Lessons of Experience No. 7: Project Finance in Developing Countries

As the experience of the crisis has demonstrated, individual projects are not a substitute for economy-wide regulatory reform designed to improve competitiveness and efficiency, or for the development of local financial markets in support of local investment

Meant for a wider audience, this volume describes the essentials and complexities of project structuring. A primary message is the importance of clearly identifying and addressing project risks up-front and the potential costs of complacency in dealing with foreign exchange or market demand risks.

In the past twenty years there has been a new wave of global interest in project finance as a tool for economic investment. Thus the technique is able to alleviate investment risk and raise finance at a relatively low cost, to the benefit of sponsor and investor alike. Though project finance has been in use for hundreds of years, primarily in mining and natural resource projects, its other possible applications-especially for financing large greenfield projects (new projects without any prior track record or operating history)-have only recently received serious attention. This is particularly so in developing markets, but here its application is also broadening, as illustrated by the following examples of IFC-supported projects:

  • In Argentina, in 1993, project finance structuring helped raise US$329 million to finance investment in the rehabilitation and expansion of Buenos Aires’ water and sewerage services based on a new 30-year concession awarded to Aguas Argentinas. The investment, financed with IFC support, has helped improve water quality and service to a city of more than 6 million people. At that time, private sector participation in a water concession in a developing country was an untested idea, and there was virtually no precedent for a private company operating in such an environment raising substantial resources in international capital markets.
  • In Hungary, in 1994, project finance structuring helped finance a 15-year concession to develop, install, and operate a nationwide digital cellular network. The $185 million joint venture project was an important part of the government’s privatization and liberalization program. Because of difficulty attracting commercial financing at that time, the project relied heavily on $109 million in debt and equity financing from IFC and the U.S. Overseas Private Investment Corporation (OPIC).
  • In China, in 1997, Plantation Timber Products (Hubei) Ltd. launched a $57 million greenfield project to install modern medium-density fiberboard plants in interior China, using timber plantations developed over the past decade, to support China’s fast-growing construction industry. As part of the limited-recourse financing for the project, IFC helped arrange $26 million in syndicated loans, at a time when foreign commercial banks remained cautious about project financing in China’s interior provinces.
  • In Mozambique, in 1998, project finance structuring helped establish a $1.3 billion greenfield aluminum smelter. Mozal, the largest private sector project in the country to date, is expected to generate significant benefits in employment, export earnings, and infrastructure development. IFC fostered the project by serving as legal coordinator and preparing an independent detailed analysis of economic results and environmental and developmental impacts. IFC also supported the project with $120 million in senior and subordinated loans for its own account.

Project finance helps finance new investment by structuring the financing around the project’s own operating cash flow and assets, without additional sponsor guarantees

In IFC’s experience, however, project finance remains a valuable tool. Although many projects are under serious strain in the aftermath of the East Asia crisis, project finance offers a means for investors, creditors, and other unrelated parties to come together to share the costs, risks, and benefits of new investment in an economically efficient and fair manner. As the emphasis on corporate governance increases, the contractually based approach of project finance can also help ensure greater transparency.

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Despite the 1997– 98 financial crisis, the investment needs in many developing markets clearly remain enormous. Meeting these needs is essential to development, not only in the more traditional sectors such as energy but also in nontraditional areas such as school and hospital construction. For most countries, this will mean a continuing need to rely on private sector expertise and finance to meet demand. Once growth and investment resume, project finance techniques are likely to be an even more important means of sharing risks and of helping these projects get off the ground-particularly in some markets and sectors that may be considered more risky for some time to come. But, in the appropriate framework, project finance can provide a strong and transparent structure for projects, and through careful attention to potential risks it can help increase new investment and improve economic growth.