Financing Urban Public Infrastructure Module 7: Financing Urban Development Financing Urban Public Infrastructure Michel Bellier Lead Transport Finance Specialist World Bank

Outline Institutional models and allocation of responsibilities Alternative financing instruments Effects of financing instruments on urban planning and control

Institutional Models and Allocation of Responsibilities

What Is Urban Infrastructure ? Infrastructure is essential to urban development Water Water treatment and distribution Waste water disposal/treatment Transport Urban roads Urban transport Electricity Waste disposal

Urban Planning Has to Address Infrastructure Financing Urban infrastructure entails high initial investment and operating costs Infrastructure assets and facilities Equipment Urban infrastructure services share a common feature: monopolistic situation

Government Is Responsible for Infrastructure Infrastructure services must satisfy users’ needs Capacity Quality standards Planning infrastructure development Ensuring that investments are financed and implemented on time Ensuring that operating services are provided

Delivery Model: Government Government can directly provide urban infrastructure services Especially when service costs cannot be charged to users Urban roads (non tolled) Usual institutional organization: government department

Government Model Allocation of Responsibilities Activities Financing responsibility Funding Sources Financing Instrument Investment Government Municipal Budget Taxes Debt Operations or User Tariff Cut last column, since details later ?? Discussion in more details of each case

Government Can Also Transfer Responsibilities Especially when service costs can be charged to users Water and waste water, urban transport services, electricity, waste disposal Two main models Public utility owned by government Private company through a PPP contract (public private partnership) Models: Management contract Lease BOT. Many examples on water treatment in China, private not facing users Concession. Includes investment, production and distribution. Not allowed in China Above Privatization where no return of assets Examples in China Conditions for success?

Public Utility Model: Allocation of Responsibilities Activities Financing responsibility Funding Financing Instrument Investment Government or Utility Municipal Budget Utility Budget Taxes, debt Debt Operations User and (possibly) Subsidy Tariff Taxes

Institutional Model: Private Company Partnership government / private sector Various PPP models with different allocations of responsibilities Operations and maintenance contract Lease Build operate and transfer (assets) Concession of service provision to users PPP contracts have to be thoroughly regulated

Matrix of Responsibilities Model Investment Operations Payer O & M Government Private Investment: Government Operations: Government Lease Operations: users BOT Investment: investors, lenders Operations: “client”, users Concession Investment: investors, lenders Operations : users Management contract Company operates assets Operating Lease Government finances assets Company operates them and provides services BOT and related models Company finances and operates assets e.g. water treatment plant Provides respective services during the duration of the PPP contract Concessions BOT + Company provides services to end users

Alternative Financing Instruments

Instrument: Taxes Taxes finance the general budget All taxpayers contribute, even those who do not use infrastructure services But when proceeds of specific taxes are allocated by law to an infrastructure sector Or when property or income otaxes in developed areas are proxy charges for some infrastructure services

Financing Instrument: Tariff Charged on users of services only Tariff income should finance all operating costs But government may subsidize services E.G. When tariff capped for social concerns Utility model: + tariff income should also finance debt service

Financing Instrument: Tariff (2) Private company model: + tariff income or client fee (BOT) should ensure a satisfactory financial return to private investors Tariff should be ruled by PPP contract provisions Government may contribute to investment when a low financial rate of return impedes full market financing

Financing Instrument: Debt Debt can be used under all delivery models, but Government: local governments must be allowed to borrow funds (not in china) Debt should finance investments (not operations) Urban infrastructure requires long term debt 10 years + with duration linked to assets amortization schedule Banks assess borrower risks before lending Strength of financial accounts affects the cost of debt (municipal budget/utility/private Cny)

Instrument: Debt (2) Government model: debt finally paid by taxpayers Debt reimbursed by the municipal budget Utility model: a government guarantee may be required if utility financially weak or poorly managed Private BOT or concession: project finance debt On the basis of the strength of operating income

Instrument: Bond Bond: long term lending instrument provided by financial investors Insurance company, pension funds Domestic or international investors Bonds should finance investment only

Instrument: Bond (2) Bond issues are constrained by the country legal and regulatory framework Municipal bonds are not allowed in china Bond availability and pricing depend upon the credit rating of the issuer Independent credit rating agencies

Instrument: Equity Equity is essentially accessible to private companies Possibly to utilities through securitization (investors, stock exchange) of assets generating income Investors provide equity if the expected financial return is consistent with market level and the project risk profile

Financing Instrument: Equity (2) Equity investors are prepared to take more risks than bond investors or lenders But equity is the most expensive financing instrument for private companies And utilities when they can attract investors

Effect of Financing Instruments on Urban Planning and Control

Planning Infrastructure Financing Means: Assessing infrastructure needs Preparing realistic financing plans Planning the use of relevant financing instruments

Assessing Infrastructure Needs Urban development is dependent upon infrastructure Demand of services is driven by population growth and economic activities Infrastructure should be laid down before land is developed Infrastructure costs should be estimated as from preliminary feasibility studies Investment and operation costs

Preparing a Realistic Financing Plan of Infrastructure Balancing financing needs / funding Amounts and financing instruments Time frame: each delivery model entails its own decision process Setting tariff is part of financing plans Objectives: operating income should fully fund infrastructure services But for social constraints

Specificities: Government Model The city budget process is affected by the planning of infrastructure At first assess impact of infrastructure financing on budget during construction and operations Then size funding to balance financing plan Impact on tax levels and indebtedness

Specificities: Public Utility Model Independent budget process But the municipal budget is affected by government contributions to utility Financial controls of and reporting by utility crucial to assess financial risks for government Government can control as owner

Specificities: Private Company Model Assess very early the possibility to mobilize private sector skills and funding To estimate savings on public expenses At the early stage of urban planning Set the services objectives, price mechanisms and standards in the tender documentation Including draft PPP contract

Specificities: Private Company Model (2) Sponsors should be responsible for their own demand assessment when possible Otherwise government may have to provide unnecessary uptake guarantees Arm’s length negotiations are required on grant/ subsidies/ guarantees by government Amounts and payment schedule should be negotiated with the PPP contract

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