|Maturity,<br>years|
|---|---|---|---|
|I Argentina|Water/Waste|<br>2.50|<br>10|
|2 Bahamas|Waste/Water|<br>2.75||
|3 Chile|Power|2.00|<br>7.5|
|4 China|Power|2.08|<br>10|
|5 China|Roads|1.40|<br>8|
|6 Colombia'|Gas|3.00|<br>15|
|7 Colombia|Roads|5.30|<br>4|
|8 Colombia|Telecom|1.75|<br>7|
|9 Colombia|Transport|3.40|<br>15|
|10 Hungary|Roads|3.00|<br>12|
|11 Hungary|Roads|3.00|<br>12|
|12 India|Telecom|2.25|<br>8|
|13 India|Telecom|2.25|<br>8|
|14 Indonesia|Power|2.00|<br>16.5|
|15 Indonesia|Power|1.15|<br>12|
|16 Indonesia|Power|1.48|<br>15|
|17 Indonesia|Telecom|1.85|<br>9|
|18 Jamaica|Transport|4.42|<br>14|
|19 Pakistan|Power|2.00|<br>12|
|20 Pakistan|Power|2.11|<br>12|
|21 Philippines|Power|1.06|<br>16|
|22 Philippines|Power|0.90|<br>9|
|23 Philippines|Telecom|2.35|<br>8|
|24 Portugal|Roads|1.63|<br>15|
|25 Thailand|Power|1.35||
|26 Turkey|Power|1.50|<br>15|
|27 Turkey|Waste/Water|<br>2.25|<br>7|
|Average|||11.08|

> * The benchmark used is US Treasuries, otherwise LIBOR

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Table 5- Descriptive Statistics for Data **Used** in the Regression Analysis

|Variable|Mean|Standard|
|---|---|---|
|||Deviation|
|**Dependent Variable:**|||
|Spread (bps)|224.9|99.0|
|**Explanatory Variables:**|||
|Macroeconomic Indicators:|||
|Inflation per annum (%)|19.19|19.84|
|External debtlexport (%)|158.36|63.58|
|GDP per capita, USD|2573.48|2903.26|
|Short term debt/Reserves<br>(%)|76.88|42.94|
|Reserves /Import (month)|4.50|1.74|
|Project Variables:|||
|Project size (investment, mln<br>USD)|707.04|749.08|
|Project leverage ratio, %|65.36|20.59|
|Project sector:|||
|Power|11||
|Roads|_5_||
|Transport|2||
|Telecom|2||
|Other|7||
|Index Type:|Frequency||
|Libor|25||
|US Treasury|2||

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Table 6- Regression results explaining the determinants of risk premium

|Explanatory variables|equation I|equation 2|equation 3|equation 4|equation 5|
|---|---|---|---|---|---|
|Intercept|-0.9613|-1.3104|-1.2403|-1.1550|-0.0823|
||(-0.9300)|(-1.1820)|(-1.0740)|(-1.0790)|(-0.0960)|
|Inflation|2.9171**|3.2725**|3.2995**|2.7781**|2.9362**|
||(3.6490)|(3.7090)|(3.6160)|(3.4140)|(3.5430)|
|ln(Extemal debt/export)|0.2321|0.2333|0.2267|0.2988||
||(1.4050)|(1.2590)|(1.1820)|(1.7040)||
|ln(GDP per capita)|-0.1013||-0.0524|-0.0440|-0.1234|
||(-0.9750)||(-0.4530)|(-0.4040)|(-1.1590)|
|Ln(Short term debt/Reservs)|0.2544|0.0963|0.1491|0.0381|0.3562*|
||(1.2520)|(0.5470)|(0.6910)|(0.1950)|(1.8110)|
|Reserves /Import|0.0904|0.0495|0.0738|0.0426|0.1077|
||(1.3200)|(0.9420)|(0.9670)|(0.5870)|(1.5420)|
|ln(Project size (investment))|-0.0967||||-0.0999|
||(-1.7470)||||(-1.7410)|
|Project leverage ratio, %||-0.0020|-0.0015|||
|||(-0.4370)|(-0.3170)|||
|Roads|0.1694|0.0251|0.0227|0.1140|0.1147|
||(0.7720)|(0.1100)|(0.0960)|(0.5740)|(0.5120)|
|Power|-0.2071|-0.2125|-0.2483|-0.2172|-0.2665|
||(-1.2350)|(-1.0140)|(-1.0780)|(-1.3170)|(-1.5830)|
|IndexType|0.0311|0.0189|-0.0037|0.1237|-0.0332|
||(0.1240)|(0.0670)|(-0.0130)|(0.4810)|(-0.1300)|
|Intercept Inflation Dummy|-1.9616**|-2.3082**|-2.321 9**|-1.9226**|-1.9774**|
||(-3.2000)|(-3.6450)|(-3.5490)|(-3.2110)|(-3.1110)|
|R-square|0.761|0.7170|0.7190|0.6670|0.5480|
|Number of observations|23|23|23|26|23|

