Clos­ing the in­fras­truc­ture gap in Le­banon

Proper use of CEDRE funds with­out gov­ern­ment bor­row­ing

Executive Magazine - - Economics & Policy - By Talal F. Sal­man

With the world’s pop­u­la­tion ex­pected to grow by 2 bil­lion—reach­ing al­most 9.5 bil­lion by 2040—one of the ma­jor struc­tural changes that would need to keep pace is the de­vel­op­ment of in­fras­truc­ture. The world is ex­pected to need close to 100 tril­lion dol­lars worth of in­fras­truc­ture in­vest­ment by 2040, mainly in de­vel­op­ing coun­tries, ac­cord­ing to es­ti­mates by the UN and the World Bank. This sum is re­quired to meet the de­mands of clean wa­ter, san­i­ta­tion, elec­tric­ity, trans­port, and telecom­mu­ni­ca­tions, in ad­di­tion to schools and hos­pi­tals. The sum is also likely to in­crease, given the es­ca­lat­ing im­pact of cli­mate change. Around 20 per­cent of the re­quired funds will not be avail- able if na­tional economies, which are fi­nan­cially in­ter­con­nected now more than ever, do not plan ac­cord­ingly. The avail­abil­ity of funds is a bless­ing that a coun­try such as Le­banon might not re­al­ize. While other de­vel­op­ing coun­tries might strug­gle to gen­er­ate sav­ings or at­tract in­vest­ment in their lo­cal economies, the Le­banese fi­nan­cial system is sit­ting on 320 per­cent of GDP in de­posits—one of the high­est in the world. There is no doubt that the in­fras­truc­ture in Le­banon has been se­verely ne­glected since the end of the civil war. The lack of proper in­vest­ment in elec­tric­ity, tele­coms, san­i­ta­tion, trans­port, and wa­ter is caus­ing ma­jor costs to the econ­omy, to the pro­duc­tive ca­pac­ity of all sec­tors, to house­hold in­come, and to the health of ev­ery in­di­vid­ual.

The de­posits in the Le­banese fi­nan­cial sys­tems, with the proper use of avail­able cheap in­ter­na­tional loans and guar­an­tees, can help Le­banon close its in­fras­truc­ture gap while min­i­miz­ing bor­row­ing.

ECO­NOMIC STIM­U­LUS

The CEDRE in­vest­ment con­fer­ence on April 6 was tes­ta­ment to the com­mit­ment of the in­ter­na­tional com­mu­nity in help­ing Le­banon to achieve the eco­nomic se­cu­rity it needs and to com­pen­sate for the seven years of near zero growth, due to the im­pact of the Syr­ian war. The reper­cus­sions for the Le­banese econ­omy—which stands at $53 bil­lion in size cur­rently—is around $30 bil­lion so far, a massive chal­lenge for any coun­try. The sup­port that Le­banon re­ceived at CEDRE pro­vides much-needed con­fi­dence, and can have great re­sults if prop­erly ex­e­cuted. The right in­vest­ment in in­fras­truc­ture is known to boost growth— in the case of Le­banon it could lead to a 3 per­cent in­crease in GDP in the cur­rent en­vi­ron­ment. How­ever, the Le­banese econ­omy has the po­ten­tial to grow at 6 per­cent a year in the ab­sence of ex­ter­nal fac­tors im­pact­ing our abil­ity to grow, and within a proper pol­i­cy­mak­ing frame­work.

The in­volve­ment of the pri­vate sec­tor through pub­lic-pri­vate part­ner­ships (PPP) is im­por­tant to at­tract cap­i­tal. How­ever, the cost of in­fras­truc­ture projects that are not com­mer­cially vi­able and thus not el­i­gi­ble for PPP—$11 bil­lion out of the $17 bil­lion worth of projects pro­posed— are in­tended to be fi­nanced through con­ces­sional loans. This means that even if the cost of debt is low, it is still

debt be­ing added to the third most in­debted coun­try in the world (Le­banon has a pub­lic debt equiv­a­lent to 151 per­cent of GDP). Debt ser­vice cost is around 10 per­cent of GDP, 50 per­cent of gov­ern­ment rev­enues, and 36 per­cent of to­tal gov­ern­ment ex­pen­di­tures, all among the high­est in the world. There­fore, adding debt to the gov­ern­ment’s bal­ance sheet does not seem to be the best ap­proach. Let’s take a look at PPP and what is the best model for Le­banon to use the pledged in­vest­ments from the CEDRE con­fer­ence to its ad­van­tage:

