41701 noTE no. 26 ­ Aug. 2007GRIDLINES Sharing knowledge, experiences, and innovations in public-private partnerships in infrastructure Private participation in infrastructure in Europe and Central Asia A look at recent trends Maria Vagliasindi and Ada Karina Izaguirre E astern Europe and Central Asia is attract- because it was driven mainly by five projects of ing more investment to infrastructure proj- more than US$1 billion each (the Turk Telekom ects with private participation than any and Slovenske Elektrarne divestitures, the Buda- other developing region except Latin America. pest airport concession, the Ataturk airport lease, Members of the European Union (EU) and coun- and the greenfield Maritza East I power plant tries seeking membership account for most of the in Bulgaria), together accounting for 40 percent investment. The Russian Federation is emerging of investment. Second, additional investment in as a leader both in attracting private activity and projects implemented in previous years accounted in sponsoring projects in neighboring countries. for 46 percent of that year's investment. Telecommunications and energy are the lead- ing sectors. But new regulatory challenges are The process of accession to the EU has been a key emerging as a result of exclusivity periods in tele- driver of regulatory and market structure reforms communications and greater market concentra- facilitating private participation in infrastruc- tion and vertical reintegration in energy. ture. Countries that joined the EU in July 2004 accounted for 50 percent of the investment and Investment commitments to infrastructure more than 30 percent of the projects in the region projects with private participation (hereafter, in 1990­2005.3 Bulgaria and Romania (which investment) in Eastern Europe and Central Asia joined the EU in 2007), along with Croatia and amounted to US$35 billion in 2005.1 That was Turkey (which gained EU candidate status in more than twice the average for the previous four 2004), attracted 25 percent of the investment years and the highest in 1990­2005 (figure 1).2 and 10 percent of the projects. The remain- The growth was driven by payments to govern- ing countries in Southern and Eastern Europe ments, with divestiture revenues and license and claimed 3 percent of both. And the countries of concession fees amounting to US$18 billion. the Commonwealth of Independent States (CIS) accounted for almost 60 percent of the projects Due to this growth and to declining investment but only 20 percent of the investment. Russia in other developing regions, Eastern Europe and attracted most of this activity. Central Asia ranked second in investment after Latin America in 2001­05, accounting for 27 percent of the total in developing countries. As a share of regional GDP, investment grew from 0.8 Maria Vagliasindi is a senior economist and Ada Karina percent in 2003­04 to 1.6 percent in 2005. Izaguirre is an infrastructure specialist in the Bank's Finance, Economics, and Urban Development Department. Twenty-nine projects reached financial closure This note is a product of the Private Participation in Infra- in 2005, just three more than the average for structure (PPI) Project Database, a joint initiative of PPIAF the previous four years. Two factors explain the and the Finance, Economics, and Urban Development divergence in trends between investment and PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY Department in the World Bank's Sustainable Development transactions. First, growth in 2005 was unusual Vice Presidency. (see www.ppiaf.org) Helping to eliminate poverty and achieve sustainable development through public-private partnerships in infrastructure PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY most CIS countries, including those that have not figure 1 privatized their dominant operator. A surge in investment in 2005 Private participation in infrastructure in Eastern Europe Since 2000 many countries divesting public tele- and Central Asia, 1995­2005 communications operators have chosen other Investment commitments options. The privatization of the Bulgarian Tele- (2005 US$ billion) Projects communications Company, for example, included 40 80 new mobile licenses. 35 70 30 60 Private activity in energy expanded 25 50 Energy lagged behind telecommunications, 20 40 accounting for 23 percent of regional investment 15 30 in 2001­05, 2 percentage points less than in the 10 20 1990s. But the sector's share of projects grew by 5 10 13 percentage points, to 50 percent in 2001­05. 0 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Activity in 2001­05 was distributed across the Investment in physical assets main business lines. Of the 65 energy transac- Payments to governments tions closed, 26 involved independent power Projects producers, 22 electricity distribution companies, Source: World Bank and PPIAF, PPI Project Database. 15 natural gas distribution companies, and the Note: Investment data are for projects reaching financial closure in 1990­2005. other 2 transmission assets in electricity or gas. Private activity in the sector expanded to six new countries (Azerbaijan, Bosnia and Herzegovina, Telecoms led private activity Bulgaria, the Slovak Republic, Tajikistan, and Ukraine) in 2001­05, bringing the total to 22. Telecommunications accounted for 70 percent of regional investment in the 1990s and in 2001­05. Among developing regions, Eastern Europe and Central Asia has become the most active New In mobile telephony, private participation had extended to the majority of the region's countries in bringing private participation to electricity regulatory by 2001, when the former Yugoslav Republic of distribution--the most politically sensitive and challenging electricity subsector because it usually challenges are Macedonia opened its mobile market to private operators. In fixed-line telephony, private partici- requires raising tariffs to achieve full cost recov- emerging in pation has lagged, especially in the low-income ery while mitigating the impact on vulnerable consumers. The region accounted for 22 of the telecoms and countries of Central Asia (World Bank 2006). 