FINANCING URBAN INFRASTRUCTURE THROUGH FINANCIAL INTERMEDIARY Taimur Samad Sr. Urban Economist, World Bank Jakarta

Outline Urban Infrastructure Needs and Sources of Finance Intermediation International Experience Country Example – Tamilnadu, India Questions for discussion: Indonesia

I. Urban Infrastructure Needs and Sources of Finances Indonesia has urbanized rapidly and continues to do so. Understanding the dynamics of urbanization is a critical starting point. There was a 39 percent increase in Indonesia’s urban population between 1995 and 2005 (4.2 % per annum), outpacing other East Asian nations. Indonesia has an urban population share of 49 percent in 2010, projected to increase to 68 percent by 2025. In 2010, 74% of total GDP was produced in the cities. Indonesia has yet to achieve the economic returns to urbanization (per 1% urbanization, 2% GDP growth in Indonesia, as compared to 6% for China, 8% for Vietnam and 10% for Thailand).

Urban Infrastructure Needs Limited and poor quality urban infrastructure is a constraint on poverty reduction and growth. In 2009, 50% of urban population has access to safe water Sewerage coverage only exists in 11 cities, with 2% of urban population has access to centralized sanitation system District road length has increased since 2001, but quality has deteriorated On average, subnational government’s investment on capital infrastructure was only 0.72% of GDRP (1997-2009)

Financing Urban Infrastructure Different sources of financing to answer to city’s different infrastructure investment needs Commercial Infrastructure e.g. markets, toll roads, etc. Source: PPP Total urban infrastructure needs Large cities/ provinces with strong finances. Source: Direct Market Borrowing Small, medium and large cities: Larger, multi-year investments, e.g. water, sanitation, solid waste management. Source: Intermediary Small cities, basic services: e.g. internal city roads, parks, street lights, etc. Source: Local Government Budget

II. Intermediation Why intermediation? Huge infrastructure backlog in environment amenities - water, sanitation and solid waste management. Capital intensive and lumpy investments, needing longer term debt so as to address these deficits with scale Difficult to finance through National Government grants/loans Developing Countries – market access may be difficult in the short term Open access, criteria-based lending builds up credit history as and when domestic commercial sources open up Lending through Intermediation reduces transactions costs and allows gradual blending of multilateral credit with domestic sources Why intermediation?

Where We are Today: Global Trends Cities across the developing world are coping with three historical trends: First, globalization, requiring quality infrastructure to attract investment, stimulate growth and employment. Second, decentralization, but often with unfunded mandates and lack of devolved authority to enter into contracts, set rates… Third, the continued growth of urban areas and flow of poor people into slums with limited titles and little access to infrastructure

Key National Decisions If city infrastructure needs debt, who should provide it National governments through multilateral borrowings? Utility companies or parastatals? In case of city governments, what powers facilitate LG borrowing - powers to set rates, enter into contracts, powers to leverage grants? On the supply side, what are the sources of finance and is intermediation necessary? If intermediation, what are the choices: Ownership, Government (US, Europe) Private (INCA, South Africa) Public – Private (TNUDF, India) Security Mechanisms – Escrows, Intercepts, Guarantees

Urban Finance Framework Type 1 – The domestic debt markets are yet to mature and the devolution framework weak – Assist cities in loan-grant blends while improving the devolution system- Nepal , Andhra Pradesh, Bangladesh Type 2 – Debt markets are pre-empted by borrowings from higher levels of government, but devolution more secure-work with domestic financial institutions to lengthen maturities and reduce transaction costs-Vietnam, Philippines Type 3 – Markets begun to mature, and devolution secure, provide instruments to link city financing with domestic markets, especially for small and medium cities- Mexico, South Africa A Suggested Typology

Can We Begin with an Agenda? Given these trends : Need for cities to develop urban infrastructure based on demands and borrowing capacities rather than tied grants. This transformation requires empowerment - authority to raise resources, create and maintain infrastructure and pay for costs over time. Urban reform agenda should include: City level Investment plans with authority to set rates, raise deposits for individual connections such as water and sewerage Stable and predictable devolution so that cities can plan their borrowing Sustainable financial structures which link domestic capital markets with city financing needs.

III. International Experience Traditional Financing: City get debt/grants from governments/government owned financial institutions/Multilaterals on basis of guarantees. Project Implementation by Parastatals/Cities with no clear duties and responsibilities for servicing debt or asset maintenance. User charges rarely covering even O&M. Usually resulting in: Drying up of institutional sources based on state guarantees on account of ceilings on national liabilities. Limited low cost / equity / grant type funds. Little impact on growth or urban poverty.