Firstly, PPP is not pri­va­ti­za­tion, which is the com­plete di­vesti­ture of a pub­lic as­set to the pri­vate sec­tor, and it is not a pro­cure­ment con­tract where the gov­ern­ment hires a pri­vate com­pany to con­struct a road or a power plant for ex­am­ple, or to pro­vide a ser­vice. Even though the term is glob­ally used to en­com­pass a wide range of re­la­tion­ships be­tween the pub­lic and pri­vate sec­tor, a proper part­ner­ship is one that de­fines two ma­jor fac­tors needed for the suc­cess of in­fras­truc­ture projects—es­pe­cially green­field ones, which are new projects as op­posed to up­grades to ex­ist­ing in­fras­truc­ture. Those two fac­tors are fi­nanc­ing and risk. The al­lo­ca­tion of fi­nanc­ing refers to what por­tion is to be in­vested by the pri­vate sec­tor and what por­tion is to be in­vested by the gov­ern­ment. The al­lo­ca­tion of risk de­ter­mines who is re­spon­si­ble for the de­sign, im­ple­men­ta­tion, oper­a­tion, and main­te­nance of the project.

The usual steps in a PPP project are first to de­fine and de­sign the project, sec­ond to struc­ture the fi­nanc­ing for the cost of im­ple­ment­ing the project, third to build the phys­i­cal re­sources, and forth to op­er­ate and main­tain these as­sets.

Gov­ern­ments tend to ben­e­fit from PPP struc­tures by at­tract­ing cap­i­tal they do not pos­sess, by im­ple­ment­ing a project at a lower cost, and by del­e­gat­ing oper­a­tions and main­te­nance to the pri­vate sec­tor, which gen­er­ally, al­beit not al­ways, does a bet­ter job.

From the point of view of the pri­vate sec­tor, PPP in­fras­truc­ture projects are at­trac­tive be­cause they pro­vide a steady and strong cash yield

Debt ser­vice cost is around 10 per­cent of GDP, 50 per­cent of gov­ern­ment rev­enues, and 36 per­cent of to­tal gov­ern­ment ex­pen­di­tures, all among the high­est in the world.

with low volatil­ity, are a nat­u­ral hedge against in­fla­tion, and have low cor­re­la­tion with other fi­nan­cial as­sets.

A third im­por­tant fac­tor when it comes to PPP—in ad­di­tion to fi­nanc­ing and risk for de­vel­op­ing coun­tries’ projects—are guar­an­tees pro­vided by mul­ti­lat­eral or­ga­ni­za­tions, such as the World Bank. Guar­an­tees to the

pri­vate part­ner in case the gov­ern­ment does not meet its cash pay­ment obli­ga­tions re­duces the risk of in­vest­ment, and hence re­duces the re­quired rate of re­turn.

The PPP law that Le­banon en­acted last year or­ga­nizes this process clearly and mon­i­tors it, and the in­ten­tion was to have projects fi­nanced 100 per­cent through pri­vate part­ners who would be re­spon­si­ble for fi­nanc­ing, con­struc­tion, oper­a­tion, and main­te­nance of a project. The gov­ern­ment would be re­spon­si­ble for col­lect­ing the fees for the ser­vices pro­vided and trans­fer­ring the agreed upon cash flows to the pri­vate part­ner in re­turn for their in­vest­ment and oper­a­tions.

ELEC­TRIC­ITY FIRST

Nat­u­rally, some projects, such as waste­water and the con­struc­tion and main­te­nance of roads, are not prof­itable for the gov­ern­ment. There­fore, in the ab­sence of a bud­get sur­plus and in the pres­ence of high bor­row­ing costs, con­ces­sional fi­nanc­ing might seem like a good idea. It is not, how­ever, be­cause it means more debt for the gov­ern­ment when there is an al­ter­na­tive method of fi­nanc­ing those projects with­out the need for the gov­ern­ment bor­row­ing.

The so­lu­tion is to start with PPP projects that can have a di­rect im­pact on the fis­cal deficit. By that, we ob­vi­ously mean elec­tric­ity. The elec­tric­ity deficit is re­spon­si­ble for 40 per­cent of our na­tional debt and 3 per­cent of GDP in yearly deficit (around $1.5 bil­lion, depend­ing on fuel prices), not to men­tion the ma­jor costs to the econ­omy, busi­nesses, and house­holds. The an­nual house­hold spend­ing on pri­vate gen­er­a­tors is around $2.5 bil­lion in the in­for­mal sub­sti­tute mar­ket for elec­tric­ity. A sim­ple cal­cu­la­tion shows that if the gov­ern­ment pro­vides elec­tric­ity ef­fi­ciently, a ma­jor re­form by it­self, it can not only elim­i­nate the deficit caused by fuel sub­si­dies to Elec­tric­ité du Liban but also be­come prof­itable to the tune of around $1 bil­lion, with­out any added cost to house­holds. Other promising projects would be those that can in­crease the gov­ern­mant rev­enues, such as ex­pand­ing the air­port, build­ing a sec­ond one, and im­prov­ing the ca­pac­ity of ports, moves which would all be prof­itable for both the pub­lic and pri­vate sec­tor.

