Knotter: 'We are very upbeat on working here'
Infrastructure-sector investments target energy, transport, telecommunications and district heating. New directions for the bank here include loans to finance municipal water and waste water treatment, setting up regional investment funds and a new contractual guarantee scheme aimed at stimulating private-sector investment in infrastructure, notably for the $8 billion motorway project.
Before coming to Poland in June 1994, Knotter mainly worked on World Bank activity in Latin America. He recently spoke with Stephen Kirkland and Michael Rey of the Business Journal about bank activity here. An abridged version of that conversation follows.
Q: So far, the World Bank has disbursed about half of more than $4 billion allocated to projects in Poland. What are the obstacles you face with project disbursement?
A: In terms of overall implementation, (Poland) is not bad. We have been in Poland, in terms of lending, for 5 1/2 years. The average implementation time for regular World Bank projects is about five years. The average portfolio in Poland is about three years old. So having disbursed 50% is actually not bad. Poland in terms of the World Bank is a new country. You cannot compare this for instance to Mexico, where we made our first loans in the late 1940s, where you have structures in place, many institutions and ministries and people who have been dealing with our type of operations for many years. Virtually all of our operations here are first-time operations with first-time borrowers. Clearly, once you get into the business of repeat loans things get a little easier. Also there have been several changes in government. What these changes have meant is not so much that there has been a major change in policy but also there have been significant changes in personnel to work for these projects. Just to get people up to scratch on what is going on, to get them familiar with procedures, is quite obviously a factor and one of the limitations.
Q: So the overall report card for Poland is "Pass"?
A: We had a lot of discussion on this in the context of our annual report on project implementation and ratings by countries. The ratings for Poland this year (since end of fiscal year, June 30, 1995) as against last year on implementation has improved significantly. This can be shown by one indicator. The disbursement ratio last year was about 33%. Now it's gone up to very close to 50%. So there is an improvement.
Q: While the World Bank has a mandate to promote the private sector, it channels funds through the public sector. How does the bank resolve the apparent dichotomy?
A: This is obviously a difficult question. According to our by-laws we can only lend to governments with the guarantee of governments. This, in turn, limits what we can do First of all, we are trying to restructure the government policy framework and (its) institutions toward the operation of a market economy. Virtually all of our adjustment loans are intended either to improve the legislative base, the regulations or the institutions. (For example), one of the limitations you have in Poland when you lend as a financial institution is inadequate collateral legislation. There is also an inadequate system of registries. We are supporting the establishment of three types of registries: land registries, company registries and registries of liens.
Q: While project guarantees to secure loans are nothing new, the World Bank has been working on a contractual scheme that could facilitate investment in large projects. What is the status of the scheme?
A: Legislation is very advanced. We have a draft framework agreement with the government. Essentially this is a scheme under which what would normally be considered political risk would be covered. We would guarantee, for instance in the case of the motorways, that the format for setting tolls would be adhered to, or that the government would not build a parallel road, similar things that are important to insure that a motorway project is going to be successful also financially. We would guarantee the conditions that in each case would have to be negotiated between the sponsor, the concessionaire, the government and the World Bank.
Q: Could this guarantee scheme have broader significance, for instance, in power-sector project financing?
A: This has had a long and very difficult history. Initially, the legislation was to be included in the motorway legislation. Then it was decided it shouldn't be limited to motorways. Once people in the Ministry of Finance looked into this, they said it was a great opportunity to, in effect, revise the whole government guarantee legislation. The progress of this new law has been relatively slow The framework agreement so far has three sections: one for motorways, a second for the power sector and a third for essentially municipal services - water supply, sewage, solid waste. Obviously we would not guarantee commercial risk. What you do is to guarantee the understandings you had when you appraised the project.
Q: When do you expect the guarantee program to be approved?
A: The latest I hear is March (this) year.
Q: Once this is in place, what kind of investment boost would you expect?