33 transactions involving electricity distribution energy in 2001­05. Those 22 transactions involved 31 A big issue in many contracts has been the balance distribution companies, in countries as diverse between creating competitive markets and maxi- as Azerbaijan, Poland, the Slovak Republic, and mizing government proceeds. In the 1990s many Tajikistan. None had been canceled by 2005. included exclusivity periods to make telecommu- nications companies more attractive. An extreme With this private participation have come lower example relates to the sale of the Armenian Armen- distribution losses, an improvement that utilities Tel to the Greek OTE in 1997: ArmenTel received had not been able to achieve prior to the involve- 15 years' exclusivity for both fixed-line and mobile ment of the private sector (EBRD 2004; World services, terms were renegotiated in 2004. Bank 2006). In Moldova, for example, divesti- tures led to reductions in distribution losses of Exclusivity arrangements were sometimes justi- more than 30 percent in three years. In Albania a fied on the grounds that they made it possible to management assistance contract brought signifi- impose conditions on the operator, such as obli- cant reduction in three years. gations to install new lines. But enforcing those conditions has proved difficult. Moreover, they New regulatory challenges have emerged, however. tend to reduce the benefits of competition--for Even countries originally intending to unbundle example, slowing fixed-line rollout by as much as the sector and introduce competition in genera- 40 percent (Wallsten 2004). Not surprisingly, on tion and distribution have seen setbacks due to a key performance indicators Armenia lags behind lack of bidders or a series of asset sales to the same Private participation in infrastructure in Europe and Central Asia investor. In Georgia, for example, the withdrawal of a Western investor left the Russian RAO UES figure 2 as the sole nonstate owner of major power sector Divestitures predominant assets. In Hungary RWE and EdF acquired gener- Distribution of activity in infrastructure projects ation and distribution assets in a series of tenders, with private participation in Eastern Europe and Central Asia by type, 1990­2005 raising questions about the capacity of the regu- latory regime to cope with the consequences of Percentage vertical reintegration. The Polish government is regulatory 1 merging some unbundled public companies to 100 3 3 4 7 6 5 reforms create stronger vertical units before privatization. 14 80 38 pay off in 44 The European Commission has launched inquiries 15 44 attracting and is reviewing proposals to introduce "ownership 60 unbundling" as a remedy against possible collu- 54 31 private sion and excessive concentration (EC 2007). 40 50 investment 20 48 through Mainly water management contracts 32 0 divestiture Private activity in water and wastewater occurred 1990­2000 2001­05 1990­2000 2001­05 in 16 countries with 65 contracts signed, half in Projects Investment the 1990s and half in 2001­05. But the sector's commitments share of regional investment dropped from 3 Divestitures Greenfield projects Concessions percent to 1 percent because of the proliferation of Lease contracts Management contracts management and lease contracts and the reliance on public investment for capital expenditure. Source: World Bank and PPIAF, PPI Project Database. Countries as diverse as Armenia, the Czech Republic, and Russia closed management or lease public utilities, though Estonia divested its railway contracts in 2005, confirming the trend. Several system. But the divestiture was canceled in 2006. factors have contributed to the pervasiveness of such contracts: Water utilities have a history of Divestitures dominant charging low tariffs. Those in EU members and candidate states face the cost of complying with Divestitures remained the most common type of EU drinking water quality and environmental transaction in the region--thanks largely to activ- standards. And publicly owned utilities are eligible ity in energy and telecommunications--followed for grants or concessional loans from the EU. by greenfield projects (figure 2). While divestitures accounted for a smaller share of projects in 2001­ Limited activity in transport 05 than in the 1990s, their share of investment remained almost unchanged thanks to additional Private activity in transport was limited to 11 investments in existing projects. countries, with 55 contracts signed in 1990­2005. Transport claimed less than 5 percent of regional A fundamental condition for divestitures has been investment except in 2005 (thanks to the Buda- the introduction of an effective regulatory frame- pest and Ataturk airport transactions). In 2005, work that promotes tariff reforms and third-party eight projects reached financial closure and were access to the network. Regional experience shows located in Albania, Hungary, Poland, and Turkey. that such a framework can help lower the risks to investors and attract private investment through Most projects involved seaports (21) or airports divestitures. Countries classified as high reformers (19). The port subsector saw new management in infrastructure