2008 global financial crisis, vulture funds and poor public sector governance ccseas paper...

8/7/2019 2008 Global Financial Crisis, Vulture Funds and Poor Public Sector Governance CCSEAS paper SUMMARIZED

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1. State of Infrastructure Development in the Philippines1. State of Infrastructure Development in the Philippines



State of Investment in Infrastructure Development

1. Underperformance of the Public Sector in Infrastructure Investment

Public sectors around the world, for so long under performers in infrastructure, will prime the pump by takingleadership - selection, design, financing, operation & maintenance - of infrastructure projects.

2. Public and Private Sector Infrastructure Investment has been low over the last 10years

Throughout the world Public and Private Sector infrastructure investment never exceeded 2.0% of GDP, and waspersistently well under this figure in many countries.

3. Sustained Demand for Market Driven Projects

There are infrastructure project that combines market driven characteristics, and high prices, job creation and longterm national competitiveness (power generation, distribution and telecommunication0

4. Desire of of Bilateral/Multilateral Financing institutions and BRIC ODA Donors toIncrease their Relevance to the Development of Emerging Countries After 2008

Global Financial Crisis

The World Bank, the Asian Development Bank, as well as regional development banks (CAF, Islamic DevelopmentBank, etc.) could easily pump $200 billion per year into new infrastructure projects -- their capitalrequirements would have to be addressed, in extraordinary session, something easily arranged.

National development banks (BNDES in Brazil, the China Development Bank, Vnescheconombank in Russia) or BRIC could easily invest another $200 billion. These monies, under the right conditions, would begin to bedisbursed immediately, and would be - again under the right conditions - fully disbursed within 12 months.



Infrastructure Expenditure in the Philippines

Public sector spending on infrastructure in

the Philippines has been between 2% to 3%of GDP in the last 10 years. While Thailandspends 5% to 6%, Vietnam 10% and China7% to 8% of GDP on infrastructure. WBprescribes a 7% of GDP for infrastructuredevelopment.

The ideal Fiscal Deficit to GDP ratio isprescribed by the ADB to be no more

than 2.5% of GDP. In the aftermath of therecent Typhoon Ondoy deficit spending inthe Philippines has risen to 3.9% of GDP

The ideal Debt to GDP ratio is prescribedby the WB to be no ore than 40% of GDP.Debt levels is 53.3% of GDP

The underinvestment in infrastructure, limits

to deficit spending, limits to debt spendingand gap between supply and demand for infrastructure is an opportunity where thepublic and private sector can worktogether develop particularly marketdriven infrastructure projects.



State of Development of Metro Manila Urban Rail System

Market Driven Projects

MRT3: Completed on time and within budget butsubjected to tariff rate setting, appropriation,contract enforcement risks

MRT4: (French Proponent) project development startedin 1998 and subjected to overlapping coverage of project

LRT1 South Extension: (Canadian Proponent)project development subject to contractenforcement risks and good governance risks

Market Driven Project overtaken by ODA Financing LRT1: maintenance risk LRT2 cost overrun of 100%, market demand as over

estimated and maintenance risks NorthRail South Rail Linkage: cost overrun, design and

good governance risks (incompatible gauge system withNorthRail and SouthRail)

SouthRail: good governance risks

Non-market Driven Project North Rail: design risks (narrow gauge to standard

gauge), cost overrun (US$ 600m to US$1.2b) and goodgovernance risks

Part 3 of 5 parts13/28



2. 2008 Financial Crisis: Its Effect on Sources of Financing for 2. 2008 Financial Crisis: Its Effect on Sources of Financing for Urban Rail DevelopmentUrban Rail Development



Limits to Effect of 2008 Global Financial Crisis on SE Asian Countries

Epicentre of the crisis is in developed countries. The crisis is unlike many of the previousfinancial crises in that it comes as an exogenous shock and not because of inappropriate domestic policies, asin the past.

Banks in developing-country have not been directly impacted as badly. Mostdeveloping-country banks were only marginally exposed to the US subprime crisis, so that a direct impact ontheir banking systems has been largely avoided.

Evidence of a measure of decoupling of growth rates in recent years. Te Velde

(2008) and Lin (2008), for instance, show that in the case of Africa and developing countries as a group,economic growth rates have decoupled from those of the richer countries from the early 1990s.

Both developed and developing countries have introduced significantcountercyclical fiscal expansion packages. Barack Obama, as US President, proposed a fiscalstimulus package intended to create 2.5 mill ion jobs mainly through public infrastructure investment.

In Europe, the European Commission (EC 2008) urged a Euro 200 billion fiscal stimulus plan, and emphasized the importance of improving Europe¶s competitiveness through encouraging employment security and entrepreneurship.

In Asia the financial crisis is a crisis of confidence rather than an actualcrisis also has significant implications for financial supervision andregulation even in the short run. In particular, regulatory authorities should proactively encourage financialinstitutions to fully disclose their exposure to and losses from the subprime crisis, perhaps through the threat of punitive penalties for inadequate disclosure.

