Infrastructure and Fiscal PolicySpecific Challenges

Marianne Fay

Many thanks to Vivien Foster on whose 2005 PEAM course presentation this is largely based

Outline

Stylized facts Funding sources Budgetary boundaries Budgetary mechanisms

I. Stylized facts

Infrastructure is “big money”

Stocks Equivalent to about 100% of developing

country GDP Dominated by electricity (45-55%), and

transport (30 to 40%) “cheaper” telecom (5-15% and growing) and

W&S (5 to 15%)

Maintenance: About 2 to 3% of GDP per year

Infrastructure is “big money”

Output: About 6% of GDP for electricity (MICs) The same for telecom & transport? Much smaller for W&S

Expensive when poorly managed

Electricity: Total hidden costs (underpricing; technical and

commercial losses) estimated in ECA at 4% of GDP

In Mexico – untargeted subsidies amount to 1% of GDP

Rail and public transport: historically huge drains on public coffers

Water and sanitation: typically much smaller (0.4% of GDP in ECA)

Much of it, public responsibility

Differences across sectors: Fairly universal trend for privatization

of telecom, air transport, possibly rail More varied with electricity, public

transport Limited potential for roads W&S – complicated…

Distinguishing features

Investment Highly capital intensive (60%+) Long term planning horizons (30 yrs) Infrequent lumpy investments Long lead times (Up to 5yrs) Unpredictable investment costs

Distinguishing features

Maintenance Long asset lives (Up to 30 yrs) High maintenance (2-3% AV) Exponential cost of deferred

maintenance Catch-22

Decision to invest based on estimated rate of return, itself conditioned by whether maintenance occurs

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If maintenance on a 20 year road is not done by the end of the 12th year. It starts to deteriorate eight times faster than in the early years

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-Filling Cracks

-Geotextile and Strengthening

-Reconstruction of the Surface-Reconstruction of the partial base course

-Complete Reconstruction

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Lifetime of Pavement (years)

The maintenance dilemma

Fiscal consequences

For all of these reasons, ill-suited to unpredictable annual budgetary cycle

Moreover, particularly vulnerable to budgetary downturns Politically soft target for budget cuts Maintenance less attractive than investment Long lived assets delay hour of reckoning Even investments can always be deferred

The infrastructure public finance paradox

Maintenance and investment are prime candidates for cuts

Subsidies – however poorly targeted - are difficult to eliminate

Some countries spend more on consumption subsidies than on either investment or maintenance…

A complication – no data

No country systematically collects investment data on infrastructure “infrastructure” a broad and vague category –

unlike health and education Poor fit with IMF GFS categories Public investment data notoriously poor – hard

to distinguish from O&M A few valiant efforts (Calderon & Serven;

specific country studies)

The implication – no monitoring

II. Funding sources

Only three possible sources

Tax payers (fiscal transfers) Users:

fees cross-subsidies

Asset depletion: quality non-expansion of service…

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Telecoms Gas Power Water

Ratio of revenue to costs

Source: WDR 1994

Historic under-pricing

Cost recovery: water

Median tariff

US$/m3 Nil At least some O&M

Full O&M and at least some capital

HIC 0.96 8% 42% 50%

UMIC 0.35 39% 22% 39%

LMIC 0.22 37% 41% 22%

LIC 0.09 88% 9% 3%

Global 0.35 40% 30% 30%

Degree of cost recovery

Source: Foster & Yepes, forthcoming

Cost recovery: electricity

Median tariff

US$/kWh Nil At least some O&M

Full O&M and at least

some capital

HIC 0.11 0% 17% 83%

UMIC 0.06 0% 71% 29%

LMIC 0.05 27% 50% 23%

LIC 0.05 31% 44% 25%

Global 0.07 15% 44% 41%

Degree of cost recovery

Source: Foster & Yepes, forthcoming

Who really gets the subsidy?

UTILITY

government subsidy

customersutility workers

alternative providers

inefficiency tariffs below cost

coping costs

inadequate quality of

service

In Hyderabad (India), employees capture 40% of the subsidy, and consumers 60%, half of which they spend on alternative providers

What distributional incidence?Omega indicator Water

subsidiesElectricity subsidies

Other welfare

programs

Consumption based 0.56 0.57 1.00

Geographical targeting 1.07 1.10 1.33

Means testing 1.63 1.28 1.55

Self-selection 1.84 1.89

Source: Komives et al., forthcoming

III. Budgetary Boundaries

Budgetary boundaries

Infrastructure has a tendency to creep off the budget for both good and bad reasons

There are a number of mechanisms through which this takes place Extra-budgetary funds (fuel tax, USL) State Owned Enterprises Public Private Partnerships

Earmarked funds

Loved by sectoralistsprovide a stable source of financing in sectors without possibility of user fees, isolated from budgetary and political interference

Loathed by macroeconomistsreduce budgetary flexibility and optimization of public resources, often lead to poor governance, lack of transparency

Argentina: exploding funds

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Source: Argentina PER, 2003

Argentina: weak governanceInternational best practice

Argentina transport fund

Legal basis Established by law Established and modified by decree

Governance Autonomous user-represented board

Controlled directly by Min Econ

Accountability Published accounts, audits

Internal public sector controls

Resource allocation

Transparent, stable guidelines

Under continual modification

State Owned Enterprises

Often represent a large percentage of public investment in infrastructure

May or may not be consolidated into fiscal accounts

May be net contributors or drains on the public purse

Operate in restricted environments that limit their autonomy and commercial orientation

Management may be guided by macroeconomic concerns

Colombia: drains vs. cash cows

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Source: REDI Colombia, 2004

Public Private Partnerships Potential for PPPs varies substantially across sectors

Key criterion for judging whether extra-budgetary is extent of risk transfer

However, unless 100% risks can be transferred contingent liabilities remain

Complex fiscal accounting issues arise regarding the treatment of Contingent liabilities Private investment Committed future public subsidies

LAC: private relative to total

Source: Calderon, Easterly and Serven, 2003

0% 20% 40% 60% 80% 100%

Venezuela

Argentina

Peru

Chile

Bolivia

Mexico

Brazil

Colombia

Ecuador

Private investment as % total

LAC: private relative to total

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Source: Calderon, Easterly and Serven, 2003

Colombia: new policy after $4.4 Bn bailouts

New policy guidelines on risk allocation between public and private partners

Mandatory estimation of contingent liabilities using Monte Carlo (continuously updated)

Required payments to cover liability are ‘smoothed out’ into a Deposit Plan

Deposits are made from budget to Contingency Fund in individual accounts

Aggregate estimates reported annually to parliament (infrastructure >0.5% GDP)

IV. Budgetary mechanisms

Budgetary challenges

Project selectiondeficiencies in technical capacity for project evaluation, plus political attraction of ‘white elephants’

Multi-year planninglong term projects required multi-year budget envelope to assure execution

Implementation bottleneckscomplex procurement plus unforeseen delays [cash budgeting!] make it difficult to execute budget

Peru: project selection

SNIP MinFin unit does (pre-)feasibility studies CBA methodology with min. IRR 14% Declares viability without prioritization

Coverage 2/3 of projects with regulated exceptions Smaller local projects with domestic financing Projects supported by Supreme Decree

Too many projects leads to budget constraints, delays and declining IRRs

Colombia: low execution

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Conclusions

Cost structure of infrastructure services leads to fiscal complications

Wide variety of potential funding sources for infrastructure

Tendency for infrastructure to be on the boundaries of the budget

Infrastructure poses challenges from a budgetary perspective