A: It very much depends on the specific project and the specific sector. By itself, the guarantee doesn't make a bad project any better. Clearly there is a lot of interest outside in these guarantees. These guarantees are not free of charge. So each lender will ultimately have to ask if it's worthwhile. We provide our guarantee to the government, in effect, at a cost of 0.25%. This means that we convert this (project) into a triple-A rating equivalent for whoever wants to lend. The government then will negotiate with the concessionaire in the context of what will actually be covered. We assume that the guarantee fee the government will charge the concessionaire will be anywhere from 0.4% to 1%. I think that by any stretch of the imagination this should be good business. They would just have their spread. In effect, they would be able to make a profit on it. And it's a profit on a risk that is entirely controlled by the government. It's not like other guarantees where, if the government provides guarantees, they guarantee in effect everything: commercial risk, force majeure, you name it.
Q: Could these World Bank guarantees be combined with World Bank loans to finance large-scale projects?
A: What we really want to do as a general proposition is act as a catalyst for financing and not provide very large percentages of financing ourselves. For instance, in the case of the motorways project, if all we have to do is provide a guarantee, that is what we will do. If there is also a need for lending we would consider this, but we are also very interested in getting others into co-finance operations with us. So, yes, we can use these instruments in any way. Also, World Bank loans have been in a basket of currency (pool loans) which our borrowers on occasion have found difficult to handle. We have now massively introduced what we call single-currency loans.
Q: While the 7% interest rate on hard currency loans is competitive, many say the requirement for guarantees makes the process cumbersome and adds to the cost of financing, in effect making loans much less attractive.
A: Clearly, if you have a pool loan and after two, three, four years you figure out the cost in dollars or German marks, in any one of the currencies, it may be significantly different. There have been periods of time where the cost of loans turned out to be higher or lower because of the difference between the pool and the single currencies. It may be significant depending on the composition ... Under the credit lines, we have left it to participating banks to evaluate the risks and set the rates in line with what they consider to be market conditions. Since the collateral legislation isn't really too advanced, there may be either perceived or actual risks that lead to these high spreads.
Q: What can the bank do?
A: It is very clear that on these, on lending operations where you use the banking system ... we do leave it to intermediaries to charge what they consider to be reasonable risk and premium.
Q: When do you expect a collateral law to be in place and the registries to be up and running?
A: I really don't understand what is holding up (the collateral law). There was a draft that we saw in March (1995) which seemed to be very much advanced There were very sensitive comments by the Ministry of Finance, because in effect the Ministry of Finance could attach so-called secret liens. Obviously if you want to lend to somebody and then, when it comes to recovery, you find out someone is ahead of you, this is not really a very nice situation. My understanding was that the Ministry of Finance, after long discussions on this point, had given up. From my discussion with bankers, they seemed less concerned about secret liens. That you cannot have first, second and third mortgages under the legislation seemed to be more important.
The project on the registries we assume we will be able to present to our board during the first half of this year. It is very advanced. The implementation of the first two components is in effect independent of the collateral law. The third component, which is registry of liens, will only make sense when the (collateral) law is in force.
Q: What is the World Bank's 1996 agenda in Poland?
A: There are several agendas. We call ourselves a bank, but I think we probably consider that our economic analyses and advice in institution building are probably more important than the financing that we provide. We are going to prepare a new economic report that will have two objectives. The last one looked at economic analyses and issues of poverty and economic equality. The next report will focus beyond the general economic analyses, on Poland's entry into the European Union. We also will be doing further work on certain sectors. For instance, we will see what is going to happen to pension legislation and reform or coal sector restructuring. We are working on about 30 new operations, which compares to 22 for the last five years. So if anything we are very upbeat on working here in Poland. The difference will be that the average size of these operations will be smaller than in the past.
In terms of specific projects that we may either be able to present to our board or will be advanced very significantly, I just mention the power transmission - the most recent one, approved for $160 million. We are getting involved in the geothermal area. We are working actually on three projects. In hard-coal sector restructuring, we have had extensive discussions over the last two to three years. If the program goes ahead that has been developed by the Secretary of State, there would be great opportunities for support. Also in this context of hard-coal restructuring, we have a major involvement in the government's task force for regional development. Out of this regional development task force, we think we are going to develop certain regional projects.
