USING PROJECT FINANCE TO FUND INFRASTRUCTURE INVESTMENTS
Throughout most of the history of the industrialized world, much of the funding for large-scale public works such as the building of roads and canals has come from private sources of capital. It was only toward the end of the 19th century that public financing of large “infrastructure” projects began to dominate private finance, and this trend continued throughout most of the 20th century. Since the early 1980s, however, private-sector financing of large infrastructure investments has experienced a dramatic revival. And, in recent years, such private funding has increasingly taken the form of project finance. The principal features of such project financings have been the following: A project is established as a separate company, which operates under a concession obtained from the host government. A major proportion of the equity of the project company is provided by the project manager or sponsor, thereby tying the provision of finance to the management of the project. The project company enters into comprehensive contractual arrangements with suppliers and customers. The project company operates with a high ratio of debt to equity, with lenders having only limited recourse to the government or to the equity-holders in the event of default. The above characteristics clearly distinguish project finance from traditional lending. In conventional financing arrangements, projects are generally not incorporated as separate companies; the contractual arrangements are not as comprehensive, nor are the debt-equity ratios as high, as those observed in the case of project finance; and the vast majority of loans offer lenders recourse to the assets of borrowers in case of default. Our purpose in this paper is to explore some possible rationales for the distinctive characteristics of project finance, from the viewpoint of both the project sponsor and the host government. We do so in the specific context of infrastructure investments. After providing some information about the growth of project finance in funding such investments, we note that project finance is but one of several mechanisms for involving the private sector in funding and managing infrastructure projects. We show how project finance, and the complex web of contractual arrangements that such funding entails, can be used to address “agency problems” that reduce efficiency in large organizations, private as well as public. We also view the contracts among the multiple parties to project financings as risk management devices designed to shift a variety of project risks to those parties best able to appraise and control them. In closing, we discuss what we believe are some common misconceptions about the benefits and costs of project finance—particularly, the notion that project finance represents “expensive finance” for governments—and we contrast project finance with other private-sector options such as privatization and the use of service contracts with private-sector companies.
THE GROWTH IN PROJECT FINANCE: SOME EVIDENCE
Comprehensive data on the financing of infrastructure projects do not appear to be available. Table 1 does, however, provide information about the growth in the value of those projects in developing countries that have been partially financed by the International Finance Corporation (the World Bank’s private sector affiliate). Over 80 percent (by value) of the projects involving the IFC have been in the power and telecommunication industries, with the remainder in transportation (roads, railroads, and ports), water, and pipelines. About 50% of the projects have been in Latin America, with the bulk of the remainder in Asia. The use of project finance has not been restricted to infrastructure investments in developing countries. Indeed, over 40 percent of the project finance loans reported in the 1995 survey conducted by IFR Project Finance International were for projects in the...
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