Intheblack magazine, July 2010

In late May, Juan Miranda was in the Afghan town of Mazar-e-Sharif, attending the inauguration of Afghanistan’s first railway. As Director General of the Central and West Asia Department of the Asian Development Bank, Miranda had been involved in the funding and development of this railway, a vital 75-kilometre link to the border with Uzbekistan and the international railway networks beyond. But as he stepped back to take a photo of the train moving slowly backwards and forwards on the tracks, he noticed a huge transmission line in the back of a shot, and a road behind it. He realised he had been involved in the development of all three.

When you are a multilateral banker in this part of the world, the work can be tough, but when it works out there’s the joy of seeing a tangible difference being made. And Miranda’s patch of Asia is all about high challenge and high reward. His department operates in 10 countries most of which few people could successfully locate on a map (and, if they could, it would be for all the wrong reasons): Afghanistan, Armenia, Azerbaijan, Georgia, Kazakhstan, the Kyrgyz Republic, Pakistan, Tajikistan, Turkmenistan and Uzbekistan. It is a patchwork of mostly landlocked countries with sometimes random borders, stubborn bureaucracy, limited commercial laws, dominated by mountains and deserts, into which Miranda must coax international private capital to invest.

The challenge is not just about getting foreigners to come in, but to get these disparate nations to work together too. One might expect the former Soviet states to be kindred spirits, but that’s often far from the truth. “After independence from the Soviet Union, these countries embraced sovereignty like you and I would a long lost brother,” Miranda says. “But as a result of that they created economic structures that were directed towards self-sufficiency and putting up borders.” The ADB is one of six multilaterals that backs the Central Asia Regional Economic Cooperation (CAREC) programme, which seeks to improve efficiencies between Central Asian nations, focusing on connectivity, energy security and trade facilitation. “The nearest port to some of these countries is 2,000 kilometres away,” he says. “Unless people can move from point A to point B efficiently, you’re not going to be very competitive.”

Miranda, CAREC and the ADB have focused their energies on transportation, and have devised six transport corridors, some north-south through Afghanistan and into Pakistan, others traversing Kazakhstan from east to west to link Europe and China. And this speaks to an advantage Central Asia does have: being in the way, separating Europe and China. Becoming an efficient conduit for goods between these states will be to Central Asia’s benefit, and will cement a shift away from reliance on Russia and towards greater integration with China. Other less visible things are no less important: trade facilitation, such as removing tariffs and speeding up the flow of goods across borders, is crucial to the ADB realising its ambition of doubling per capita income within the region within a decade, pulling poverty down from 40% to 25% in the process.

The good news is that when something works, it really has an impact. That transmission line in the back of Miranda’s photo in Afghanistan runs from Uzbekistan to Kabul, and supplies it with constant electricity for the first time. “Delivering electricity 24 hours a day instead of two hours a day is a transformation,” he says. “It’s not a solution in itself, but it’s a means to an end.” By this he means that helping with infrastructure makes it a little easier for Afghanistan to find its footing as a country. “Optimism is something that can come and go, but we have to let it be with us,” he says. “You’ve got to wake up in the morning thinking that you’re doing good. The task is not for the faint-hearted and the security aspects are not getting any easier but I am optimistic this resilient country, these resilient people, can put things together.”

“The political differences between groups across the country are clear, but one thing that binds them together is to reconstruct the nation, and to do that you need development,” he says. “We are part of that agenda, to do projects that will make a little difference to the country.”

Elsewhere in Central Asia, the ADB has been making gradual headway. Talking to IntheBlack at the ADB’s annual meeting in Tashkent, Uzbekistan in May – the first time the bank had held its meeting in Central Asia – Miranda bemoaned the lack of a landmark public-private deal that would get the region truly noticed. “We haven’t had in Central Asia the unique transaction that says: the future looks like this,” he says. “If one happens, we’ve created a message. We convey an opportunity to the international investment community that this place is open for business.”

