Improving the Domestic Impact of Mega-Projects Global Experience

Improving the Domestic Impact of Mega-Projects Global Experience and Options for Mozambique Antonio Nucifora, Peter Nicholas, and Boris Utria World Bank March 2010 Namaacha

Improving the Domestic Impact of Mega-Projects o The context: Opportunities and challenges o Improving the project preparation cycle o How to ensure domestic participation: Funding from the budget? o Macroeconomic impacts and how to manage them o Natural resource ‘curse’ and policies to avoid it o Concluding questions Mozambique 2

Rovuma Basin – Gas (and Oil? ) Moatize Power Cahora Bassa Mpanda Nkuwa Moatize Coal Benga Power Refinery Forestry Potential Petroline Moma - Titanium Gas Fields Refinery Chibuto - Titanium Moamba Power Station Mozal Maputo Metallurgical Complex Mozambique 3

Mega-projects: Opportunities and challenges o Mozambique has gained strong reputation as investor friendly, and S&P and Fitch have given a stable outlook on their B+ credit ratings o Increasing investor interest in Mozambique is translating in multi-billion dollar investments o Mega-projects contributions to budget can be cash-cow to finance infrastructure investments o Looking ahead: Need to balance reputation as investor-friendly destination with maximizing domestic fiscal, ownership, employment, social and environmental benefits of mega-projects Mozambique 4

Improving the project preparation cycle Mozambique 5

Improving the project cycle: current status o Weaknesses in current project cycle set up o Gaps exist in legal and regulatory framework (e. g. length of concessions, electricity royalties, etc. ) o Ad hoc process of inter-ministerial coordination o MOF often called in when discussions are advanced o Large investors report that GOM delegations are often not adequately prepared/staffed Mozambique 6

Improving the project cycle: Legal & Regulatory Framework o Lack of a comprehensive framework law for mega-projects, concessions and PPPs to provide guidelines for project selection and risk allocation n who is the contracting authority n maximum timescales for approval of contracts n which bodies need to provide approvals and at what stage n how concession and other agreements might be regulated and/or monitored n different procurement options which are available Mozambique 7

Improving the project cycle: Institutional process o Need to develop a clearly structured process for mega-project screening, tendering, negotiations and post-implementation monitoring n Clear demarcation of responsibilities between ministries n Guarantee key role of MOF in negotiation and monitoring of mega-projects, concessions and PPPs n Assess and prioritize key human resource needs, such as financing expertise Mozambique 8

Improving the project cycle: Institutional process o Need to facilitate private sector participation n Strengthen capacity to respond to big investors n Develop greater in-house GOM capacity to initiate projects and respond robustly to unsolicited proposals n Need instrument to provide financial support for project development and transaction activities to line ministries o Need to develop a framework for assessing: n the overall benefits of proposed investments n financing options n if a broader tendering process would be beneficial for unsolicited bids (for example, a 'Bonus System’ or 'Swiss Challenge System' of competitive bidding) Mozambique 9

Improving the project cycle: Institutional process o Would it be better to have a dedicated and adequately staffed unit? n Should responsibility for specific project cycle activities continue to be decentralized, or should it be moved to a centralized ‘Mega-project, PPPs and Concessions Unit’? n Is it better to develop needed skills within each interested ministry or would a specialist centralized unit be an appropriate institutional solution? Mozambique 10

How to ensure domestic participation in megaprojects? Mozambique 11

Should there be any domestic participation in mega-projects? o It is essential that domestic private interest be invited competitively and transparently n Avoid concerns regarding Politically Exposed Persons o It will take time for Mozambican individuals, corporate and institutional investors to build up the financial resources to invest in M-P o GOM has expressed interest in financial participation in a number of upcoming projects n Protect national interest: control of strategic assets n Socio-political: wider domestic share ownership n International investor see local participation as extremely important risk mitigant Mozambique 12

How can domestic participation in mega-projects be financed? o Option 1: GOM to invest directly and finance domestic participation in mega-projects o But should GOM use its limited resources (or borrow) to fund shareholdings in mega-projects? n Need to take into account the opportunity cost in terms of other possible uses of public funding o Direct public investment in mega-projects should generally be the least preferred option and driven only by strategic considerations o Precise form of vehicle and appropriate structure for such public investments would depend on Mozambican law Mozambique 13