_Note:_ t-ratios are in parentheses ** significant at the 0.05 level * significant at the 0. 1O level 21
|Variables Definition||
|---|---|
|Inflation|Average CPI growth rate (92-95)|
|External debt/export|Debt /Exports of G&S (%), end-year 1995|
|GDP per capita|GDP per capita, USD, 1995|
|Short term<br>debt/International reserves|Short-term external debt to International reserves, %, 1995|
|Reserves /Import|International reserves to imports of goods and services.<br>(RES times 12/MGS)|
|Project size (investment)|Project's investment in mln USD|
|Project leverage ratio, %|Total debt to investment, in %|
|Roads|Dummy variable: 1 for a Road project, 0 otherwise|
|Power|Dummy variable: 1 for a Power project, 0 otherwise|
|Index Type|Dummy variable: 1 if the index type is US Treasury, 0<br>otherwise|
|Intercept inflation dummy|Dummy variable: 1 for countries with average CPI growth<br>rate more than 50%|

22
# V. **Concluding Remarks**

The success with which middle- income indebted developing countries have been able to gain access to private international finance in the 1990s is a tribute to their own domestic economic performance, international policy in dealing with the debt crisis of 1 980s, and innovations in international financial markets. Thus, private capital flows, in the form of foreign direct investment, portfolio investments in domestic stocks and bonds, and issuance of equity and bonds in offshore markets, have grown in the 1990s to dominate external finance to developing countries. In explaining this surge in capital flows previous research has emphasized the role of domestic economic reform, external factors such as the US interest rates, and official interventions, particularly under the Brady Plan.

In this paper we have emphasized the role of infrastructure finance in the process of capital flows to developing countries. Capital flows to infrastructure sectors in developing countries have witnessed a remarkable growth in recent years from $1.3 billion in 1986 to $27 billion in 1996. Such flows embody certain desirable features which bode well for their sustainability. In contrast to the short-term capital flows of the 1970s, flows to infrastructure projects are of a long-term nature, with debt maturities of 7 to 15 years, or permanent equity, and are invested in assets which underpin long-term economic growth and export expansion. Secondly, by virtue of the fact that most infrastructure financing is in the form of project financing, the claims of new creditors and investors are differentiated and are not subordinated to any existing claims, at the project level, although at the national level, the hierarchy of claims depend on the specific contractual arrangements.

A key element in understanding the recent surge in capital flows to infrastructure is the assessment of credit risks on infrastructure investments in the country risk environment of host countries. With a few exceptions, most developing countries are still rated as "non-investment grade" by major credit rating agencies, and as demonstrated by the experiences of Mexico and Thailand, vulnerability to speculate exchange rate attacks and sudden loss of investor confidence remain a feature of the current pattern of capital flows once policies go off course. We show in this paper that the risk premia on foreign currency loans to infrastructure projects can be related to country and project-specific risk attributes.

The results of our paper offer interesting insights into the determination of foreign borrowing costs to infrastructure projects in developing countries. Our regression results are most robust with regard to the role of inflation. Using both simulation and econometric analysis, our evidence indicates that the market demands a higher risk premium on loans to countries with high inflation and to road projects, and that the market seems to reward countries that have succeeded in lowering their inflation.

