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A3.3 Financing options II: Loans and equity

Characteristics

Grants and internal sources (A3.2) can be supplemented by borrowing and the injection of equity capital. In the long run, both these types of finance have to be repaid or reimbursed from the cash flow from water sales, so should not be regarded as additional sources.

Some of the larger and middle-income developing countries have large and well-developed local capital markets that can provide the required amounts of loan capital for water. In other cases, foreign borrowing is subject to macroeconomic constraints on the size of public debt, reinforced by IMF pressure, which severely limit the amount of foreign borrowing by poor and highly-indebted countries. The offer of public guarantees, e.g. for foreign exchange risk, represents a contingent liability which effectively raises public debt (though these liabilities are not always reflected in budgets).

Loans should be tailored to the cash flow profile of the investment, and match the offshore/local content of the project. The main sources are:

  • Long-term loans from multilateral agencies (World Bank, regional development banks, European Investment Bank, etc);
  • Guarantee facilities from the above agencies and governments which improve the terms and conditions on which local loans can be raised;
  • Export credit, usually officially guaranteed by the exporting country, subject to the OECD Consensus rules;
  • Loans on commercial terms from local banks (normally for no more than five years) and international banks (sometimes longer-term if enhanced by guarantees of various kinds);
  • Bonds raised locally or overseas, by central and less often municipal governments, requiring public.

Equity capital can also be raised by private companies, joint ventures, or utilities with a corporate structure. Equity sources include:

  • Private international companies, e.g. in concessions, asset transfers, joint operating ventures, etc.;
  • Purchase of shares by specialised water and environmental investment funds, usually requiring a rate of return;
  • Local institutions, e.g. commercial & development banks, pension funds;
  • International and bilateral investment agencies, e.g. International Finance Corporation (IFC), Commonwealth Development Corporation (CDC), European Bank for Reconstruction and Development (EBRD).

Lessons learned

  • Since water revenues arise in local currencies, it is prudent to raise money locally where possible, to avoid a foreign exchange risk.
  • There has been little international commercial bank finance for the water sector; project finance for water has been meagre, partly due to high fixed costs relative to the size of the deal.
  • Many of the recent high-profile private international water projects have been problematic, due in particular to foreign exchange risks. These risks are underlined by recent international financial troubles.
  • Equity investment is a high-cost source of finance. It is flexible in the short term and a buffer for loans, but shareholders demand market rates of return.
  • The development of local capital markets are crucial to water finance in the long term.
  • Political and regulatory risks are problems in addition to exchange risk. Counter-guarantees between multilateral agencies, central governments and municipalities can help to address this.



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