Viewpoint MiAc- No. 180 April 'ggl Karenz Mitigating Currency Convertibility Risks RasmusNen in High-Risk Countries A new IDA lending approach ThisNote examines A proposed Currency Convertibility Fund, backstopped by a contingent credit from the howthe International Development International Development Association (IDA)-the World Bank's concessionary window for the Association's lending instruments can be world's poorest countries-has been designed for the Songo Songo Gas Development and tailored to support foreign equity Power Generation Project in Tanzania. The fund is a transitional mechanism aimed at investment in projects that generate only local supporting the Tanzanian government's efforts to attract foreign equity in circumstances where currency and for which currency convertibility the private sector perceives a high level of risk and is otherwise unwilling to invest. The Songo insurance is not commercially available. Songo power project has suffered delays since 1997 arising from a dispute between the government and the Malaysian sponsors of another private power project. Now that this dispute is being resolved, preparation of the proposed Songo Songo project has resumed. The World Bank's support for the Currency Convertibility Fund is not due to go before the Bank's board for approval until 2000. Still, the fund may be a replicable mechanism that, by mitigating sovereign risks that investors are unwilling to bear and unable to hedge against, could help catalyze foreign equity investment in other IDA countries and in projects that generate local currency. The government of Tanzania solicited private The project would establish Songas, a majority sector interest in a project involving the con- privately owned and managed gas and electricity struction of a gas processing plant on Songo utility. TI'lhe project would he structured as a build- Songo Island and of a 220-kilometer gas pipeline. own-operate arrangement, underpinned by a The project also includes the privatization and power purchase agreement between Tanesco conversion to gas firing of a 110-megawatt gen- and Songas. Project costs are estimated at about erating plant owned by Tanesco, the public elec- US$280 million (table 1). Equity investors would tricity utility. The government saw significant provide about US$72 million, and the govern- advantages in a puLblic-private partnership-with ment woutld contribute about US$8 million. The a direct stake in the project, equity investors remaining UT$200 million woould be provided to slhould have a strong incentive to operate the the government through a credit from IDA and a facility efficiently, and Tanzania has no expertise loan from the European Investment Bank, both in gas-fired electricity generation and so could of which wotuld be on-lent to Songas on com- benefit from private sector technical and inan- mercial terms. In addition, IDA would provide a agerial expertise. contingent credit of US$35 million that would _______ The World Bank Group *Finance, Private Sector, and Infrastructure Network Wr. ~~~~~x Mitigating Currency Convertibility Risks in High-Risk Countries TABLE 1 PROJECT FINANCING PLAN US$ millions against whlich they could not heclge. Specifically. OTC (Ocelot Energy and TransCanada foreign investors wantecd assurances that, on pro- Pipelines, the two private sponsors) 50 50 ject sustainability grounds, they cotulci reasonably International Finance Corporation 6 6 expect to cover the project's operations and maintenance expenditures payahle in foreign Commonwealth Development Corporation 6 6 raneac xeciLrspybei oeg exchange, and repatriate their earnings in a con- Deutsche Investitions und vertible currencv. Entwicklungsgesellschaft mbH 6 6 European Investment Bank/Tanzania The conclusions of a World Bank studly andcl dis- Development Finance Corporation 4 4 cussions withi international oil and gas companies IDA project loan (on-lent to Songas) 155 155 and political insurance agencies confirmed that foreign equity investment for the project would not materialize unless IDA or other donors were (on-lent to Songas) 45 45 willing to addcress the project's currency convert- Government 8 8 ibility risk. The project's foreign exchange needs Total 72 208 280 woUild he high relative to the size of the foreign exchange market. The project wvould require the IDA contingent credit 35 35 equivalent of 8 percent of the annual Volum-ne of foreign exchange transactecl in the market. Source: International Development Association. The