Then we have a strong portfolio in transport. We have appraised a port access and management project and there will be a second ports project. The two projects are overlapping. One is going to focus much more access roads and bridges to ports. The second is going to look much more on port's infrastructure. We have a series municipal water and waste water projects. The first one has been negotiated and should be presented to our board within the first three months of the year. We are working on others, for example, rural finance technical assistance and registry form laws If the government goes ahead with pension reform, social security reform, we would be prepared to support this through an adjustment operation.
Q: And in the area of privatization?
A: We are quite advanced on a project called post-privatization assistance. We would provide loan and equity funding to regional funds either existing or to be established to finance small and medium-sized enterprises, new ones or expansion of existing operations, including possible restructuring of debt.
Q: How much is targeted for this project?
A: We're talking tentatively about $100 million. At the moment there are a whole series of Warsaw-based venture capital funds. This project would essentially address a niche that is not covered with equity financing of about $250,000 to
$1 million, which is smaller than most of these funds would consider.
Q: How would these funds be set up?
There would be a process of almost competitive bidding. Certain regions - which means supporting voivods, major towns, financial institutions - would in effect invite bids by those who want to establish and operate these funds. There is some interest. What we would do together with other donors, for instance IFC (International Finance Corp.) would help provide some of the equity, we would provide long-term financing of these funds.
Q: Six, seven years?
A: No. In terms of our pool loans, the terms for Poland are 17 years with four years of grace. The terms for single-currency loans, depending on the currency, can be somewhat shorter These funds would be expected to provide venture capital services, helping companies restructuring. They would make investments most likely in existing companies (Overall) it would be like a credit line with clearly identified participants as far as venture capital and regional funds are concerned.
Q: So existing venture capital firms and banks could access these funds in the estimated $100 million credit line?
A: We will see. We assume that the regional funds, since we want to have very much a regional focus, will actually be operated out of certain regions and will be established there. We would assume from the outset only pre-identified, appraised regional funds would participate. The initial figure we have in mind is 3-5 funds. This is a kind of pilot operation. If this operation should be successful, then we would go back.
Before coming to Poland in June 1994, Knotter mainly worked on World Bank activity in Latin America. He recently spoke with Stephen Kirkland and Michael Rey of the Business Journal about bank activity here. An abridged version of that conversation follows.
Q: So far, the World Bank has disbursed about half of more than $4 billion allocated to projects in Poland. What are the obstacles you face with project disbursement?
A: In terms of overall implementation, (Poland) is not bad. We have been in Poland, in terms of lending, for 5 1/2 years. The average implementation time for regular World Bank projects is about five years. The average portfolio in Poland is about three years old. So having disbursed 50% is actually not bad. Poland in terms of the World Bank is a new country. You cannot compare this for instance to Mexico, where we made our first loans in the late 1940s, where you have structures in place, many institutions and ministries and people who have been dealing with our type of operations for many years. Virtually all of our operations here are first-time operations with first-time borrowers. Clearly, once you get into the business of repeat loans things get a little easier. Also there have been several changes in government. What these changes have meant is not so much that there has been a major change in policy but also there have been significant changes in personnel to work for these projects. Just to get people up to scratch on what is going on, to get them familiar with procedures, is quite obviously a factor and one of the limitations.
Q: So the overall report card for Poland is "Pass"?
A: We had a lot of discussion on this in the context of our annual report on project implementation and ratings by countries. The ratings for Poland this year (since end of fiscal year, June 30, 1995) as against last year on implementation has improved significantly. This can be shown by one indicator. The disbursement ratio last year was about 33%. Now it's gone up to very close to 50%. So there is an improvement.
Q: While the World Bank has a mandate to promote the private sector, it channels funds through the public sector. How does the bank resolve the apparent dichotomy?