A month later, over the phone in the ADB’s Manila headquarters, he is able to suggest that such a deal is finally close to the finish line. The $3.2 billion Surgil project in Uzbekistan will involve the construction of a petrochemical plant with a production capacity of more than 500,000 tons of polypropylene and polyethylene, made by converting gas deposits. It will be structured as a PPP (a public-private partnership) and will combine a number of foreign investors – who have not yet gone public in their involvement – with the Uzbek state oil and gas company, with the management and the exports run by international shareholders. “In turning gas into chemicals it moves a commodity into a value-added product with an international market ready-made,” Miranda says. “If it works well, instead of just exporting their gas they can get foreign investment into the country and generate jobs.”

Getting foreigners in requires more than just a visible opportunity. What’s also lacking is the legal infrastructure to protect and encourage an investor. “In Central Asia we have the big ticket projects waiting for the private sector to invest, but unlike other parts of Asia the upstream work lags behind,” he says. There are places where concession laws do exist – Kazakhstan has gone so far as to build a dedicated PPP unit within its government and has an approved list of projects for it to pursue – but few foreigners have so far been willing to jump in. “There is a comfort zone that is not that huge here, and we need to expand that comfort zone.”

Uzbek landmarks apart, he thinks it’s important to be reasonable in expectations. “Would you be able to have an all-singing, all-dancing concession and BOT [build-operate-transfer, the classic public-private model in more developed markets]? Maybe not right now. Maybe you go in more realistically and expect a management contract to start with. If you go from zero to something that’s no longer zero, that still represents success.”

Miranda himself, who is Spanish-born and English educated with a degree in agricultural economics from Reading University, first visited Central Asia in 1992 after the Soviet Union was dismantled. Back then he was working at the European Bank for Reconstruction and Development. When he took over his current department for the ADB in 2006, he felt that he had “a longer memory of the region” thanks to his earlier role, and he remembered its potential. “They have the things that everybody should want: a growing market, investment opportunities for regional and international players, and an area strategically as important as most. It is an area with rich traditions but is landlocked and needs to be integrated into the world economic system.”

Miranda’s career has involved plenty of private sector work between the multilaterals: at once stage he set up and managed his own project finance boutique investment bank that he later sold to Morgan Stanley, becoming a senior executive at the US powerhouse as well as a stint in a Spanish investment bank. People who have sold their own banks to Morgan Stanley don’t generally need more money, and one suspects he is drawn to this ADB role, with its dismal flights and endless visa queues, out of a sense of duty. “Central Asia has the importance and that thrill where things are yet to be done,” he says. “As a development bank we like to be involved with change.”

And, once in a while, there’s a visible reward. That Afghan railway, the first in the country’s history, built across unforgiving topography in a nation at war? It was finished ahead of schedule.

BOX: Out of Hours

What are your interests?

Lots of them – music, sports; I play golf well enough to beat most of my colleagues. I like classical and jazz music and I like to watch football – I’m a long-standing fan of a team called Deportivo La Coruna. I’m happy to report to you that we beat Manchester United twice.

What words do you live by?

Accountability and responsibility.

What keeps you awake at night?

The happiness and health of my healthy and happy children.

What are you reading?

Henry Kamen’s Spanish Empire. It argues that the empire could well have been the first big example of globalization and outsourcing!

If you want to get a sense of the challenges facing Central Asian trade, take a look at a map. Landlocked countries, some of them with at least two other nations between them and the sea in any direction; harsh terrain; and intricate, apparently random Soviet-era borders, often drawn without regard for communities or trade routes. “The nearest port to some of these countries is 2,000 kilometres away,” says Juan Miranda, Director General of the Central and West Asian Department at the Asian Development Bank. “Unless people can move from point A to point B efficiently, you’re not going to be very competitive.”

The CAREC programme – for Central Asia Regional Economic Cooperation – aims to help create this efficiency. It includes eight countries – from Azerbaijan in the Caucuses, across Kazakhstan, Kyrgyzstan, Uzbekistan and Tajikistan, plus Afghanistan to the south and Mongolia and China to the east – and is backed by six multilaterals, including the Asian Development Bank, which serves as secretariat to the CAREC Institute. “The programme aspires to find ways for countries in the region to work together for the good of all,” Miranda says. Specifically, it tries to work in three main areas: connectivity; energy security; and trade facilitation.

Part of the challenge is historical, Miranda explains. “After independence from the Soviet Union, these countries embraced sovereignty like you and I would a long lost brother,” he says. “But as a result of that they created economic structures that were directed towards self-sufficiency and putting up borders – economic borders. CAREC is about doing away with those.”

