Help for Projects in Developing Countries
The World Bank is moving to make more useful and accessible a “partial risk guarantee program” under which it stands behind foreign government undertakings to sponsors of private infrastructure projects. The program is an additional tool for financing projects in developing countries.
A core question for project developers and lenders has been how to take government undertakings seriously when developing and financing infrastructure projects.
The project’s economics may depend on the host government standing behind the terms of the concession, an offtake agreement, or an agreement to supply fuel or build related facilities. The host government may have agreed to guarantee performance or payment by offtakers or suppliers whose own credit ratings are too weak to support adequately the financing. The risk of nonperformance of government obligations has become an ever greater challenge with the increasing number of projects that have suffered government defaults.
Unfortunately, the prospective host government is likely to lack a track record of performing such obligations if only because infrastructure project structures are relatively novel. The governments themselves may be relatively young, particularly in the former Soviet Union. The term of the debt supporting many important emerging market projects very likely exceeds the prospective terms in office of the specific individuals who signed the various governmental undertakings upon which the project’s economics are based. Thus arises the difficulty in taking host government promises seriously.
This is where the World Bank partial risk guarantee could come to the rescue. Under its charter, the World Bank can only lend to governments or under a sovereign guaranty. Thus, where governments are trying to keep the project financing off the public balance sheet, the utility of the bank’s core sovereign lending program is limited.
The World Bank decided more than a decade ago that it could guarantee commercial loans to a private project against the specific risk that the host government might fail to perform its contractual undertakings in favor of the project.
The World Bank can make that guarantee — not withstanding its charter — if the World Bank can get a backup agreement with the host country in which that government promises to reimburse the World Bank for any amount that the World Bank must pay out as a consequence of the government’s breach of its promises to the project. This gives the World Bank the financial recourse to the host government required by the bank’s charter.
While the conventional expropriation coverage that is typically available from political risk insurers envisions the insured project as being a business apart from the government, the partial risk guaranty was invented with public-private joint ventures in mind. As such, these guarantees — which have now been offered by, besides the World Bank, also the Inter-American Development Bank, the European Bank for Reconstruction and Development and the Asian Development Bank — fill a large hole in the fabric of effective project risk mitigation that was created by the past decade’s proliferation of public-private partnerships.
Although partial risk guarantees have been an exciting development in theory, their actual track record has been limited. At the World Bank, this has been the case for two principal reasons. First, until recently they have only been offered as a source of project support “of last resort.” The bank has encouraged potential applicants first to seek debt financing from the International Finance Corporation (better known by its acronym “IFC”) and conventional political risk insurance from the World Bank Group’s Multilateral Investment Guarantee Agency (called “MIGA”). Only if such support was determined to be unavailable, and only if the project complied with a number of World Bank policies, would an application for a partial risk guarantee have any prospect of receiving serious attention.
The very value in the partial risk guarantee lies in the fact that the World Bank Group’s more conventional investment support programs through the IFC and MIGA typically fail to address the risk of sovereign breach of contract. MIGA’s breach of contract coverage, patterned after similar coverage available through the Overseas Private Investment Corporation, is restricted to standing behind arbitral awards. If, for instance, a host government is not willing to submit to arbitration in a foreign tribunal (and some constitutions prohibit their doing so), then MIGA coverage is unlikely to be of much help.
Similarly, the IFC, as a project lender, is subject to, and possibly deterred by, the very risks of governmental breach that the partial risk guarantee program addresses. Consequently, these three branches of the World Bank Group offer private investment support that is mutually complementary. The World Bank’s practice over the past decade of treating them as substitutes rather than complements has limited the impact of the partial risk guarantee program.
A second factor stunting demand for partial risk guarantees has been their accounting treatment within the World Bank. The full face amount of a partial risk guarantee has typically been counted against a country’s borrowing limit. Thus, if a host government accepts a $100 million partial risk guarantee, it receives no cash, only enhanced credibility permitting the privately-sponsored project to go forward. The host government’s ability to borrow from the World Bank for public sector purposes — for example, for schools and roads — is reduced by the full $100 million. Consequently, the partial risk guarantees have been favored in countries where World Bank borrowing has been beneath the ceiling. This has rendered the program substantially useless for the poorest countries that generally borrow to their limits and are often unwilling to assign, in effect, a portion of their credit limit to the private sector.
In recent weeks, the World Bank has taken steps to improve the partial risk guarantee program.
First, project sponsors (or lenders or host governments) can now approach the World Bank directly (without prior approaches to MIGA or IFC) for an initial expression of the bank’s interest in supporting a project. The bank promises a response within 10 days.
Second, going forward, guarantees will be available to support equity as well as debt investors. This is a structural innovation rather than a formal change to the program. Equity will get the benefit of the partial risk guaranty through a letter of credit that will be posted to guarantee performance of the host government’s obligations. If the government breaches its undertakings, the letter of credit is drawn and is reimbursed by the World Bank, which then has recourse against the government. The beneficiary of the letter of credit can be either a debt or equity investor. Whether the investor can have direct recourse to the World Bank in the event the letter of credit provider defaults is, apparently, still open to negotiation. No deals have been closed under this structure, but the first, being offered in support of a major West African project, is in the pipeline.
Third, the World Bank is trying to reduce the credit limit disincentives for host countries to use the partial risk product. For non-IDA countries — the less poor member countries of the World Bank — only 25% (versus the previous 100%) of the amount of a guarantee now counts against a country’s credit limit at the World Bank. Although the impact of a guarantee in reducing borrowing capacity is even more important for the IDA countries — that is, the poorest members — no such change has been adopted yet for them. However, such a change (though perhaps with less than the 75% discount approved for richer countries) was proposed for approval at the bank’s annual meeting in September in Dubai.