A: This is obviously a difficult question. According to our by-laws we can only lend to governments with the guarantee of governments. This, in turn, limits what we can do First of all, we are trying to restructure the government policy framework and (its) institutions toward the operation of a market economy. Virtually all of our adjustment loans are intended either to improve the legislative base, the regulations or the institutions. (For example), one of the limitations you have in Poland when you lend as a financial institution is inadequate collateral legislation. There is also an inadequate system of registries. We are supporting the establishment of three types of registries: land registries, company registries and registries of liens.
Q: While project guarantees to secure loans are nothing new, the World Bank has been working on a contractual scheme that could facilitate investment in large projects. What is the status of the scheme?
A: Legislation is very advanced. We have a draft framework agreement with the government. Essentially this is a scheme under which what would normally be considered political risk would be covered. We would guarantee, for instance in the case of the motorways, that the format for setting tolls would be adhered to, or that the government would not build a parallel road, similar things that are important to insure that a motorway project is going to be successful also financially. We would guarantee the conditions that in each case would have to be negotiated between the sponsor, the concessionaire, the government and the World Bank.
Q: Could this guarantee scheme have broader significance, for instance, in power-sector project financing?
A: This has had a long and very difficult history. Initially, the legislation was to be included in the motorway legislation. Then it was decided it shouldn't be limited to motorways. Once people in the Ministry of Finance looked into this, they said it was a great opportunity to, in effect, revise the whole government guarantee legislation. The progress of this new law has been relatively slow The framework agreement so far has three sections: one for motorways, a second for the power sector and a third for essentially municipal services - water supply, sewage, solid waste. Obviously we would not guarantee commercial risk. What you do is to guarantee the understandings you had when you appraised the project.
Q: When do you expect the guarantee program to be approved?
A: The latest I hear is March (this) year.
Q: Once this is in place, what kind of investment boost would you expect?
A: It very much depends on the specific project and the specific sector. By itself, the guarantee doesn't make a bad project any better. Clearly there is a lot of interest outside in these guarantees. These guarantees are not free of charge. So each lender will ultimately have to ask if it's worthwhile. We provide our guarantee to the government, in effect, at a cost of 0.25%. This means that we convert this (project) into a triple-A rating equivalent for whoever wants to lend. The government then will negotiate with the concessionaire in the context of what will actually be covered. We assume that the guarantee fee the government will charge the concessionaire will be anywhere from 0.4% to 1%. I think that by any stretch of the imagination this should be good business. They would just have their spread. In effect, they would be able to make a profit on it. And it's a profit on a risk that is entirely controlled by the government. It's not like other guarantees where, if the government provides guarantees, they guarantee in effect everything: commercial risk, force majeure, you name it.
Q: Could these World Bank guarantees be combined with World Bank loans to finance large-scale projects?
A: What we really want to do as a general proposition is act as a catalyst for financing and not provide very large percentages of financing ourselves. For instance, in the case of the motorways project, if all we have to do is provide a guarantee, that is what we will do. If there is also a need for lending we would consider this, but we are also very interested in getting others into co-finance operations with us. So, yes, we can use these instruments in any way. Also, World Bank loans have been in a basket of currency (pool loans) which our borrowers on occasion have found difficult to handle. We have now massively introduced what we call single-currency loans.
Q: While the 7% interest rate on hard currency loans is competitive, many say the requirement for guarantees makes the process cumbersome and adds to the cost of financing, in effect making loans much less attractive.
A: Clearly, if you have a pool loan and after two, three, four years you figure out the cost in dollars or German marks, in any one of the currencies, it may be significantly different. There have been periods of time where the cost of loans turned out to be higher or lower because of the difference between the pool and the single currencies. It may be significant depending on the composition ... Under the credit lines, we have left it to participating banks to evaluate the risks and set the rates in line with what they consider to be market conditions. Since the collateral legislation isn't really too advanced, there may be either perceived or actual risks that lead to these high spreads.
Q: What can the bank do?
A: It is very clear that on these, on lending operations where you use the banking system ... we do leave it to intermediaries to charge what they consider to be reasonable risk and premium.
Q: When do you expect a collateral law to be in place and the registries to be up and running?
