POTENTIAL FINANCIAL TRAPS IN RE DEVELOPMENT

AMONG the many news and analysis sources I subscribe to, one of the most informative for my particular set of interests is Devex, which is an independent news bureau that covers global development, largely from an economic perspective. Devex’s description of itself on its website is a bit overwrought and not especially clear, but the basic thinking behind it seems to be this: Development is great, and everyone wants the world to make progress, but when it comes right down to it, it’s still a form of business, and information about how that business is being pursued is interesting and important.

One of the biggest shortcomings of a lot of well-meaning plans and aspirations, whether involving poverty reduction, climate resiliency, new energy or other socially driven economic developments is that not enough of it is grounded in reality. Somebody has to pay for it; creating a project comes at a cost, and keeping it sustainable requires continuous effort and investment, and that can’t or won’t happen unless it is realistic. In order to create the world as you want it to be, you have to work with the world as it is. Not enough people who have otherwise noble aims understand that, and so Devex serves as a vital source of information to remind them.

One recent example, and one that may have immediate relevance to the Philippines, was a recent (May 20) analysis published by Devex of an International Finance Corp. (IFC) program called the Scaling Solar Program, which was launched in 2015. The IFC program had two main objectives: First, to increase solar power in lower-income countries, particularly those experiencing chronic shortages of reliable electricity; and second, to use donor development funds to prime the pump, so to speak, and attract more private capital to development investments. Renewable energy is a good place to start since it has fair prospects of providing a good return on an investment.

Eight years later, however, IFC’s Scaling Solar program has been deemed a flop, although that is a characterization the people at the IFC strongly disagree with. The program is still alive and has awarded about 700 MW of solar projects in six different countries, although a big part of that portfolio is actually a second-round project expansion in Uzbekistan that hasn’t started construction. IFC is looking to expand the program to other countries and is developing a couple of offshoots called the Scaling Mini-Grid and Scaling Wind programs. However, eight years along, most outside observers say that the program should have achieved much more by now, and should be moving faster than it is.

To figure out why it has underperformed, Devex made a case study of what was apparently supposed to be Scaling Solar’s flagship project, facilitating the development of solar power in Zambia to alleviate that country’s energy woes that were caused by a combination of very poor management and drought across large parts of Africa that has hit hydropower hard; Zambia relies heavily on hydroelectric for its energy needs. The setup was that IFC would help the government create an auction for solar projects and introduce a standardized power purchase agreement, as well as arrange World Bank guarantees to protect developers from the risk that the troubled state utility company Zesco would be unable to pay them. IFC would ordinarily take a fee from the government for these services, but in this case, this was covered by a grant from the US Agency for International Development (USAid).

The Devex story goes into great detail about this particular project — which resulted in two solar power installations, built by different developers, with a total of 75.7 MW capacity — but to summarize, it went wrong for the sake of the broader Scaling Solar program and for other solar power developments in Africa, in two ways. First, rather than pulling in private investment as intended, the projects were funded by $81 million in debt financing from development financial institutions (mostly from the African Development Bank), and covered by an additional $5.7 million in World Bank guarantees. Second, because of this financing structure, the two winning bidders of the power auction were able to offer electricity at a rate about half of what had been anticipated and would have made sense for commercial investment — about 7 cents per kilowatt-hour versus the 15 cents the IFC and the government had assumed.

This had the effect of blowing up a great many other solar power projects that were being planned elsewhere in Africa with private capital; governments heard about the deal the Zambian government got and started to demand electricity at a comparable rate, which didn’t make sense in most places. As for the IFC, efforts to expand its program slowed to a crawl for the same reason; what had worked in Zambia was unique to Zambia, and it wouldn’t work elsewhere unless circumstances were closely similar. Moreover, the Zambian project has not exactly achieved the goal of creating energy generators that can sustainably relieve the economic burden on the government by providing low-cost electricity while still being viable businesses; due to construction cost increases, the Zambian government has had to provide a number of tax incentives to the two companies involved to “maintain the project’s original economics.”

There are two useful takeaways from this. Development finance institutions are under a great deal of pressure to deliver on renewable energy, and this is an opportunity for the government — particularly for projects like mini-grids that, due to the unique circumstances of the Philippines, are especially risky for investors — but on the other hand, there must be some realism about the level of subsidy that is available. If the funding institution isn’t fully transparent about this, which it should be, the government needs to be prepared to ask some hard questions to cover itself for the inevitable issues that will arise, such as cost overruns and delays. The added transparency will also better reassure investors that they know exactly what they’re getting into.

The second point that should be emphasized is that for individual projects, the planning focus should probably be on 5, 10, or 20 years down the road, rather than simply focusing on getting the project built and running. Outcomes like those of the two Zambia solar power projects are simply not sustainable; the government’s hands are tied by having to indirectly subsidize them, and the two private companies who sell their power to the governmentowned distributor are likewise constrained. It could be argued that it was originally their fault for bidding so low in the initial power auction, but on the other hand, they simply based their bids on the parameters that were presented at the time. If the government had set those parameters according to what financial conditions might be anticipated to be 10 years in the future, a more reliable deal would have likely been the result.