The most practical illustration of this is in building roads to enable goods to move. And here, the region does have one geographic advantage: it’s in the way. It separates the powerful blocs of Europe and East Asia, and if it can become an efficient conduit for the goods moving from one region to the other, then Central Asia should benefit.

The program spent more than US$2.5 billion on the transportation field alone last year. It envisages six transport corridors: one traverses Kazakhstan to link Europe and China; another links East Asia to the Mediterranean through the Caucuses; others go north-south, connecting the region through Afghanistan and Pakistan. It’s not all roads: the program is backing a rail link between Hairatan, on the Uzbekistan border, and Mazar-e-Sharif in Afghanistan. Here, an Uzbek company – the national rail utility, Uzbekistan Temir Yullari – is handling the construction in Afghanistan in exactly the sort of regional cooperation the ADB wants to see more of.

The program’s ambitions on energy embrace security, efficiency and trade. The idea here is to ensure balanced development of energy infrastructure and institutions in the region, with better integration of energy markets themselves. An example is a new transmission line from Uzbekistan to Kabul. “Today, it supplies Kabul with 24 hours of electricity a day,” Miranda says. “Ten months ago if you went to Kabul you would only get two hours a day. It has been transformational: it has helped business and people.”

Trade facilitation, while less visible than a road or a power station, may prove to be the most important of all, and the toughest to effect. If it works, some of the ADB’s grander ambitions – that increased regional cooperation could double per capita income in the region within a decade, and pull poverty down from 40% to 25% in the process – become realistic. “Cross-border activity is critical,” Miranda says, “especially when many countries are landlocked.” He estimates that within the next 10 years five to 10 per cent of Eurasian trade will take place through the various corridors the program is working on – but that’s only going to work if, to go with the new roads, there are streamlined border and customs processes to go with it. “We cannot only focus on the hard infrastructure: the roads being safe and well paved and maintained. We also have to focus on border arrangements so there are fewer delays on the borders. At the moment it takes too many days; we have to bring it down to several hours.”

Getting the cross-border side going requires not only cooperation but trust. “We have to build confidence between the countries again,” Miranda says. Efforts in this area include customs reforms and modernisation, such as harmonised and simplified procedures and automated systems; and integrated trade facilitation, with the adoption of a single window scheme to streamline transport, trade logistics and customs. There will also need to be reforms to create sound legal frameworks and regulatory environments in order to give the private sector confidence to come in and invest.

When IFR Asia spoke to Miranda Kyrgyzstan was in the headlines following the coup there, but in fact – Afghanistan apart – the region has been reasonably peaceful. “We’re very sorry to see the events in Kyrgyzstan but we haven’t generally had political instability – in fact there has been considerable stability,” he says. He hopes it won’t put off investment and that people will be able to distinguish one market from another. “Many countries are opening up and looking for investors and financiers,” he says. “The investment requirement is high and the opportunity is high.”

For many years now, the Asian Development Bank has being trying to coax the private sector to take a leading role in its projects and initiatives. The logic is straightforward: the ADB’s own assets as a lender are finite and inadequate for the social and infrastructure challenges the region faces, but if the bank can be a catalyst for private sector investment, then impossible funding targets become potentially achievable.

Last year the ADB put out a book, Infrastructure for a Seamless Asia, which argued that between 2010 and 2020 Asia needs to invest approximately US$8 trillion in national infrastructure, as well as $290 billion on specific regional infrastructure projects in transport and energy. On the flip side, it argued that if this happened, “developing Asia’s real income during that period and beyond could reach $13 trillion.” This contention – that if you spend money, you will make money – is the message the ADB must get across to the private sector.

How’s it done so far? “As a bank I think we’ve made tremendous progress both from the perspective of real investment, and catalysing additional investment in the region,” says Philip Erquiaga, director general of the Private Sector Operations Department of the ADB. Firstly, the bank has “ramped up our operations rather dramatically” in pure dollars and cents commitments, Erquiaga says. “Back in 2001 we were doing less than $100 million a year [private sector operations] in terms of approvals; last year we were close to $1.7 billion, with $1.8 billion anticipated this year.” By 2020, the bank hopes that engagements in private sector development will account for 50% of approvals.