A: I really don't understand what is holding up (the collateral law). There was a draft that we saw in March (1995) which seemed to be very much advanced There were very sensitive comments by the Ministry of Finance, because in effect the Ministry of Finance could attach so-called secret liens. Obviously if you want to lend to somebody and then, when it comes to recovery, you find out someone is ahead of you, this is not really a very nice situation. My understanding was that the Ministry of Finance, after long discussions on this point, had given up. From my discussion with bankers, they seemed less concerned about secret liens. That you cannot have first, second and third mortgages under the legislation seemed to be more important.
The project on the registries we assume we will be able to present to our board during the first half of this year. It is very advanced. The implementation of the first two components is in effect independent of the collateral law. The third component, which is registry of liens, will only make sense when the (collateral) law is in force.
Q: What is the World Bank's 1996 agenda in Poland?
A: There are several agendas. We call ourselves a bank, but I think we probably consider that our economic analyses and advice in institution building are probably more important than the financing that we provide. We are going to prepare a new economic report that will have two objectives. The last one looked at economic analyses and issues of poverty and economic equality. The next report will focus beyond the general economic analyses, on Poland's entry into the European Union. We also will be doing further work on certain sectors. For instance, we will see what is going to happen to pension legislation and reform or coal sector restructuring. We are working on about 30 new operations, which compares to 22 for the last five years. So if anything we are very upbeat on working here in Poland. The difference will be that the average size of these operations will be smaller than in the past.
In terms of specific projects that we may either be able to present to our board or will be advanced very significantly, I just mention the power transmission - the most recent one, approved for $160 million. We are getting involved in the geothermal area. We are working actually on three projects. In hard-coal sector restructuring, we have had extensive discussions over the last two to three years. If the program goes ahead that has been developed by the Secretary of State, there would be great opportunities for support. Also in this context of hard-coal restructuring, we have a major involvement in the government's task force for regional development. Out of this regional development task force, we think we are going to develop certain regional projects.
Then we have a strong portfolio in transport. We have appraised a port access and management project and there will be a second ports project. The two projects are overlapping. One is going to focus much more access roads and bridges to ports. The second is going to look much more on port's infrastructure. We have a series municipal water and waste water projects. The first one has been negotiated and should be presented to our board within the first three months of the year. We are working on others, for example, rural finance technical assistance and registry form laws If the government goes ahead with pension reform, social security reform, we would be prepared to support this through an adjustment operation.
Q: And in the area of privatization?
A: We are quite advanced on a project called post-privatization assistance. We would provide loan and equity funding to regional funds either existing or to be established to finance small and medium-sized enterprises, new ones or expansion of existing operations, including possible restructuring of debt.
Q: How much is targeted for this project?
A: We're talking tentatively about $100 million. At the moment there are a whole series of Warsaw-based venture capital funds. This project would essentially address a niche that is not covered with equity financing of about $250,000 to
$1 million, which is smaller than most of these funds would consider.
Q: How would these funds be set up?
There would be a process of almost competitive bidding. Certain regions - which means supporting voivods, major towns, financial institutions - would in effect invite bids by those who want to establish and operate these funds. There is some interest. What we would do together with other donors, for instance IFC (International Finance Corp.) would help provide some of the equity, we would provide long-term financing of these funds.
Q: Six, seven years?
A: No. In terms of our pool loans, the terms for Poland are 17 years with four years of grace. The terms for single-currency loans, depending on the currency, can be somewhat shorter These funds would be expected to provide venture capital services, helping companies restructuring. They would make investments most likely in existing companies (Overall) it would be like a credit line with clearly identified participants as far as venture capital and regional funds are concerned.
Q: So existing venture capital firms and banks could access these funds in the estimated $100 million credit line?
A: We will see. We assume that the regional funds, since we want to have very much a regional focus, will actually be operated out of certain regions and will be established there. We would assume from the outset only pre-identified, appraised regional funds would participate. The initial figure we have in mind is 3-5 funds. This is a kind of pilot operation. If this operation should be successful, then we would go back.
