Scope

1
Scope limits of financial guarantees for
development

• James Winpenny
• Wychwood Economic Consulting Ltd

2
Scope of the study

• guarantees with a developmental motive for equity
  investors project lenders borrowers for long
  term investment.
• products offered by IFIs some schemes of
  bilateral development agencies.
• Criterion the operation, if it had been financed
  directly by donors through concessional credits,
  would be considered as oda.
• Export credit insurance is excluded this
  normally covers only payment risks for the export
  of goods and services by firms resident in the
  country of the agency concerned

3
Purpose of guarantees

• encourage lending and investment in developing
  countries and emerging markets by mitigating key
  risks.
• apply both to physical infrastructure projects
  to promotion of local capital markets as
  suppliers of finance.
• works through credit enhancement of local
  borrowers and bond issuers, and development of
  new types of local financial institutions.

4
How guarantees work

• Mitigating specific risks which are the critical
  sticking points on a project
• Enhancing securities (e.g. bonds, share issues)
  to take them over a critical threshold of
  creditworthiness (e.g. investment grade)
• Improving terms on which borrowers and project
  sponsors can get access to loans equity
• Giving lenders investors exposure to unfamiliar
  markets products

5
Four principal risks

• Political war, civil disturbance, terrorism,
  kidnappings, nationalisation, expropriation ,
  restrictions on conversion transfer of foreign
  exchange .
• Regulatory contractual Breach of contract by
  public partner, adverse decisions by regulators
  etc. due to political pressure.
• Credit late payment or default on loans made, or
  for goods and services provided
• Foreign exchange devaluation, increasing local
  currency cost of debt servicing, dividend
  remittances other forex commitments.

6
Main sources of guarantees

• IFIs bilateral donor agencies bilateral
  official insurers private insurance cos.
• Political MIGA, other IFIs (through B loans),
  bilateral official agencies, private companies. A
  large, well established and active market, with
  supply well matched to demand.
• Regulatory contractual MIGA Breach of Contract
  policy, World Bank Partial Risk Guarantee. Few
  policies issued so far. The product is
  case-specific, complicated to draw up recovery
  difficult.
• Credit Partial Credit Guarantees by IFC other
  IFIs bilateral donor Partial Loan Guarantees
  insurance policies of private Monoline companies.
• Foreign exchange in practice, this is not widely
  available from either private or official
  agencies (n.b. OPIC, Camdessus proposal).

7
Extent of usage

• Size of bilateral agency guarantees difficult to
  estimate data not collected systematically by
  DAC.
• annual amounts c. 2-500 mn ?? (below 1 of
  total oda) .
• IFI guarantees 2 bn. p.a., below 10 of their
  total operations.
• (above based on 2001-3 data)

8
Constraints to wider use

• supply-side attitudes self-imposed constraints.
  capital provisioning rules and practices low
  internal profitability and appeal of guarantees
  compared to direct loans and other services
  attitudes of ratings agencies agencies desire
  to preserve AAA rating.
• attitude of host/borrowing country. prefer direct
  loans where these count equally with guarantees
  against national borrowing limit hostility by
  host governments and local banks to other
  agencies crowding in on local savings markets.
  Limited understanding of guarantees.
• weak pipeline of projects (e.g. power and water).
  
• Flux of international capital flows volume of
  PSP cases, which generate demand for guarantees.
• Absence of necessary conditions for the success
  of guarantees, e.g. sound local banking system,
  potential supply of local savings, good local
  project promoters, good system of commercial law
  and legal redress, clear central-local fiscal
  relationships, established policy framework (e.g.
  over tariffs), etc.

9
Potential downsides

• Costs to supplier opportunity cost of a
  contingent liability high transaction costs in
  creating the products diversion dilution
  of aid not reckoned as oda by DAC.
• Costs to recipients charges premiums competes
  with sovereign debt capital market
  distortions risk of unsustainable debt
• Theoretical objections moral hazard adverse
  selection rent-seeking

10
Developmental impact

• Correlation with level of development?
• Cant compensate for lack of fundamentals
• distorting capital markets or compensating for
  market and policy failures?
• Comfort, prop or stimulus?
• GUARANTEES GO WITH THE FLOW CANT SWIM AGAINST
  THE TIDE!!

11
Says it all!
Impact of Partial Credit Guarantee on loan terms Without guarantee With guarantee
Philippines 3 7 years 2.5 15 years
Uganda 8 n.a. 3.1 16 years
Bangladesh 3 1 year 2 13 years
Ivory Coast 3 1 year 2.75 12 years
China maturity 7 yr 15 yr
Pakistan maturity 3 yr 15 yr
Jordan maturity 2 yr 7 yr
12
Promoting use of guarantees

• Change rules on IFI capital provisioning
• Change DAC recording conventions
• Cooperation public-private insurers
• More local currency guarantees (Guarantco?)
• Identifying first-time market entrants
• Extending range of products
• Streamlining more realistic pricing
• Create specialised Guarantee Agency?