World Bank Group examined the instru- ments it had available to encourage equity invest- ment. At the time the Bank's pilot program ftor provicie limited protection to the project sponsors partial risk guarantees to private lenclers in IDA against the risk of currency inconvertibility. countries was not available to help raise com- mercial debt. NMoreover, the Multilateral Invest- The currency pro blem ment Guarantee Agency (MIGA) was unwilling to offer currency convertibility coverage on its own Private involvement in the project ran into two account because of the high perceived risk of the main impediments: the unavailablity of currency project. So, to maximize mo)ilization of private convertibility insurance from public and private equity in the proposed project, the Bank de- sources, and Tanzania's weak balance of pay- signed a new financial mechanism, the Currency ments performance and heavy debt burden. Convertibility FIund (CCF), to mitigate the risk of There were no prospects for commercial debt currency inconvertibility. financing for the project because foreign com- mercial banks have heen willing to lend only for What is the Currency Convertibility short-term trade transactions (all export credit Fund, and how does it work? agencies are otf cover in Tanzania). Ancd in any event, foreign-denominated commercial debt The CCF is a financial instrument, to be backed would have exacerbated the project's foreign by a contingent IDA credit of U.S$35 million, that exchange requirements. woxould provide the project sponsors with limited protection (up to tJS$35 million) against currency For these reasons, the government preferred to inconvertibility for operations ancd maintenance seek private equity in the project rathier than coIIi- expenditures. dividends, and capital redemptions mercial debt. BLut w'hile foreign equity investors payable in foreign exchange. wer e willing to assume the construction and com- mercial risks associated with the project, they The CCF will mitigate but not eliminate the risk to Welre not willing to take on sovereign risks Songas of currency inconvertibility. Songas's annual foreign exchange requirements for opera- mercial operations under the twentv-year power tions and maintenance, dividends, anti capital purchase agreement). This period is considered redemptions are estimated at about lJSS2S mil- reasonable because it reflects the time required lion, or US$500 million over the twenty-year term for investors to generate adequate cash flows at of the power purchase agreement. The coverage the agreed tariff level, and because it will help provided by the CCF wouldl help ensure the finan- ensture that Songas remains a going private sec- cial viability of the project in the ev ent of a tem- tor concern over the long term. porarv lack of foreign exchange in the market. The CCF is equivalent to about sixteen months of The CCF is structured to discourage both the the projects foreign exchange requirements. government andi the project sponsors from causing a claim to be filedl. For the sponsors The CCF Wvould dishurse only as needed to pay these disincentives include an extended transfer valid claims submitted by the project sponsors delay period before which a claim can be filed, and substantiated by MIGA, vwhich will adminis- a less than 100 percent claim coverage ratio. and ter the fund on behalf of the government (figure an annual stop loss. Government deterrents 1). The government would issue to MIIGA an include mandatory use of any foreign exchange irrevocable right to make wTithdrawals from the recovered by MIGA in connection with a claim fund to pay eligible claims. The IDA credit (and to prcpay the CCF credit to IDA, and IDA's contract of guarantee) for the CCF would have a option of accelerating the credit if a call is made term of fifteen years (or thirteen years of com- on the CCF. FIGURE 1 THE CURRENCY CONVERTIBILITY FUND SCHEME '4 CCcotneRepayment through any MIGA recovery CCF contingent .3 of claims in foreign exchange credit 4 I + t US$200 RpyetUS$35 million Premiums less million Repayment standby credit - administrative fee Disbursements of IDA US200 million I on-lent Repayment US$72 million Annual premium payments Investors' dividend Currency Convertibility payments Fund coverage Note: Arrows indicate money flows. a. Ocelot Energy Inc. and TransCanada PipeLines (the project sponsors) are providing US$50 million in contributions. CCF coverage is being provided only for the private equity