Alongside that, the ADB has put heavy resources into what Erquiaga calls “upstream work” – creating the right environment for private investment, from company law and land registration to adjudication. Another challenge has been capacity. “If there is one lesson we have learned in dealing with the private sector in our operations, it’s that they don’t want the rules of the game to be changing on them midway through their investment. To ensure that does not occur you need to establish the right environment and to ensure that a PPP is staffed with the right people with the right competence.”

Since the ADB can only ever take a 25% role in the financing of a project, it has necessarily moved from being a banker to a broker. “It’s in our nature to act as a broker to make sure the deal gets done,” Erquiaga says. This, though, has changed as a consequence of the financial crisis: these days the ADB finds itself putting a lot of deals together with other international agencies, rather than with commercial co-financing. When the New Bong Escape hydro plant in Pakistan, the country’s first run-of-river hydro development, was financed last year, the ADB was alongside the Islamic Development Bank, IFC and Proparco, the French development finance institution. “Otherwise the financing would not have been available,” Erquiaga says.

Hopefully, though, that retreat of the private sector is temporary, and in the meantime the ADB continues to try to provide the facilities to keep them interested, such as political risk cover, partial credit cover – a guarantee can cover as much as 99% of credit on an individual transaction – and simply the ADB’s own participation. “A lot of people look to us for the halo effect,” says Erquiaga. “The fact that the ADB is involved in a transaction, with our close relationships with governments and so forth, means there are fewer instances of the rules of the game changing midway through.”

For many years the ADB has used a funds model to try to attract investment. The bank has been active in private equity since 1983, and today has 40 current funds, covering about 400 individual portfolio companies, with around $720 million of total current commitments.

Again, the ADB is held to a 25% limit on fund participation, but funds are one area where the catalytic effect of the ADB is easily measured. “If we look across the entire portfolio since 1983, we see that for every one dollar we have put into a fund, approximately eight is raised elsewhere,” explains Robert van Zwieten, director of the private sector capital markets division at the ADB. “That’s a huge effect and amplifies the impact we could have with our own resources.

“It’s far beyond what we ourselves could muster. The multiplier effect continues as funds then take minority equity stakes in portfolio companies.”

For much of the decade the focus was exposure to the SME and infrastructure sectors. “Those are widely seen to be a huge source of employment, and jobs are a conduit for poverty reduction,” says van Zwieten. From 2007 the department’s view broadened, with more activity in areas such as microfinance, clean energy and water, and socially responsible investing, as well as an increasing focus on frontier markets “where private equity is nascent or non-existent.”

The change of focus brought a shift in approach too: in clean energy the bank struggled to find suitable investable funds in late 2007, so stepped up to incubate some itself. That process entailed an RFP process that attracted 19 bids, five of which were accepted, and today they are “only just coming to the starting line, due to the harsh fundraising climate for such novel funds in 2008 and 2009.”

Hopefully these funds will, in time, be free-standing. One fund manager the ADB has long backed approached van Zwieten recently saying they hoped to start a fourth fund, and raise $700 million through it. “These follow on funds are getting a lot of mainstream institutional investors coming to the fore, which is exactly how it should be – but if they can do that, there’s no role for us,” van Zwieten says. The ADB’s own capital is better deployed in those that have yet to develop such traction.

The global financial crisis required decisive thinking from regulators, governments and institutions worldwide, but none more so than the World Bank, IMF and the World Bank’s finance arm, the International Finance Corporation (IFC). A decade ago, these groups were instrumental in trying to turn around Asian economies during the financial crisis there, and they were widely criticised for some of the measures they took. This time around, how did they do?

The headlines fell to the IMF by dint of the enormous sums involved, and the public nature of their announcement. In April, when the G20 group of leaders spoke of committing $1.1 trillion to combat the financial crisis, the bulk of it – $750 billion – was pledged to be delivered through the IMF, representing a trebling of its lendable resources. The institution’s emphasis appeared to be on building its power to act: as Andrew Tweedie, the director of the IMF’s finance department, put it in the IMF’s own in-house magazine, the IMF built bilateral borrowing arrangements “to strengthen its lending war chest to combat the ongoing global economic crisis”.

