Anil K Malhotra, World Bank Regional Energy Adviser, assesses the key emerging issues in financing Asia's energy sector

Energy demand in the developing countries is growing rapidly. Countries in Asia have, over the past decade, had an average annual growth rate of 6-10 per cent in energy consumption. Driven by rapid economic growth, population increase, industrialisation, urbanisation and the competitive needs of the global market, electricity demand in Asia is projected to increase by an average of 7.3 per cent a year over the next decade. This means an estimated additional generation capacity of about 290,000MW, requiring an additional investment of US$35 million.

The magnitude of the investment required poses formidable financing problems. The bulk of external financing in energy development in the past has been in the form of export-related credits, finance from multilateral and bilateral agencies and commercial flows. In the present environment, the projected required investments in the power sector are unlikely to be available from conventional sources alone, leaving two alternatives: the domestic and international capital markets. But before capital markets can be used to raise funds for the power sector, the sector will have to dramatically improve the performance of its public sector institutions.

Despite impressive expansion over the past decade, the overall technical, institutional and financial performance of state-owned utilities has deteriorated. Institutional arrangements in the developing countries have tended to be characterised by widespread ad hoc government involvement in most aspects of the management of the utilities and the sector as a whole; rivalry and inadequate co-ordination among sector institutions and with other agencies; and weak accountability of sector managers to both supervising ministries and their customers. As a result, with few exceptions, the power sector suffers from a combination of poor pricing, investment and regulatory policies, and inefficient operating and maintenance practices.

As a region, Asia represents the largest potential power market and consumer base well into the next century. But, despite widespread recognition of a role for private participation, the poor performance of public sector institutions has hampered the needed inflows of private capital: less than 20 major private power projects are in operation.

The major impetus for private sector entry in power has been the investment shortfall - the financing gap - being experienced in most Asian countries. The other important driving forces are the endemic inefficiencies, the demands by industrial and commercial consumers for an improved service and the realisation that global competitiveness requires a functioning infrastructure.

Several key issues concerning the power debate in Asia have emerged in recent years.

Government commitment. It is clear that providing a credible, and sustained, government commitment to private sector entry is the fundamental requirement for success. Private developers need a clear long-term structure and credible government commitment to reforming state-run power sectors. The reform and the move to the private sector thus need to be codified in law. Explicit government statements and legislative pronouncements have been seen in almost all Asian countries during the past few years. The Philippines and Pakistan have used presidential directives or legislative decrees. In India, Malaysia and Indonesia certain restrictive clauses in the Electricity Act were amended. China amended its foreign investment laws to allow entry in the power sector. Given that these initiatives by themselves eased only the legal impediments to private power entry, countries have also begun to assess the financial incentives that could attract the required capital. The limited experience suggests that countries where the government has either defined a policy position or is willing to work with investors and multilateral agencies in defining a framework have had some success in implementing projects or at least being approached by foreign investors. These countries include China, India, Indonesia, Malaysia and Pakistan.

Risk sharing. At the heart of the relationship between government and private investor lies the issue of risk sharing. In high-risk countries, investors expect the government to provide a greater level of support - but governments feel that investors are not bearing adequate risk. There is no such thing as fair and unfair risk sharing: the risk allocation arrangement required to make a project a reality is probably some indication of what is possible and perhaps equitable.

Returns. The return on capital (the equity return) is perhaps the most important variable determining investor interest in potential power projects. Governments have devoted a great deal of effort to defining an appropriate policy position on this issue, while facing various internal political and economic pressures. Chief among these is the perception that private investors seek 'unfairly high' returns on their investment and that the economic interests of the country are being subordinated to that of the private investor.

A transparent project selection process. The need for transparency in the process of selecting projects is vital. While there is no completely objective process for project selection, there will always be factors that require an element of negotiation: the challenge is to ensure that negotiations are done in good faith as a process of addressing the legitimate concerns of both purchaser and project.

Stability of the investment framework. Private power investors - both domestic and foreign - seek an investment framework that is stable and predictable. Most surveys of investor preferences also indicate that investors place greater emphasis upon policy stability - even if it is less favourable - than they do on a significant tax break which is likely to be subject to ad hoc reversal. This is in turn related to investors' perceptions of whether conflicts, if any, will be resolved on a timely and fair basis.

Finally, the introduction of private finance into the power sectors of Asia's emerging countries has, as an off-shoot, necessitated reform of existing patterns of sector ownership and control. Nevertheless, although proponents of the private sector often note that it is capable of providing the necessary financial, managerial and operating resources for power sector expansion, government will always have a role to play in the power sector, even in areas with significant foreign involvement.

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©Kensington Publications 1996