As an engine of economic growth and poverty reduction, public capital for public-private partnerships (PPP) are on the rise in Latin America and the Caribbean. In the last decade, there were approximately 1,000 PPP infrastructure projects valued at US $ 360 billion. Especially today, in a market of limited fiscal budgets and growing social gaps, PPPs have become more relevant than ever.
How to attract more private capital
Despite this historic rebound, many projects are not able to mobilize enough private capital. PPPs attract approximately one dollar of private financing for each dollar of public financing, a proportion that has not been able to close the infrastructure financing gap.
On the supply side, institutional investors have funds equivalent to 20% of the Gross Domestic Product (GDP) of the region, a hefty sum when an additional 2-2.5% of GDP is needed to meet the demand on infrastructure. The management of long-term assets, such as pensions and insurance, is an ideal combination for the long-term tenors of projects carried out through PPPs. In addition, PPPs offer investors relatively predictable repayment terms, promising financial returns and protection against inflation.
In the past, private capital, mainly institutional investors, has been cautious. However, it is possible to mitigate certain risks to arouse the interest of the investors and make the projects viable.
1. Legal and regulatory risks
Legal and regulatory risks encompass policies, regulations and institutions. Strengthening this regulatory framework to deal with market failures, encourage shared risk and regulate consistently, reassures investors. Countries are establishing government agencies and units with experience to supervise PPPs. Advisory services to governments can further strengthen institutions, their regulators and their supervisory mechanisms, as well as the programming of long-term projects.
2. Risk in the preparation of projects
Capacity building, combined with the right incentives, can mitigate the risk of project preparation. This can optimize the project’s efficiency, its predictability and its attractiveness to investors. Technical assistance can support project investment plans and share knowledge with public officials from agencies that promote private capital. For example, supporting investment planning can align the development of PPPs with nationally determined contributions, making projects more sustainable and climate resilient. The advice also allows governments to determine the optimal service delivery models through price-quality evaluations, in order to ensure that each asset contributes value to public agencies, investors and end users.
3. Risk in the exchange rate
Most PPPs, except in the energy sector where they are financed in dollars, are denominated in local currency. For the success of a PPP, the key is to avoid the risk of the exchange rate, but most governments are limited in the amount of dollars they can guarantee. The mobilization of local currency allows local borrowers to repay in the currency that is generating cash flow, avoiding misalignments. Exchange risk can be mitigated through investors, by creating local treasuries that can issue debt in the local currency or by providing guarantees in local currency project by project.
4. Construction risk
The construction risk includes expropriation, geological exposures and additional losses during the construction phase. Investors prefer to participate in PPP once the construction is complete. However, projects can reduce their risk through liquidity facilities, mixed financing, subordinated debt and completion guarantees that cover the construction risk and private capital, until the first 24 months of operation, can provide greater comfort and encourage early entry of PPPs.
The multilateral development banks are in a unique position to offer many of the solutions that address legal, regulatory and project preparation risks. BID Invest (formerly known as the Inter-American Investment Corporation), by the IDB Group, recently mitigated the risks and attracted institutional investors in the Reventazón hydroelectric project in Costa Rica, and in the Campo Palomas and Colonia Arias wind farms in Uruguay. The next phase seeks to bring institutional investors closer to PPPs and the construction phase.
We can also lend private capital in a local currency, like what Paraguay, Brazil, Colombia and Mexico are currently doing and we can implement guarantee and debt instruments to mitigate construction risk.
As the region’s PPP portfolio continues to grow, we will implement more solutions to optimize APP’s bancarization and mobilize more financing. The momentum we see in PPPs brings benefits to governments, private companies and citizens of the countries we serve.