Sunday, 17 February 2019

Only the best projects survive

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Chile’s national public investment system remains a global gold standard thanks to its transparency and the efficiency of its capital spending. By Adrian Murdoch.

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Global spending on infrastructure remains generally woeful. According to the World Economic Forum, the global infrastructure deficit currently sits at around US$1trn. Global spending on infrastructure such as transport, power, water and communications, totals US$2.7trn a year, when it should be US$3.7trn.

It is easy to criticise, but the solution is not simple. Governments can be inefficient; public money is not always forthcoming when austerity is the watchword of the day; and private money is not as easy to come by as it should. Thanks to Basel III rules, banks are pulling back their funding, while at the same time institutional investors are often scared off by the size, tenor and complexities of infrastructure projects; and that is before they even consider the risks that affect everything from the political and environmental to the question of currency risk.

But despite the challenges there are exceptions. Chief among these is Chile. The Latin American country’s Sistema Nacional de Inversiones (SNI), its national public investment system, is consistently held up as the gold standard for best practice in global infrastructure thanks to the efficiency of its capital spending. In the World Economic Forum’s Global Competitiveness Report for 2013–2014, it stood in 46th place for infrastructure, ahead of all of its Latin American neighbours – with the exception of Panama – and ahead of countries such as Hungary, Kuwait and South Africa.

“The Chilean system has passed one crucial test – it has passed the test of time,” says Edgardo Mimica. Now associate professor at the Universidad Adolfo Ibanez in Santiago, Mimica has extensive project management experience both as adviser to the minister of finance, and as a former minister for national planning and economic policy in charge of the SNI.

“Pragmatism is what holds it together. It has gained the respect of all the people involved,” he continues, pointing out that it has been in place in one form or another for 40 years. It began in the 1970s with the military government under Augusto Pinochet advised by the Chicago Boys, the Chilean economists who had studied at the University of Chicago under Milton Friedman and Arnold Harberger. It survived the transitional governments and the subsequent leftist heads of state. More recently it was preserved by both president Sebastián Piñera and now Michelle Bachelet. “All of them have maintained the system because it works,” says Mimica.

In a form recognisable today, the SNI truly emerged in 1991 with the first concessions law that established the framework for private-sector participation. The first concessions were awarded in 1993 and the first PPP infrastructure project was completed in 1995 – the 23-year concession for the El Melón tunnel, located in central Region V in north of Santiago along Route 5. It was awarded to Enersis, an energy holding company controlled by Endesa of Spain.

Between 1995 and 2008, some 55 concession contracts were awarded, representing a total investment in infrastructure of almost US$11.5bn. These projects had a wide range of values, from US$8m up to US$850m. And while the focus of the concession system was initially only on transport, since 2003 it has broadened out to look at airports, ports and prisons too.

The image Mimica uses for how the system works is that of a water reservoir. “When a country is in a water/drought cycle it has to build a reservoir to stabilise the supply of water it needs for irrigation. The same is absolutely true for projects. A country needs to have a project reservoir,” Mimica says. “You start with 1,000s of ideas and narrow that down to profiles, then pre-feasibility studies and feasibility studies. It is almost a Darwinian process. Once the feasibility studies have been approved, they become projects. Not all of these are financed, but after they have the seal of approval, then they can compete for money in the budget cycle.”

The filtering process, he believes, is absolutely central to the system. “It is about using our money smarter,” he says. Standard forms, procedures and metrics are used to assess every project that is submitted. The management consultancy McKinsey estimates that at this first stage between 25% and 35% of all projects are rejected.

It is, of course, fair to ask how Chile can be sure that a system like this is comparing apples with apples. At first glance there appears to be little in common with the US$716m 15-year expansion tender to operate and develop Santiago’s Arturo Merino Benitez International Airport and the US$360.4m 15-year concession for Antofagasta hospital in the north of the country, to give two recent examples of projects.

“There are standard metrics which work for any capital investment project which we use,” says Mimica – those like net present value and rate of return work for any project. It is only how they are calculated that is project specific. He points out that there are 40 different methodologies for different types of projects. Here, Mimica speaks highly of Britain’s Green Book, the treasury guidance for public sector bodies on how to appraise proposals before committing funds to a policy, programme or project. “In Britain, we see how you evaluate projects. The Green Book provides a great deal of information,” he says.