How can domestic participation in mega-projects be financed? o Option 2: Reserving shares through ‘a call option’ to buy shares in the future o When issuing concessions, GOM could reserve equity for Mozambicans to buy in the future n Concession agreement could indicate that a given percentage of the shares will have to be divested to Mozambican entities (citizens, companies, stock market, pension funds, etc) at a date in the future at the price then current n This is like a ‘call option’ on a share issue to increase Mozambican private participation in the future o Future sales of shares should be at market value Mozambique 14

How can domestic participation in mega-projects be financed? o Option 3: ‘Warehousing’ shares until there is sufficient local demand to purchase the shares (at a market rate) n (a) third party private companies might be prepared to undertake the warehousing role n (b) the warehousing role could also be played by one or more development finance institutions (DFIs) n (c) the Mozambican government itself could borrow to finance the warehousing o Private sector or DFI’s to act as the warehouse would avoid need for GOM to use its scarce resources (or borrow) to fund the shareholding Mozambique 15

Setting up a Multi-Investment Warehousing Facility? o Public ownership would best not be held by the national utility, to ensure good corporate governance and avoid conflict of interest n Keep clear role and objectives of government ownership n If national utility is involved in financing they may become involved in operational / management decisions n There is conflict of interest when the company is both seller and buyer/investor and off-taker n A purely financial vehicle would not have that problem o Better to keep warehousing on case by case basis or to set up specialized vehicle? Mozambique 16

How a Mozambican Holding Company might be structured Mozambique 17

The Singapore example: TEMASEK public holding company o Singapore’s State holding company provides a good model of both strategy and governance n Temasek holds full or partial stakes in Singapore’s largest companies, particularly power and utilities n Invests in areas with strong public good features, with occasional participation in catalytic investments outside infrastructure n Managed by independent board and professional and accountable management team n Full disclosure of materials and related party transactions n Publication of audited financial statements Mozambique 18

Singapore’s Public Holding Company: TEMASEK Mozambique 19

Macroeconomic and Budgetary Impacts of Mega-Projects Mozambique 20

Recent Steps to Increase the Fiscal Benefits of Mega-Projects o GOM wants to increase mega-projects domestic benefits, notably fiscal contribution to budget o Given increased confidence of investors, GOM has rightly reduced fiscal incentives and standardized fiscal terms of all new projects n New legal frameworks for the mining and petroleum fiscal regimes in 2007 n Revised Fiscal Benefits Code in 2009 Mozambique 21

Next Steps to Increase the Fiscal Benefits of Mega-Projects o Need proper legal framework to minimize fiscal risk and limit quasi-fiscal activities resulting from GOM participation in mega-projects o Need mechanisms to ensure that additional resources are budgeted in an efficient and transparent manner, and properly monitored o Consider reducing fiscal benefits for investment projects, in parallel with reduction in corporate tax rates Mozambique 22

Are incentives useful to attract investment? o Most of the literature argues against incentives o Survey on impact of incentives in Mozambique (Bolnik, 2009) n Random sample of 60 companies that qualified in 2005, 2006 and 2007 for CIP fiscal benefits o Critical factors influencing investment decision n n n growing domestic market (38 times) lack of local competition (16 times) political stability (14 times) business environment (12 times) and access to neighboring markets (9 times) just one respondent cited “incentives” 23

Are incentives useful to attract investment? o Survey on impact of incentives in Mozambique n Fiscal benefits are not decisive for most investments o 85% of investors stated their decision did not depend on receiving income tax breaks, giving 80% redundancy rate o for import duty relief on capital goods the corresponding redundancy rate was 73% n Very few of these projects could be categorized as “footloose” o Only 12 percent of the investors considered locations outside Mozambique—and none of them regarded tax breaks as critical n Fully 90 percent of the investments—and 80 percent of those critically influenced by tax breaks, were driven by domestic market opportunities 24