The US Financial Crisis, Global Financial Turmoil, and Developing Asia: Is the Era of High Growth at an End?, William E. James, Donghyun Park,Shikha Jha, Juthathip Jongwanich, Akiko Terada-Hagiwara, and Lea Sumulong, No. 139 December 2008, ADB



Sovereign Debt and Interest Rates in Asia and the Philippines

Only sovereigns and the highest-rated

companies are able to access the debtmarket. For example, ONLY thePhilippines, Indonesia, and Korea havesuccessfully issued sovereign bonds,and Australian and New Zealand bankshave issued government-guaranteedbonds.

Based on the outlook of the Philippines,BSP¶s reported that RP bond spreaddecreased from 528bp in 4th qtr 2008 to473 bp 1st qtr 2009 (JP Morgan¶s EMBI)

Sovereign Spreads

LIBOR historical data



Rising Trend in PrivateRising Trend in Private--Public Sector Equity InvestmentPublic Sector Equity Investment

Prominence of dual firms; these are quasi-government, quasi-private firms that have grownout of stalled reform processes and that own andoperate infrastructure (Woodhouse, 2005). Inseveral markets, dual firms have been able toacquire assets at low prices after internationalinvestors have lost money and pulled out.

Rise of BR IC country export import banks. Thisrefers to public financial institutions situated in theBRIC countries that are rapidly expanding their

trade and investment promotion functions (Caspary,2007).

Rise of Petrodollars: as a result of supply-demandimbalances, national oil companies and sovereignwealth funds have become key investors in energyinfrastructure and ancillary infrastructure along theextraction supply chain.

³Looking outside ASEAN´ is apparent ASEA ASEANmarkets have developed stronger financial ties withthe advanced markets in Western Europe and in theUS rather than strong links within the region.

Reduction of global private sector investmentby 82% and the focus in Asia will force countrieslike the Philippines to calibrate its macro-economicpolicies and good governance track record to attractthe cherry picking private sector investors ininfrastructure development.



3. Vulture Funds and Poor Public Sector Governance: Its Effect on3. Vulture Funds and Poor Public Sector Governance: Its Effect onUrban Rail ProjectsUrban Rail Projects



Lessons in Issuing MRT linked Securitized Paper and Entry of Adverse Private Sector Investors (Vulture Funds)

In Peru, a vulture fund company bought distressed

sovereign backed papers and proceeded to collect the fullface value plus interest after winning in court as a holdoutcreditor.

It blocked the restructuring of Peru¶s debt and causingthe collapse of the Government. The same strategy wasapplied in Argentina, Congo and in the Philippines.

Amounts awarded to Vulture Funds Amounts awarded to Vulture Funds varies from 1 to 6varies from 1 to 6

times the original value of the debt.times the original value of the debt. The average hasThe average hasbeen 2.2 times the original value.been 2.2 times the original value.

MRT3 Shareholders securitized its US4 1.9 billion incomefrom the government and sold the paper in the bond market.

Delayed payment from 2000 to 2005 rated the MRT3securitization papers as distressed papers

In late 2006, a vulture fund company, was able to buy at adeep discount the MRT3 bonds and issued a notice of anevent of default which forced the Philippine government tobuy back the MRT3 papers above the Net present value of the US$ 1.9 billion guaranteed income.



Lesson learned in Chinese ODA FinancingLesson learned in Chinese ODA Financingfor an Urban Rail Projectfor an Urban Rail Project

Mingling of foreign policy with international aidMingling of foreign policy with international aid

US Foreign Policy and BRIC ODA financing in theUS Foreign Policy and BRIC ODA financing in the ASEAN ASEAN

U.S. concern is the growing influence of China in SE Asia. Beijing aims to reclaim its position as the leader of SE Asia.

China has already displaced Japan and the UnitedStates among SE Asian nations as their primary tradingpartner and an increasing source of economic

assistance.

It also has pursued a ³charm offensive´ that appears tobe winning the ³hearts and minds´ of many people in thecountries there.

The danger exists from US perspective is when Chinacomes to dominate regional institutions in East Asia, itcould steer them down a path inimical to U.S. interests,much as Beijing has already done with the ShanghaiCooperation Organization.

Chinese Foreign Policy and ODA Financing

Economic security refers to a country¶s global economiccompetitiveness; its capacity to resist disruptions to,threats to, and invasion of its economy; and thedomestic and international environments enabling acountry¶s economy to survive and grow continuously(Zhao Ying, et al, 1994:3).