23
Annex I - Developing Countries' Sovereign Ratings (as of April 1997)

|Sta<br>**Investment Grade**|ndard & Poor's|Moody's|
|---|---|---|
|Chile|A-|Baal|
|Colombia|BBB-|Baa3|
|Croatia|BBB-|Baa3|
|Czech Republic|A|Baal|
|Egypt|BBB-|Ba2|
|Greece|BBB-|Baal|
|Hungary|BBB-|Baa3|
|India|BB+|Baa3|
|Indonesia|BBB|Baa3|
|Latvia|BBB|_NR_|
|Oman|BBB-|Baa2|
|Poland|BBB-|Baa3|
|Slovak Republic|BBB-|Baa3|
|South Africa|BB+|Baa3|
|Tunisia|_NR_|Baa3|
|**Non-Investment Grade**|||
|Argentina|BB|B**1**|
|Brazil|BB-|B1|
|Bulgaria|_NR_|B3|
|Dominican Republic|B+|_NR_|

24
|El Salvador|BB|_NR_|
|---|---|---|
|Jordan|BB-|Ba3|
|Kazakhstan|BB-|Ba3|
|Lebanon|BB-|BI|
|Lithuania|_NR_|Ba2|
|Mexico|BB|Ba2|
|Moldova|_NR_|Ba2|
|Pakistan|B+|B2|
|Panama|BB+|Bal|
|Paraguay|BB-|_NR_|
|Peru|_NR_|B2|
|Philippines|BB+|Ba2|
|Romania|BB-|Ba3|
|Russia|BB-|Ba2|
|Trinidad & Tobago|BB+|Bal|
|Turkey|B|B 1|
|Uruguay|BB+|Bal|
|Venezuela|B|Ba2|

25
Table 7- Inflation' trends in Developing countries, 1985-1996

||**1985-89**|**1990-94**|**1995**|**1996**|
|---|---|---|---|---|
||**Average an**|**nual %**|**Annua**|**l %**|
|**Latin America**|**407.93**|**852.60**|**46.15**|22.20|
|Argentina|863.27|505.07|3.38|0.16|
|Brazil|514.21|1840.87|84.38|18.23|
|Chile|20.35|17.48|8.23|7.36|
|Colombia|24.03|26.60|20.96|20.24|
|Ecuador|42.88|44.80|22.89|24.37|
|Guatemala|18.03|21.42|8.41|11.06|
|Haiti|2.70|24.23|25.46|17.12|
|Honduras|4.91|19.71|29.46|23.84|
|Mexico|82.00|16.31|35.00|34.38|
|Nicaragua|3357.64|2096.43|10.95|11.61|
|Panama|0.49|1.11|0.99|1.26|
|Paraguay|25.56|23.27|13.43|9.80|
|Peru|878.57|1607.41|11.13|11.54|
|Venezuela|33.00|41.05|59.92|99.88|
|**Others**|**8.38**|**10.28**|**11.68**|**9.17**|
|India|7.73|10.24|10.22|8.98|
|Indonesia|6.86|8.59|9.43|7.92|
|Jordan|7.02|7.04|2.35|6.50|
|Nigeria|25.88|35.83|72.81|29.29|
|Pakistan|6.10|10.54|12.34|10.37|
|Philippines|9.72|11.68|8.09|8.41|
|Sri Lanka|8.55|13.05|7.67|15.94|
|Thailand|3.19|4.86|5.71|5.81|
|Uganda|155.25|25.89|8.55|7.31|
Figure Al: Capital Flows to Developing Countries ($billion) <!-- Start of picture text --> 300 300 ~~~~~~~~~Aggregate284.6<br>250{<br>200 1 243.8<br>/rivate flo<br>150<br>100.6 ~<br>100<br>50 --44<br>0 1 1 i i 1 1<br>1990 1991 1992 1993 1994 1995 1996<br><!-- End of picture text --> Figure A2: Government Deficit in Developing Countries (weighted average of 20 developing countries' central government deficit % of GDP) <!-- Start of picture text --> 7-<br>1 o- - - - - - - - - - - - - - - - - - - -- - - - - - - - - - - - - - - - - - - -<br>0 - - - - - - - - - - - - - - - - - - - -- - - - -- - - - - - - - - - - - - - - - - - -<br>196 18 98 199 19 91 192 19 94 19<br>a~~~~~~~~~~ 4 -- - -- -- - - -- - -- -- - Y- ars-- r -- -- -- -- -- - -- -- -- --- --- -<br>----<br>Weighted----- aver- g of--2-de---loping--countries cen--al--go---rnment<br>2 - - - -- - --- - - -- --- deficit---- over-- --- --- --<br>2~~~~~~~2<br>-I - - -- ---- - - ---------- ------------ ------ --- ----2 7- ---<br><!-- End of picture text -->