Reform Fiscal Policy to Boost Competitiveness of SMEs o Fiscal climate could be significantly improved by reducing simultaneously fiscal incentives and the number and level of tax rates—without compromising government revenues n Enlarge tax base to create level playing field for all potential investors n Considerably simplify tax administration n Allocate investment to their most productive use n Reduce room for discretion and corruption n Improve fiscal regime for investment by small / medium entrepreneurs—the very entrepreneurs that are needed to sustain growth and job creation 25

Potential Further Improvements in Macro-Fiscal Impact of M-P o Enhancing revenue forecasting and the efficiency of spending n Developing and implementing a macro-fiscal model for the mega-projects n Improving the efficiency of spending as part of an effort to avoid Dutch Disease o Strengthening transparency and accountability n Adopting practices to closely monitor the collection and distribution of mega-project fiscal revenues n EITI membership is a great start n Adopt same principles / approach throughout the value chain for all natural resources projects Mozambique 26

Potential Further Improvements in Macro-Fiscal Impact of M-P o Fine-tuning the monetary policy framework n Tailoring Central Bank intervention policy mix to facilitate absorption of capital inflows from M-P n Improving central bank liquidity management and monetary policy operations to effectively manage surplus liquidity associated with M-P inflows o Developing exchange rate policy with a medium term focus n In the short-term, mitigate appreciation pressures on the exchange rate associated with M-P inflows n What exchange rate policy would optimize the resource flows associated with mega-projects over the mediumto-long term? Mozambique 27

Revenue Transparency and Good Governance Mozambique 28

Natural Resource Wealth and Economic Growth: ‘The Curse’ Mozambique 29

The ‘Natural Resource Curse’ What is it? o Many studies find that abundance of natural resource has strong negative impact on growth o For example (Sachs and Warner 1995, 2001) n Cross-section of countries in the period 1970 -90 n Ten percentage point increase in the ratio of natural resource exports to GDP associated with 0. 4% - 0. 7% lower annual per capita GDP growth o Three main explanations for resource curse: n ‘Dutch disease’: appreciation of real exchange rate and loss of competitiveness n Rent seeking: Natural resource rents are easily appropriable (bribes, distortions in public policies, …) n Institutional and policy quality deterioration Mozambique 30

The ‘Natural Resource Curse’: Key Role of Good Governance o Consensus emerging that outcome depends on quality of country’s institutions and policies (Collier and Goderis 2007) n Time series of 130 countries over the 1963 -2003 n Divide their sample into good and bad governance countries (ICRG rating >than 75 is ‘good’) n Negative impact on growth only in countries with bad governance; positive relationship in countries with good governance Mozambique 31

Key policy implications for the use of natural resources o Mozambique has so far avoided the resource curse, reflecting ‘enclave nature’ of existing M-Ps o Four types of policy can help Mozambique address the challenges of natural resource based development n Good governance and transparency n Fiscal regime for the natural resources sector n Sound fiscal policy stance o Adopting appropriate fiscal rules for saving enough from natural resource revenues) o Policies to allocate public expenditures to promote long run growth and minimize Dutch disease Mozambique 32

Conclusions Mozambique 33

How to maximize benefits from mega-projects o Strengthening the project preparation cycle Carry out full review of legal framework, institutional and project cycle process? n Would a framework law for PPPs, Concessions and Mega -projects be useful ? n How can the assessment of State liabilities be improved n Should there be a centralized unit? n o Ensuring Mozambican participation n Should it be financed from the budget or should alternatives be used (call option, warehousing)? n If from budget, what principles should guide the operation of a Mozambican Holding Company? Mozambique 34

How to maximize benefits from mega-projects o Macroeconomic and budgetary impacts n Need a macro-fiscal model to forecast fiscal revenues and predict the resource envelope for government spending over the medium-term? n In there need to offer investors fiscal benefits? Should GOM consider a reduction in fiscal benefits, in parallel with reduction in number and level of tax rates? n What exchange rate policy would optimize the resource flows from mega-projects over the medium-to-long term? o Revenue transparency and good governance n Should GOM consider adopting EITI-like principles / approach throughout the value chain for all natural resources projects? Mozambique 35

Obrigado! Antonio Nucifora Senior Economist, PREM, World Bank, Mozambique Tel: +258 -21 -48 -2371 Fax: +258 -21 -492893 Email: anucifora@worldbank. org World Bank - Mozambique March 2010 Namaacha