Chinese ODA Financing in the Philippines has not

been positive due to the following experiences

1. US$ 360.0 million ZTE Project was cancelled due to lackof overpricing (US$ 135 million) and transparency insolicitation of bids

2. North Luzon Railways Project

After drawing the full amount of US$ 600.million, theproject cost has been adjusted to US$ 1.0 billion with

no visible project accomplishment (narrow gaugecommuter rail service)

Revised scope of work to include only civil works andexcludes mechanical-electrical systems. Project cost isestimated to be a total of art least US$ 2.0 billion

This is now more expensive than a Spanish ODAProject Cost of US$ 1.5 billion for ahigh speed railservice project in 1998.



Others Lessons Learned in PPP/BOT and ODA FinancedRail Transit Projects in Metro Manila to Manage Fiscal Deficit

Public Sector Risks Tariff rate setting risk is high Cost overrun of the project is consistent to WB estimate of Cost overrun of the project is consistent to WB estimate of 50% to 70 % time overrun50% to 70 % time overrun

and 20% to 50% cost overrun for publicly administered projects (Klien, M, So, J, Shin B; and 20% to 50% cost overrun for publicly administered projects (Klien, M, So, J, Shin B; World Bank Viewpoint; 1996) (LRT2 ODA financed project)World Bank Viewpoint; 1996) (LRT2 ODA financed project)

100% FX movement due 1998 Asian Crisis was burdened public sector subsidy (100% FX movement due 1998 Asian Crisis was burdened public sector subsidy (MRT3MRT3PPP/BOT financed project)PPP/BOT financed project)

Creeping Public Sector expropriation of PPP/BOT projects has proven to be a disincentive

for foreign investment in PPP/BOT rail projects in the Philippines since the start of theadministration of the current administration..

Private Sector Risks Contract rights enforcement: i.e. payment and arbitrary expropriation. (MRT3 BOT financed

project, LRT1 South Extension and NAIA Terminal 3)

Annual budgetary appropriation for shortfall in Farebox Revenue (MRT3 (BOT Project)

Entry of hostile Vulture Funds with acquisition of Privately issued MRT3 NotesEntry of hostile Vulture Funds with acquisition of Privately issued MRT3 Notes (Disrupted(Disruptednegotiation to discount Equity Rental Fee Repayment)negotiation to discount Equity Rental Fee Repayment)



4. Recommendations for Undertaking Urban Rail Development



Policy Recommendations to Expand Private Sector Investmentand Mitigate Default Risks from Vulture Funds

Private Sector Investment in UrbanRail Development

Regulate the growth of Dual Firms so that itdoes not crowd out Private Sector participation in market driven projects andpromote Dual Firms in Non-Market DrivenProjects

Monitor the entry of Sovereign WealthFunds from the point of view of Vulture FundHoldout provisions to promote medium tolong term investment outlooks

Encourage multilateral investments inprivate equity funds for infrastructureinvestment and development.

Seek enforcement of international treatiesregarding anti money laundering with other countries to further erode the sources of graft in BOT/PPP projects.

Legal Framework to MitigateInvestment Holdout Risks from VultureFunds

Use English Laws instead of the New Yorklaws to eliminate the use of a unanimousvote to change an investment bond¶s (withsovereign guarantees) financial terms whichmakes restructuring more difficult with

holdout creditors like Vulture Funds.

The absence of majority restructuringprovisions in many investment bonds(with sovereign guarantees) makes holdout strategies usually by vulture funds aviable option to maximize returns.



Recommendations to Equalizethe Advantages of OECD and BRIC ODA Financing

Harmonize ODA Guidelines ( CI RR rates and Tenors) between DAC and BRIC Donor Countriesto promote competition and transparency in ODA financing

Harmonize Washington Consensus (free market) and National Industrial Development (regulatedmarket) development policies to strike a balance in the prioritization and segregation of marketdriven and non-market driven projects for ODA financing.

Strike a balance governance philosophy of between DAC Donor Countries of liberty and justiceand Asian governance of harmony and stability (Elloit, Micheal, Into the Unknown, Time,

8/10/2009)

DAC and BRIC Donor Countries should promote sustainable ODA Debt Levels

Focus ODA Loan Projects to Non-Market Driven Projects



Future Role of Multilateral Institutions in ODA Financing

Champion Regional Infrastructure

Projects to Strengthen Regional Tradeand Logistics. Public sector should takeadvantage of matching non-market driven railprojects that would support the objectives of the ADB.

Champion Public-Private InterfaceManagement. Role as a buffer between thepublic and private sectors. Their involvementin a transaction can help to keep host

governments from abusing their powers andcan keep private sector participation fromcherry picking plum projects.

Strengthening Transparent Legal andRegulatory Environments. Help countriescreate enabling environments, implementreforms and create more transparent legalsystems that promote private sector

development.

Lifelines in Times of Crisis. Assistancefrom the multilateral lending institutions hasbeen vital during times of economic crisiswhen other sources of financing becomeunavailable. They will continue to play afundamental role in this area in the future.

Proposed Regional Infrastructure, Trade and LogisticsDevelopment Framework by the ADB

2008 global financial crisis, vulture funds and poor public sector governance ccseas paper...

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