The IMF approach had some interesting elements, particularly the $250 billion allocation of a reserve asset called Special Drawing Rights. In July the IMF’s executive board approved a framework for the issuance of IMF notes to member countries and their central banks, as a method of raising funds and – the IMF says – providing members with a secure investment. Additionally it has expanded credit agreements, increased concessional lending to very poor countries, brought forward a review of the fund’s country quotas, and is considering revising its own investment mandate with a limited sale of gold holdings to create an endowment to generate income.

But one could argue most of the interesting things about the IMF, chiefly reform, are still to come and not yet really up for review. Instead, when it comes to individual, technical programmes, many of the most interesting policy initiatives relevant to financial markets came out of the IFC, part of the World Bank group. All told, its programmes designed to help private enterprises cope with the crisis are expected to involve more than US$30 billion of financing over the next three years – not all of it from the IFC, but in combination with funds mobilized from governments and other financial institutions. That is in some sense the point of the IFC: not to put a vast balance sheet on the line in isolation, but to use it to draw in other sources of funds.

From that perspective, the most obvious cause for alarm at the outset of the financial crisis was trade. Trade is, as the IFC has frequently said over the last year, “the lifeblood of the global economy”, and it was immediately under threat. As capital moved towards lower-risk assets, it left emerging markets, with trade finance lines being cut in some of the areas that needed it most.

The IFC already had a Global Trade Finance Program, basically a one-off guarantee facility which did not deploy funds for trade but did provide support in the form of guarantees in order to make sure emerging market trade transactions would still go through. So its first step was natural: it doubled the size of this programme, from US$1.5 billion to US$3 billion, in December 2008. But something strange happened.

“We thought when we doubled the programme there would be immediate uptake across the markets,” recalls Scott Stevenson, manager of the Global Trade Finance Program at the IFC. “But when we made that increase the immediate uptake was much less than was anticipated.” Banks had pulled back all their own capital, and in Europe they were further constrained by the arrival of Basel 2 with its heavy risk weighting towards emerging market exposure. “It was a convergence of negative effects, but it meant that global liquidity collapsed – not only the interbank market, but liquidity available for trade finance.”

What was needed was not the guarantees, but the pool of funding in the first place. “When we saw the market dry up like that we started fishing around for what we could do,” says Stevenson. “It was not just a drying up of liquidity but the entire secondary market, because the investors who would traditionally be buying up the securitized trade portfolios had put their tails between their legs.” So the IFC’s next step was to build what it calls the Global Trade Liquidity Pool, which among other things was a sort of synthetic secondary market. At that point, the World Bank was estimating that the gap in the liquidity in the system, between what was there and what was needed, was between $200 and $400 billion, clearly beyond the remit of the IFC balance sheet or anyone else’s in isolation. The idea was instead to partner with governments and development institutions to pool resources, and then to get the banks themselves involved: “established international players with footprints in emerging markets, who had liquidity but not the secondary market to churn their portfolio,” Stevenson explains. The banks would create portfolios, the pooled IFC fund would purchase 40% of them, and the banks retain 60%. IFC’s own contribution to the fund was $1 billion, additional donors $3 billion, and the involvement of the international banks is intended to put a further $6 billion to work, making a $10 billion programme.

It took time, but by April the World Bank was able to announce that the UK, Canadian and Dutch governments were all involved, and that the first two lines, of $500 million and $400 million, would go to Standard Chartered Bank and Standard Bank respectively (in Standard Bank’s case as a full loan rather than the 60/40 arrangement, since Standard’s extensive networks in Africa were deemed vital). Since then Citigroup and Rabobank have agreed terms, while Commerzbank and JP Morgan will be next.

The theory of the scheme was widely supported, with criticism instead focusing on the length of time involved to get it running. The IFC funds were put to work at the end of June and the commitment for donor funds is in place, but at the time of IFR’s interviews, in early September, disbursement of the pooled funding had still not taken place, although it may well have done so by the time this article is published. “I think the lesson learned is that in dealing with public sector counterparts, a lot more time is necessary in terms of response,” says Stevenson. While private sector institutions were, he says, the ones who pushed the programme, “from the donor side you do get into the machinations of governments, and that’s the slower part.”