Re­vers­ing a deficit into a sig­nif­i­cant sur­plus would of­fer room in the bud­get that could be spent on projects that are not prof­itable for the gov­ern­ment but cru­cial for so­ci­ety and the econ­omy, such as waste­water and roads. The max­i­mum ab­sorp­tive ca­pac­ity of an econ­omy like Le­banon with re­gard to in­fras­truc­ture is 2 per­cent of GDP yearly, or in Le­banon’s case $1 bil­lion. The ab­sorp­tive ca­pac­ity refers to the abil­ity of gov­ern­ment in­sti­tu­tions and the size of the econ­omy to trans­late in­fras­truc­ture in­vest­ment into sus­tain­able growth in out­put. There­fore, since the in­vest­ments pro­posed will be im­ple­mented grad­u­ally, start­ing with the right ones will make oth­ers pos­si­ble with­out the need to add to the gov­ern­ment’s debt bur­den.

The max­i­mum ab­sorp­tive ca­pac­ity of an econ­omy like Le­banon with re­gard to in­fras­truc­ture is 2 per­cent of GDP yearly, or in Le­banon’s case $1 bil­lion.

We can use the in­ter­na­tional sup­port re­ceived at the CEDRE con­fer­ence in two ways. First, to di­rect the con­ces­sional fi­nanc­ing pro­vided to­ward PPP projects and not to­ward the bal­ance sheet of the gov­ern­ment. Any pri­vate part­ner in a PPP project will be look­ing to fi­nance the project through a com­bi­na­tion of equity and debt to max­i­mize his re­turns; the debt por­tion will be bor­rowed from a com­mer­cial bank and the in­ter­est rate level will be based on the risk pro­file of the pri­vate part­ner. If the pri­vate part­ner is given ac­cess to con­ces­sional fi­nanc­ing, his re­turns would be im­proved, which means the gov­ern­ment can in­di­rectly ben­e­fit from bet­ter terms in the PPP struc­ture by chan­nel­ing its ac­cess to con­ces­sional fi­nanc­ing to­ward PPP projects. Se­condly, the avail­abil­ity of guar­an­tees that donors and mul­ti­lat­eral or­ga­ni­za­tions could pro­vide to in­vestors would re­duce the risk pre­mium in­vestors re­quest when they in­vest in de­vel­op­ing coun­tries with low credit rat­ings such as Le­banon. Ad­di­tion­ally, the avail­abil­ity of funds in the Le­banese fi­nan­cial system means that the fi­nanc­ing struc­ture of PPP projects can in­clude in­vest­ment con­tri­bu­tions from small Le­banese de­pos­i­tors. This means the Le­banese pop­u­la­tion can reap a por­tion of the fu­ture cash flows gen­er­ated by the projects, which will of­fer a higher re­turn than the de­posit rate from their point of view, and will give an op­por­tu­nity for the Le­banese fi­nan­cial system to di­ver­sify its use of funds. The lat­ter would cre­ate an im­proved eco­nomic cy­cle as a por­tion of the prof­its would re­main in the Le­banese econ­omy rather than be­ing repa­tri­ated as prof­its by for­eign en­ti­ties.

The CEDRE con­fer­ence was a step in the right di­rec­tion, but the real suc­cess would be to achieve the needed projects with no ad­di­tional debt on the gov­ern­ment through an in­no­va­tive fi­nan­cial struc­ture, proper use of funds, and proper im­ple­men­ta­tion. This would re­sult in in­creased re­turn for in­vestors, the gov­ern­ment, the econ­omy, and so­ci­ety. The only way to achieve that is to start build­ing elec­tri­cal power plants (in­stead of rent­ing ex­pen­sive barges) us­ing con­ces­sional fi­nanc­ing pro­vided to the pri­vate sec­tor, cou­pled with a por­tion from lo­cal de­posits, and turn the bud­get deficit into sur­plus to be used for other cru­cial projects in a grad­ual man­ner that en­sures eco­nomic, fi­nan­cial, and op­er­a­tional ef­fi­ciency.

TALAL F. SAL­MAN is project di­rec­tor of the UNDP’s Fis­cal Re­form Project.

A to­tal of $11.3 bil­lion in low in­ter­est loans for ins­fras­truc­ture projects in Le­banon was pledged by donor coun­tries and mul­ti­lat­eral in­sti­tu­tions at the April 6, CEDRE con­fer­ence in Paris. At­ten­dees at the con­fer­ence in­cluded min­is­ters and heads of...

Newspapers in English

Newspapers from Lebanon

© PressReader. All rights reserved.