Recent Innovations – Linking Cities with Domestic Commercial Finance Since the 1990’s innovations for sustainable financing by leveraging domestic capital: Larger cities with medium-term investment plans have repeatedly accessed local markets, establishing a credit relationship with the private sector, but use intermediaries for smaller financings Johannesburg, Ahmedabad, Ho Chi Minh City, Chennai Smaller and medium cities mobilized domestic capital through intermediaries South Africa-INCA; India-TNUDF; Colombia-Findeter Serious efforts to provide a greater domestic market orientation for municipal intermediaries – CAIXA-Brazil, MDFO-Philippines

Lessons Learnt Viable urban financing strategies usually need: Rational and predictable devolution largely formula based as in South Africa, Zambia. Tamilnadu Maharashtra Legal frameworks for borrowing, such as The Municipal Finance Management Act (MFMA) in SA, Urban Local Bodies Act (Tamilnadu), Master Trust Structure (Mexico) Strong domestic financial intermediaries working with cities such as DBSA, INCA in S. Africa, TNUDF in India

Intermediation – Some Examples INCA - South Africa, privately owned, strong legal recourse to courts, faces competition from state owned DBSA FINDETER – Colombia, refinances commercial bank loans, needs to strengthen resource raising LDIF – Vietnam, facility for private sector, unutilized BMDF – Bangladesh, largely grants and not sustainable DFV – Shanghai China, limited by lack of Liscense and bar on municipal lending

IV. Country Example – Tamilnadu, India Municipals subsistence level institutions, headed by bureaucrats dependant on state for capital grants, usually tied. Majority of the debt from State raised on guarantees, debt passed on to municipals but projects executed by parastatals – huge defaults – INR 5000 million had to be written off However since for eight years 1988-96, a Municipal Fund (MUDF) located in government lent to municipals based on principles of open access and clear lending criteria. Lent INR 2000 million with high repayment rates 1996- Government introduced major reforms – rational devolution, elections Also restructured MUDF into a corporate entity TNUDF, in partnership with three major Financial Institutions, with objective of lending and raising resources for municipal infrastructure Pre- and Post- 1996

TNUDF – Lending and Resources Over 380 sub-projects with US$ 500 million in lending Profitable with high (100%) ULB loan repayment till date Raised nearly US$ 140 million in private finance Focus on financial sustainability, entity based appraisals and escrow as securities Transactions: municipal PPPs, first pooled bond issue, capital contributions from beneficiaries, Sewerage DBOTs, etc. TNUDP-III (US $ 300 million) focused on sewerage compared to roads in TNUDP-II (US 60 million)

TNUDF – Enabling Factors Eight years (1988-96) of successful credit history, of lending based on municipal financial operating plans Accompanied by major reforms transferring authority to municipalities and backed by statutory devolutions 15 years of partnering with WB, allowing gradual blending of longer term finance with domestic sources Technical support from WB, DCA

Systematic Access for Small and Medium Cities An example from Tamilnadu Umbrella Credit Enhancements Central Govt Grant Central Govt. Transfer Payments MLA WSPF Reserve Account Revenue Intercept Partial Credit Guarantee Technical Assistance Investors Bonds Trustee Local Govt. Project Funds Market Rate Long term Principal & Interest payments If necessary

Water and Sanitation Pooled Fund: Lessons Learnt What does Commercial Finance Assess? Stable Revenue Streams from devolution and own sources Demand driven Medium term Investment Plan, Commitment by cities to tariff and collections Strength of the Credit Enhancement What do Cities and National Governments Get? Systemic Access to Commercial Finance Leveraging of scarce state grants Maintenance of Assets built into budgets Disclosure of Investments and Pricing The Role of Development Partners The use of a DCA Partial Credit Guarantee as a market making tool

The Pooled Bond The terms of the issue:

The Cities and the Investments

The Investors Water and sanitation pooled fund

Beginnings of a New Market WSPF bonds have created an active secondary market Bonds sold by original holders to mainly private pension

V. Questions and Discussions Indonesian context Com Bank Approach or Capital Market? Ownership – Government, Private or PPP? Loans and Grants: Tied or Untied?

Capital, Assets, Management Capitalization – Existing loan assets or Greenfield? Lending Policies, Pricing and Security Management Partnerships with Multilaterals – Integrate in the new line of credit?

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