Although the global markets have clearly improved dramatically in the meantime, Stevenson has little doubt the funds will still be necessary. “Because of the advent of the increased capital rules that Basel 2 is demanding, a lot of the major banks are still constrained in terms of what they can do in higher risk countries of the world,” he says. “That really is the focus at IFC as well as other donors. First tier banks are fine and seeing liquidity come back into the market. But second and third tier banks in those countries, for them, liquidity has not returned.” In fact, he has no doubt that additional funding is going to be necessary. “If you look at the overall ability to respond to the shortage in the market, this is – I don’t like to use the term – a drop in the bucket.”

While it would obviously have been preferable to see funds deployed faster, a benefit that may have come from the process is an unprecedented level of cooperation among world bodies. “This was a crisis that was well beyond what anybody would have imagined,” says Jyrki Koskelo, vice president for Europe, Central Asia, Latin America and the Caribbean, and global financial markets and funds, at the IFC. “It forced everybody to work together. Some of these initiatives helped us and the international community to align our interests, and when we worked on that basis the damage was contained a bit more than if the IFC had done anything alone. A lot of it is signaling to the market: this is what happens in a crisis, and this is what had to be done.”

While trade and liquidity were among the most visible problem areas, there was plenty else to worry about too. Another example was microfinance, which in a relatively short time has become absolutely vital. According to Martin Holtmann, who heads microfinance for the IFC, there are believed to be about 140 million households in the world that have access to microfinance credit, and a much larger number who have access to micro savings. Many of these institutions, and the people who borrow from them, faced a double hit within the space of the year, first with the vast food price rises in 2007, and then the financial crisis. Deposit-taking microfinance institutions, excepting some problems in Eastern Europe and particularly Ukraine, came through the crisis largely unscathed and in some cases enhanced by the run on commercial bank deposits. But those that exist chiefly to provide credit faced a serious liquidity crunch. “Take a country like Bosnia,” says Holtmann. “There would normally be commercial banks providing funding to the MFIs [microfinance institutions] but that supply has totally disappeared, creating a liquidity issue. You wouldn’t call it a crunch, because MFIs like any other prudent institutions had secured medium term financing, but eventually you hit the rollover risk, and certainly that’s happening in certain parts of the world.”

So IFC set up a $500 million facility, the Microfinance Enhancement Facility, with the German development bank KfW to support microfinance institutions facing refinancing difficulties. It aims to support more than 100 institutions in up to 40 countries. “The top 150 microfinance institutions in the world account for roughly 70 to 80% of the total supply out there. That’s essentially the group this facility is targeted at,” says Holtmann. At the time of our interview about $140 million of funding had already been approved, mostly in the area covering Eastern Europe and the Balkans, and Latin America. (Perhaps surprisingly, African institutions suffered less in the crisis, partly because they have tended to have more access to deposits, and also because the crisis had less of an impact on African than it did in, for example, Eastern Europe).

As elsewhere, things have already improved, but Holtmann says it is “too early to cry victory.” He sees quasi-commercial investors coming back into the market, but “a creeping up of portfolio at risk – a slow deterioration of loan portfolio quality.” Even so, this is not so bad compared to many retail banks since the default rate on microfinance portfolios is often strikingly low, although he says institutions in Bosnia, Morocco and Ukraine are on the watch list. In some cases, there is a need for capitalization, and part of the IFC’s role is to provide the right instruments for that, whether equity infusions or subordinated debt.  “When the crisis hits you first and foremost need liquidity, you don’t worry so much about solvency,” he says. “In the long run of course you do have to worry about solvency, but the moment you’re illiquid, you’re dead.”

One interesting element of the microfinance response is that the facility is managed externally, by BlueOrchard Finance, responsibility Social Investments and Cyrano Management, all specialist fund managers. This, Holtmann says, increased the capability. “Last  year we did 33 transactions in microfinance. With these fund managers we can triple, quadruple the number of transactions.”

Another vital area requiring a response was infrastructure. “In several countries in the world today which are developing infrastructure projects are funded only partially with a long term debt structure with quite a bit of it based on rollover maturities,” says Koskelo. “When that [the ability to roll over debt] stops, the good infrastructure projects get stopped as well.”

