The Importance of Project Finance

Topics: Finance, Investment, Debt Pages: 14 (4601 words) Published: July 5, 2013
Project Finance in Developing Countries
THE IMPORTANCE OF PROJECT FINANCE

Chapter 1

In the past twenty years there has been a new wave of global interest in project finance as a tool for economic investment. Project finance helps finance new investment by structuring the financing around the project’s own operating cash flow and assets, without additional sponsor guarantees. Thus the technique is able to alleviate investment risk and raise finance at a relatively low cost, to the benefit of sponsor and investor alike. Though project finance has been in use for hundreds of years, primarily in mining and natural resource projects, its other possible applications—especially for financing large greenfield projects (new projects without any prior track record or operating history)— have only recently received serious attention. This is particularly so in developing markets, but here its application is also broadening, as illustrated by the following examples of IFC-supported projects: • In Argentina, in 1993, project finance structuring helped raise US$329 million to finance investment in the rehabilitation and expansion of Buenos Aires’ water and sewerage services based on a new 30-year concession awarded to Aguas Argentinas. The investment, financed with IFC support, has helped improve water quality and service to a city of more than 6 million people. At that time, private sector participation in a water concession in a developing country was an untested idea, and there was virtually no precedent for a private company operating in such an environment raising substantial resources in international capital markets. • In Hungary, in 1994, project finance structuring helped finance a 15-year concession to develop, install, and operate a nationwide digital cellular network. The $185 million joint venture project was an important part of the government’s privatization and liberalization program. Because of difficulty attracting commercial financing at that time, the project relied heavily on $109 million in debt and equity financing from IFC and the U.S. Overseas Private Investment Corporation (OPIC). • In China, in 1997, Plantation Timber Products (Hubei) Ltd. launched a $57 million greenfield project to install modern medium-density fiberboard plants in interior China, using timber plantations developed over the past decade, to support China’s fast-growing construction industry. As part of the limitedrecourse financing for the project, IFC helped arrange $26 million in syndicated loans, at a time when foreign commercial banks remained cautious about project financing in China’s interior provinces. • In Mozambique, in 1998, project finance structuring helped establish a $1.3 billion greenfield aluminum smelter. Mozal, the largest private sector project in the country to date, is expected to generate significant benefits in employment, export earnings, and infrastructure development. IFC fostered the project by serving as legal coordinator and preparing an independent detailed analysis of economic results and environmental and developmental impacts. IFC also supported the project with $120 million in senior and subordinated loans for its own account. The change in attitude toward project finance can be attributed to a number of factors, a prime one being that most countries today rely on market mechanisms to guide their economic activity and on the private sector to supply investment. Greater focus on the private sector has necessitated major regulatory reforms, which in turn have created new markets in areas previously the preserve of government activity. When the 1

United States passed the Public Utility Regulatory Act (PURPA) in 1978 and established a private market for electric power, for example, it provided a strong model for the growth of project financing in many other industrial countries. Similarly, recent large-scale privatizations in developing countries aimed at strengthening economic growth and stimulating...
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