Infrastructure Gaps and Private Sector Participation in Latin America and the Caribbean

By Luis Alberto Moreno, President, Inter-American Development Bank, Washington DC

The gap between infrastructure needs and actual investment continues to widen in Latin America and the Caribbean ("LAC") region. Although the coverage and quality of most infrastructure services have improved in the last decades, key gaps remain. For example, LAC has fallen behind the middle-income country average with respect to coverage levels of several infrastructure categories (e.g. electricity, transportation, communications). While current levels of annual investment in infrastructure are around 2.5% of GDP, it is estimated that the region needs to invest 4%-6% of GDP for the next 20 years to achieve demand growth and maintain existing services. Quality also lags behind that of competitors: recent studies show that public infrastructure in the region is 26% less effective than that of industrial countries due to poor quality. From the investors’ viewpoint, most countries in LAC are ranked low in competitiveness indices owing largely to their poor infrastructure.

Large disparities within the region also prevail. While some countries display service levels closer to those of OECD countries (e.g. Chile), others are closer to less developed countries (e.g. Bolivia, Paraguay, Guyana). There are also differences between rural and urban coverage within countries (e.g. in Colombia, one-third of the rural population does not have ready access to the road network, and the average rural household lives 2.5 kilometres from an all-season road). Coverage and quality are also deficient in poor urban areas, which tend to be highly populated but lack basic services.

Private sector investment in infrastructure can ameliorate the gap in service needs, both in scope and in quality. Governments have experimented with a myriad of modalities of private sector participation in the provision of infrastructure services, such as: (a) concessions for the use of public assets (e.g. airports, water companies), public resources (e.g. water for hydroelectric power generation, steam for geothermal power generation) or public assets (e.g. roads); (b) privatization of public utilities (e.g. electricity, telecommunications); and (c) various contractual arrangements for service provision involving the public sector, such as build-operate-transfer contracts (e.g. power), independent producer agreements (e.g. water treatment, power generation), tolling arrangements (e.g. co-generation) and service contracts (e.g. gas pipelines, roads), and various forms of public-private partnerships ("PPPs").

The track record of such experiments has varied by country and by sector: telecommunications has been the most successful sector in virtually all countries, whereas water and sanitation has been the most limited sector, in both scope and performance, in all countries. The power sector has also been successful in attracting significant amounts of private investment in many countries (e.g. Chile, Mexico, Brazil, Colombia), whereas opportunities in road concessions have been increasing (e.g. Costa Rica, Brazil).

There are two key factors underlying the successful track record of certain sectors in attracting private investment, relative to others: the political decision to allow for private investment in the sector, and the stability (more than the adequacy) of the underlying regulatory framework. The first one is key because the bulk of private infrastructure projects tend to be originated by national governments (federal, state and/or municipal), either directly, such as through an outright privatization of public assets, or indirectly, such as through a concession; in other words, governments are the main "creators" of private investment opportunities in infrastructure.

The second key factor for attracting private investment in infrastructure is a stable regulatory framework for private participation. The Inter-American Development Bank’s experience in financing private infrastructure projects has shown that, subject to a minimum threshold (which is met in most cases), the stability of a given regulatory framework, more than its specific design features and hence of its bankability (and sometimes irrespective of the latter) determines the prospects for attracting private investment from the viewpoint of both investors and lenders. This is because, in general, deficiencies in the particular contractual arrangements (e.g. concessions, power purchase agreements, service provision agreements or any other form of private participation), particularly from the viewpoint of lenders, can be addressed through the structuring of the financing. For example, sponsor support and reserve accounts can address deficiencies in contractual provisions related to, for instance, termination provisions, tariff indexation and payment obligations by a public entity.

The above factors are necessary but not sufficient to ensure a sustained increase in private investment to help bridge the infrastructure gap. One key constraint to bringing projects to fruition, particularly the larger ones, is the lack of funds for undertaking basic feasibility studies (e.g. technical, environmental, financial or legal). The IDB has been supporting LAC governments in getting their projects "out of the paper" (and thus financed and implemented) through its many technical assistance funds for project preparation. Additionally, certain types of projects may require innovative PPP schemes to ensure their commercial viability for private investors while maintaining the cost of service provision at a reasonable level.

Government guarantees may also be necessary to enhance private participation, particularly in PPP schemes: one example is Brazil’s federal government’s guarantee fund for PPP projects, which backstops the government’s obligations vis-à-vis private investors in these types of projects. Another useful role of government guarantees is their use as financial instruments, e.g. covering project completion and the start of operation and thus assuming certain risks that it is most suited to address: upon project completion, the guarantee terminates and the fully operational, revenue-generating project is sold to a private investor. This structure will allow governments to jump-start many projects in which full blown concessions may be costly and/or not readily viable. Guarantees against political risks can also be instrumental in providing the necessary comfort for both investors and lenders.

However, even taking into account the potentially ample room for private participation in infrastructure investments, the bulk of such investments in the medium term will come from the public sector (historically private investment in infrastructure has accounted for less than 10% of total investment). This will require that governments and international financial institutions work together to produce, within a stable macroeconomic framework, the fiscal resources and/or indebtedness capacity needed to fund such investments, including (if applicable) their contribution to PPP schemes (e.g. lump-sum payments, revenue guarantees).

In sum, breaching the infrastructure gap will require that: (a) governments continue to support the bulk of necessary investments, which in turn requires the effective management of key macroeconomic parameters with a view to having available either fiscal resources or access to credit to fund such investments; (b) new investments be focused on key bottlenecks that affect both the country’s competitiveness position (e.g. the cost of power, deficiencies in transportation systems) and its social goals (e.g. universal coverage of water services); and (c) governments create opportunities for private sector investment by allowing its increased participation in infrastructure service provision within a regulatory framework that, if not ideal, is at least stable in the medium term.