regulation have had more divesti- contracts for Riga port in Latvia and many in tures on average than low reformers (figure 3). the CIS, the divestiture of some assets in Russia, and new greenfield contracts in Turkey. Armenia, This is powerful evidence that reforms pay off in Hungary, Poland, Russia, and Turkey introduced attracting and keeping private investment through private activity in airports. Croatia, Hungary, and divestiture, the mode resulting in the greatest Poland did so in the road sector. In railways, reform transfer of risks to private operators. In addition, has focused on commercializing and restructuring adopting the most transparent process to select privateinvestorsandaligningriskstoreturnprovide a powerful incentive to improve performance, figure 3 bringing the ultimately desired improvement in More effective regulatory reforms attract quality, cost, and service reliability. more divestitures Average annual infrastructure divestitures in high- and low-reform countries in Eastern Europe New regional sponsors emerge and Central Asia, 1990­2005 1.8 While Western European sponsors have main- 1.6 tained a strong presence in the new EU member es High reform Low reform 1.4 countries, utilities from other transition econo- 1.2 mies have become more prominent among the top 1.0 10 sponsors. Most notable are three from Russia divestitur 0.8 (Russian Communal Systems in water, RAO UES 0.6 in electricity, and Gazprom in gas transmission verageA and distribution), and more recently Czech CEZ 0.4 group in electricity and Turkey's Akfen Holding 0.2 in transport. 0 EU members South and CIS Eastern Europe Russian activity has been significant. The three largest Russian mobile operators (MTS, Vimpel- Sources: World Bank and PPIAF, PPI Project Database; EBRD 2006. com, MegaFon) have expanded into Belarus, Note: High-reform countries are those with a score of 2 or Kazakhstan, Tajikistan, Ukraine, and Uzbekistan. above on the EBRD infrastructure transition indicator, low- RAO UES has been moving into difficult elec- reform countries those with a score of less than 2. tricity markets, in some cases using debt swap arrangements when Western investors have pulled out. The company now holds assets in several CIS policy arena, with a number of inquiries launched countries, including Armenia, Georgia, Kazakh- by the European Commission about anticompeti- stan, and Ukraine. Gazprom's reach extends into tive effects and the impact of price increases on the Baltic states and Bulgaria. consumers. The use of exclusivity periods in tele- communications has led to similar concerns. what lies ahead? References In the region, as in the rest of the developing EBRD (European Bank for Reconstruction and Development). 2004. Transition Report 2004: Infrastructure. London: EBRD. world, private activity remains concentrated in a few countries. EU members and EU accession ------. 2006. Transition Report 2006: Finance in Transition. London: EBRD. countries have attracted the most investment, EC (European Commission). 2007. "Inquiry into the European Gas while others (except for Russia) account for and Electricity Sectors." a marginal share. Better regulation and greater Wallsten, Scott. 2004. "Privatizing Monopolies in Developing political stability are among the key reasons for Countries: The Real Effects of Exclusivity Periods in Tele- the differences. Both have helped reduce inves- communications." Journal of Regulatory Economics 26 (3): 303­20. tors' perception of risk to levels comparable to World Bank. 2006. "Infrastructure in Europe and Central Asia those of Western economies. Region: Approaches to Sustainable Services." World Bank, Europe and Central Asia Region, Washington, DC. GRIDLINES But new challenges are emerging even Notes Gridlines share emerging knowledge in countries that have adopted EU 1. The note uses the World Bank's definition of the region. on public-private partnership and give an directives. In energy, reintegration 2. Investment data are in real terms (2005 U.S. dollars using the U.S. overview of a wide selection of projects from of previously unbundled struc- consumer price index). The data are from the Private Participation various regions of the world. Past notes can be tures will create new difficulties in Infrastructure (PPI) Project Database and include projects that found at www.ppiaf.org/gridlines. Gridlines are a reached financial closure in 1990­2005. The investment data refer for regulatory regimes. Greater to commitments and include private and public contributions. For publication of PPIAF (Public-Private Infrastructure PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY more information, see the Web site (ppi.worldbank.org). Advisory Facility), a multidonor technical assistance concentration in electricity facility. Through technical assistance and knowledge and gas markets already raised 3. Countries in Eastern Europe and Central Asia joining the EU dissemination PPIAF supports the efforts of policy concerns in the international in July 2004 were the Czech Republic, Estonia, Hungary, Latvia, makers, nongovernmental organizations, research Lithuania, Poland, the Slovak Republic, and Slovenia. institutions, and others in designing and implementing strategies to tap the full potential of private involvement in c/o The World Bank, 1818 H St., N.W., Washington, DC 20433, USA infrastructure. The views are those of the authors and do PhoNe (+1) 202 458 5588 fAX(+1) 202 522 7466 not necessarily reflect the views or the policy of PPIAF, PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY geNerAL eMAiL ppiaf@ppiaf.orgweb www.ppiaf.org the World Bank, or any other affiliated organization.