By PAUL CONSTANCE

Large infrastructure projects evoke images of a physical world reshaped by raw energy and man-made materials. But of all the ingredients required to build highways, dams, pipelines or electricity grids, the most essential is actually intangible.

That's because infrastructure projects, and particularly those financed by private investors, are built on confidence. Confidence that a government will honor the terms of its contracts. Confidence that an economy will be managed well enough to justify projections of future demand. Confidence that laws and regulations that affect the profitability of infrastructure projects will not be changed arbitrarily.

Until recently, that kind of confidence was a scarce commodity in the nations of Latin America and the Caribbean. As a result, very few private investors were willing to risk committing funds to projects that can take many years to recoup costs and generate profits. Infrastructure projects had to be financed entirely by governments, a limitation that both held back development and tied up resources that could have been spent on other priorities.

But in the late 1980s, things began to change, according to Antonio Vives, Deputy Manager of IDB's Sustainable Development Department. By then, many countries were adopting financial, regulatory and trade reforms that were creating a more attractive environment for long-term investments by the private sector.

Privatization policies also helped. Telecommunications and energy, the two sectors where most privatizations took place, have attracted tens of billions of dollars in domestic and international private capital. To a much lesser degree, transportation, water and sanitation services are also benefiting from private investment. Today, Vives estimates, fully 15 percent of all infrastructure spending in Latin America and the Caribbean is financed by the private sector. Around 10 percent comes from multilateral development banks with the remainder still provided by the region's governments.

Still, the problem of confidence remains daunting. To overcome investors' doubts, private companies in the last five years have developed innovative financing arrangements that spread the economic risk of a project among governments, banks, contractors, institutional investors and development banks.

The IDB supports the efforts of firms to put together these innovative financing packages in several ways. First, it helps governments to modernize the laws, institutions, and regulatory entities that affect infrastructure investments and international capital flows. The IDB's Multilateral Investment Fund (MIF) has taken the lead in this area. Most of the 32 energy, transportation and water projects it has financed in the past several years are helping governments to create the legal and regulatory framework necessary to privatize or grant concessions to the private sector. MIF operations include airport privatization in Jamaica, cruise tourism facilities in the port of Bridgetown, Barbados, and a program to strengthen Mexico's Energy Regulatory Commission.

The Bank also invests directly in private infrastructure projects. The IDB's Private Sector Department targets projects where the Bank's size, experience, special relationship with the governments, and AAA credit rating can provide the extra measure of confidence needed to bring in private investors. By late 1997, the IDB had approved direct financing totaling $640 million for 18 energy, transportation and water and sanitation projects in nine countries worth more than $4 billion. In addition to the Aguaytía project profiled in this issue (see "Against the odds"), these projects have included toll roads in Argentina, Brazil and Uruguay, and power projects in Honduras, Mexico and Colombia.

At the same time, the Inter-American Investment Corporation (IIC), a member of the IDB Group, has pioneered investments in small-scale infrastructure projects throughout the region. Since 1989, the IIC has lent $51.9 million to 14 projects in transportation, warehousing, potable water, telecommunications and power generation. One noteworthy investment in 1992 (a $3 million loan and $1.4 million in equity) went to IMPSAT Argentina, a company that was then providing satellite-based data networks to corporate clients around Buenos Aires. IMPSAT was so successful that it subsequently expanded to Ecuador, Mexico, Peru, Venezuela and Colombia.

The IIC has also financed specialized private investment funds that target Latin American infrastructure projects. It contributed $5 million to the Latin American Energy and Electricity Fund (FondElec), a $50 million fund owned by six United States electricity companies, and late last year it placed an additional $5 million in FondElec Essential Services Growth Fund, a new vehicle that will invest up to $100 million over eight years in projects in the region.

In one of the most innovative IDB projects in the infrastructure sector, money did not actually change hands. In April 1997 the Bank approved its first-ever partial risk guarantee for private investors' for a wastewater treatment plant in Bogotá, Colombia. To reduce long-term contract and currency risks associated with operating the plant, the IDB guaranteed $30 million to senior debt note holders investing in the project, which is run by the Colombian subsidiary of the French water company Lyonnaise des Eaux.

"The Bank was able to do this because of its preferred creditor status," explained Blair Thomas, a former IDB official who served as team leader on the project. "When we cover these risks, we unlock the whole financial package and make it work." The operation represented the first guarantee ever granted by a multilateral institution for private sector financing in Latin America. It was also the first IDB private sector project in which a private placement of securities was used as the principal source of debt financing.

According to Vives, most private investment in Latin American infrastructure has come from foreign lenders, particularly insurance companies and banks. "Although welcome, these funds are still quite limited," he said. "A much bigger pool of potential investment capital is held by institutional investors [such as pension funds] in the industrialized countries that cannot invest in infrastructure because most of these projects are not considered ‘investment grade' by ratings agencies." Likewise, infrastructure projects in the region are only beginning to tap the international capital markets, primarily by issuing bonds, and less frequently through offers of equity, he added.

The best way to overcome the limited supply of foreign capital, according to Vives, is to improve the region's own capital markets and attract local investors. Consider the case of Autopistas del Sol, S.A., a consortium of Argentine, Italian and Spanish companies that owns a 23-year concession to operate a crucial access road to the city of Buenos Aires. The consortium complemented $133.3 million of its own equity in the project with $356 million in construction loans from local banks. Its 18-lane toll road, opened in 1996, was an immediate success, cutting commuting times from 2.5 hours to as little as 45 minutes for some 250,000 drivers. Investor confidence in Argentina's long-term economic prospects persuaded the consortium to refinance its debt last July by issuing bonds on the domestic and U.S. capital markets. The bonds, totaling $380 million, were rated BB- by Standard & Poor's and were snapped up by a combination of U.S. investors and Argentine pension funds. Under the terms of the concession, Autopistas del Sol must also hold an initial public offering of a 30 percent stake of its capital stock by August 1999, meaning that even small investors will have a chance to own a piece of the firm.

"That's the kind of creative financing that brings local money into local projects," said the IDB's Vives. "We hope to see a lot more of that in the future."