What Chile never loses sight of is that infrastructure investment does not exist in a vacuum. There is a social aspect to every project. It is often cited that one of the benefits of the national infrastructure system is that thanks to power concessions, the number of rural users of electricity in the country went from only half the population in 1994 to 92% of the population by 2006.

At its most obvious level, the government’s commitment to the people is in the transparency of the system. Every single project that has been proposed can be looked at online by anyone at “It starts at the moment when you create a project file with a new name and a code number,” says Mimica.

It is also built into the one important metric that sits at the heart of every infrastructure project in Chile and is always assessed – the social discount rate or the economic opportunity cost of public funds. “If you use one dollar from public funds, you are taking it,” says Mimica. “You have to ask the question: ‘What am I losing by using this money for my project?’ You could be giving up a school, a new regiment for the army, or a new water system. The cost of that money has to be looked at every single time.”

Part of the reason for this emphasis on the social value of every project is that much of the funding comes from the country’s sovereign wealth fund. The US$15.2bn Economic and Social Stabilisation Fund (ESSF) has been tremendously important. “Companies don’t go to the banking system for project finance, they come to the ESSF. Not only does that provide financial stability, it also gives us as Chileans an independence from foreign funds,” says Mimica.

An additional dimension to the infrastructure systems is the manner in which government and private sector keep talking to each other. The system is flexible enough that project ideas do not just come from the government – indeed, they are welcomed from the private sector. There is material benefit for the companies to propose ideas. “If that initiative is taken into the bidding process, then the company that proposed it gets a 10% weighting in its bid,” says Mimica. He adds that this has been particularly seen in the prison sector, where the government has been able to outsource construction.

Oversight of infrastructure projects is split between two government ministries. Unlike the national public investment system of Mexico and Peru, for example, where the entire system is a subset of the ministry of finance, the governing body of the SNI sits with the ministry of planning, now the ministry of social development, and not the ministry of finance. The legislators decided to separate the responsibilities. It is only once a project has been accepted and has the seal of approval that it heads towards the ministry of finance.

Is the system perfect? Of course not, but what is notable is the constant evolution, the national will that there is to fix problems. For example, by the mid-1990s a loophole emerged that allowed the concessionaire to shift commercial risk to the government through a clause that allowed a demand for compensation when adverse contingencies affected the economic equilibrium of the contract. This has been closed.

And since 2004, there have been a number of tweaks that have increased transparency further. A Concession Board with independent directors was appointed to oversee each contract renegotiation in that year. Two years later a new policy for all road and airport concessions was introduced that was based on present value of revenue and reduced the need for contract renegotiations. And the year after that, new administrative regulations meant that any additional construction work that emerged from a renegotiation of contracts had to be auctioned.

In 2010, a new concession law levelled the paying field further with the creation of a council to review negotiations and to increase accountability. At the same time, the new law also introduced a permanent independent dispute resolution board.

Changes are still being discussed. Mimica believes that a greater emphasis should be placed on risk assessment. “We are lacking an understanding of risks involved in our portfolio. It is one thing that is lagging behind,” he says, explaining that while the profitability of a project is carefully assessed, the risk of that investment is not. He speaks of the need to use Monte Carlo simulations as standard, a series of algorithms often used to model project schedules. “We need a broader picture of our investment portfolio,” he says. 

Perhaps more generally, there is a current debate about how the investment system is supervised. In 2011, the ministry of planning morphed into the ministry of social development. Many are unhappy that the national public investment system sits there. There is a natural incompatibility, they say, between infrastructure and the formulation of social development policy. An independent superintendency has been mooted. It is not clear whether this will happen or not, but it remains significant that it is being discussed.

The constant debate and refining of the model is what makes the Sistema Nacional de Inversiones such a good system. External proof, if it is needed, of the regard with which it is held is the number of countries that have used the SNI as a model. In April alone, Zambia visited Chile hoping to tap into the country’s infrastructure technology while Nigeria’s own National Integrated Infrastructure Master Plan, announced at the end of the month, is based on the SNI too.

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