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Infrastructure and Fiscal Policy Specific 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 The maintenance dilemma Very Good 100 90 -Filling Cracks Good 80 70 -Geotextile and Strengthening Fair 60 -Reconstruction of the Surface -Reconstruction of the partial base course 50 Poor 40 30 -Complete Reconstruction Very Poor 20 10 0 0 2 4 6 8 10 12 14 16 18 20 22 24 26 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 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… Historic under-pricing Ratio of revenue to costs 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 Telecoms Source: WDR 1994 Gas Power Water Cost recovery: water Median tariff Degree of cost recovery US$/m3 Nil At least some O&M Full O&M and at least some capital HIC 0.96 8% 42% 50% UMIC 0.35 39% 22% 39% LMIC 0.22 37% 41% 22% LIC 0.09 88% 9% 3% Global 0.35 40% 30% 30% Source: Foster & Yepes, forthcoming Cost recovery: electricity Degree of cost recovery Median tariff US$/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% Source: Foster & Yepes, forthcoming Who really gets the subsidy? government subsidy inefficiency UTILITY tariffs below cost inadequate quality of service utility workers customers coping costs alternative providers 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 subsidies Electricity 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 Tot al energy and t ransport subsidies ($m) Argentina: exploding funds 2000 Special Funds Transport 1800 1600 1400 Special Funds Energy 1200 1000 800 National Budget Transport 600 400 200 0 1999 2000 Source: Argentina PER, 2003 2001 2002 2003 National Budget Energy Argentina: weak governance International best practice Argentina transport fund Legal basis Established by law Established and modified by decree Governance Autonomous userrepresented board Controlled directly by Min Econ Accountability Published accounts, audits Internal public sector controls Resource allocation Under continual modification Transparent, stable guidelines 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 Contribution to public surplus/deficit (% GDP) -0.1 -0.2 -0.3 Source: REDI Colombia, 2004 Ecopetrol ISAGEN ISA EPM ESSA Huila Corelca Telecom ETB Emcali Colombia: drains vs. cash cows 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 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 Ecuador Colombia Brazil Mexico Bolivia Chile Peru Argentina Venezuela 0% 20% 40% 60% Private investment as % total Source: Calderon, Easterly and Serven, 2003 80% 100% Private investment as percentage total LAC: private relative to total 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Telecom Power Transport Source: Calderon, Easterly and Serven, 2003 Water Colombia: new policy after $4.4 Bn bailouts New policy guidelines on risk allocation between public and private partners Mandatory estimation of contingent liabilities using Monte Carlo (continuously updated) Required payments to cover liability are ‘smoothed out’ into a Deposit Plan Deposits are made from budget to Contingency Fund in individual accounts Aggregate estimates reported annually to parliament (infrastructure >0.5% GDP) IV. Budgetary mechanisms Budgetary challenges Project selectiondeficiencies in technical capacity for project evaluation, plus political attraction of ‘white elephants’ Multi-year planninglong term projects required multi-year budget envelope to assure execution Implementation bottleneckscomplex procurement plus unforeseen delays [cash budgeting!] make it difficult to execute budget Peru: project selection SNIP Coverage MinFin unit does (pre-)feasibility studies CBA methodology with min. IRR 14% Declares viability without prioritization 2/3 of projects with regulated exceptions Smaller local projects with domestic financing Projects supported by Supreme Decree Too many projects leads to budget constraints, delays and declining IRRs Inversion de INVIAS (US$m) Colombia: low execution 1200 1000 Aprobacion inicial 800 600 Aprobacion final 400 200 0 9 5 99 6 99 7 99 8 99 9 00 0 00 1 00 2 00 3 9 1 1 1 1 1 2 2 2 2 Ejecucion final 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