sponsors. The International Finance Corporation, Commonwealth Development Corporation, Deutsche Investitions and Entwicklungsgesellschatt mbH, and European Investment Bank are providing US$22 million in equity. Mitigating Currency Convertibility Risks in High-Risk Countries In addition to the proposed development creclit ihility risk coverage to the sponsors up to the agreement between the government and IDA for same amount. Thus this clocument Would spell investment in the Songo Songo Gas Develop- out the specific terms and conditions of the ment and Power Generation Project, the CCF CCF contract of guarantee, includcing the items WLould involve three legal agreements: covered, the terms of coverage, and the pre- *Te developnent credit agreement between miums to he charged annually to the sponsors thegovernmeni and IDA./brthe credit(tofund and the procedures to he followed b)y the the CCF The proposed IDA credit of US$35 sponsors before filing a claim. million to the goverminent of Tanzania to fund the CCF would he provided under a separate Catalytic role development credit agreement because thc CCF wvoulcl involve terms and conditLons that IDA's involvement in the project is seen as cru- differ significantly from those that would gov- cial to catalyze foreign private investment by ern the proposed IDA credit to the govern- alleviating equity investors' concern about non- mnent for the investment project. For example, commercial risks. This involvement is consistent this agreement wvould contain conditions of with the Bank's policies to assist sector reform ClisbLursement related to the submission of by involving the private sector and to assist gov- documentation from MIGA substantiating that ernment borrowers in attracting this private cap- a valid claim had been filed for wvhich pay- ital by alleviating investors' and lenders' concern ment was to he made. It would also confirm about sovereign risk. The contingent IDA credlit Viewpoint is an open the government's assignment to MIGA of an of USS35 million has a leveraging effect, mobi- forum intended to irrevocablc right to withdraw funds from the lizing US$50 million of private eqIuity andt US$22 of and dedats on ideast CCF credit on the occurrence of the clefinecd million in other foreign eqthitV that wvould other- innovations, and best events. Thus the CCF would disburse only if wise not have materializecl. practices for expanding MIGA were to determine that the project the private sector The views published are sponsors had filed a valid claim substantiat- ' i estors were nnso coneeriled alouLt rio. 1s1ok (It 11(lipatyent In those of the authors and ing their inability to convert or transfer Tones-o Tihis risk It, heen mittg.o,l thro,l,gh .:i rovunttn should not be attributed operations and maintenance expenclitures funded rLf-N ifvig liloliritfay feaility designed to ensuir cotlcI< ,l .10d to the World Bank or any ioinelv ca;mc.it rinod energ) paymients hy T.inesc 1o songas, ald of its affiliated organiza- payab)le in foreign exchange, dividends, or v .in c.ctow\ .ccouInt thlat wuttild fMioilt tile pyjec .s1polsolts tions. Nor do any of the capital redemptions in accordance with the 1gainsthlse louss Of their e nit) ivestnitn in ili)- cven) of zn irn til- conclusions represent provisions of the conitract of guarartee (see tIhe gowernment flet.l official policy of the World Bank or of its helow). Executive Directors or *7he adminiistrartion agreemnent betiveen the Karen Rasmn ossen (k?rasm.issenGzoii i rldbtinki. the countries they gotvernlment and 1MIGA relating to the C'CF. org,i Africa Region represent. This agreement would spell out the relation- To order additional ship bettween the government and MIGA wx ith copies please call respect to the management and administration 202 4!i8 1t 1 or contact of the CCF ancl the responsibilities of each Room F11K-208, partyv including the procedLures for paving eli- The World Bank, gible claims, recovering claims, and distribttt- 181 H Street, NW, Washington, D.C. 20433, ing premiutIms. or Internet address * The contract ofguarantee betzieen the pro/ect ssmith7aworldbank.org. sponsors and MlIIGA spelling oa2t the insu rance The series is also available on-line Cocerage to be provided c j' the governmnent (www.worldhank.org/ and issned b;'1MJ IIGA. The contingent IDA crecdit html/fpd/notes/). of L'S$35 million to be made to the govern- @ Printed on recycled ment of Tanzania woould proxvide the financial paper. backing for MIGA to issue currency convert-