Usha Rao-Monari, senior manager in the infrastructure department at the IFC, recalls: “A number of projects had come to the market for financing and were not getting it, and in a number of other projects preparation was stopping because of fears that they wouldn’t get long term debt.” She recalls from the Asian financial crisis how banks can back away from this capital-intensive, long-term sector; “it ended up becoming what is known as the lost decade for infrastructure in Asia. We did not want to repeat that.”

The response here was the Infrastructure Crisis Facility, which has debt and equity components. The debt side had raised US$2.4 billion when announced in April and Rao-Monari hopes by the annual meeting in Istanbul in October another $700-800 million may be in place. Then on the equity side, $1 billion is targeted; IFC has approval to put in $300 million of its own balance sheet on the equity side and up to $2 billion in loan co-financing. But – once again – as yet, none of it is deployed yet. “We already have a pipeline of projects waiting for it to be set up and we will start putting money up almost instantly,” Rao-Monari says. Her hope is that, when funds finally do get put to work, “it will send such a huge signal to the market we are going to be deluged by projects. There is stable financing available, Mr government representative and Mr private sponsor, so don’t worry about building projects.”

Then there’s agribusiness. During the 2009 financial year IFC invested $2 billion – a record – across agribusiness, through the supply chain from farm to retail, to boost production, increase liquidity and improve logistics, as well as increases access to credit for small farmers.

Elsewhere, the IFC Capitalization Fund was launched with $1 billion of the IFC’s money and $2 billion of Japan’s, through the Japan Bank for International Cooperation, in order to provide additional capital for banks in developing countries, in subordinated loans or equity investments. Here, too, little has been dispersed, although the first investment took place in Paraguay’s Banco Continental, with a US$20 million contribution.

And IFC is also planning a private sector programme to take on and resolve distressed assets.”If you look at the NPL rates in Eastern Europe, there are horrible projections about where they might end,” says Koskelo. “We’ve tried to prepare ourselves for that. We haven’t signed individual NPL platforms yet but we do expect to sign some of the first vehicles for NPL funding soon.”

The capitalization fund in particular is an area that looks like shutting the stable door after the horse has bolted, with the financial environment now much improved, but Koskelo says there is every need for such a facility. “Unfortunately the capitalization needs are pretty much in line with what we expected,” says Koskelo. “There’s a significant uptick of demand today. There was a limited need about six months ago, because the crisis had not yet hit the banking sector properly through NPLs. Today, the pipeline of banks requiring capitalization is unfortunately increasing.”

Apart from criticism of the time taken to get things moving, NGOs have focused concern on the increased power of the IMF without a change in its policies. Speaking of the IMF funds, Peter Chowla of the Bretton Woods Project noted in August: “This substantial amount of resources may never be provided, and, if it is, may not have the intended positive effect on developing countries. Experience so far demonstrates that the IMF is still imposing damaging pro-cyclical conditions on some borrowers, and that the finance provided to low-income countries will be too small.” Chowla noted that by early July only $100 billion of the $500 billion of new lending that was supposed to come through the IMF had actually been signed off.

At Third World Network, another NGO, Bhumika Mucchala has argued: “At a time when devastating financial and economic crisis is calling into question the governance and policies of all the major institutions that constitute the existing international financial order, the IMF appears to have escaped any such major reevaluation…. The IMF, now financially reinvigorated with a fresh infusion of funds, is still pursuing some of its discrete policies.” Like Chowla, Mucchala wanted to see reforms in lending instruments, conditionality and policies “toward more even-handed and broad-based implementation which better meets the needs of its developing-country members.” Mucchala sees a contrast between loan conditions – for example, advising a reduction in Pakistan’s deficit through lowering public expenditure and removing energy subsidies; or, in Hungary, freezing public sector wages and placing a cap on pension payments – and the rhetoric of officials calling for fiscal stimulus programmes to boost demand and consumption. To this point Mucchala quotes the IMF’s wording in a $532 million loan to Serbia: “Anything less than a tight fiscal stance could… jeopardize the credibility of the programme in the eyes of foreign investors and the Serbian public.”

The charge that the IMF has opportunistically bolstered its own standing through the crisis is occasionally leveled at IFC too. Bretton Woods Project in July noted that the crisis had given the IFC an expanded role “but its methods may leave a bitter taste with civil society.” The NGO argues that the liquidity deals with Standard Chartered and others “likely subsidises their activities in the sector”. Bretton Woods is also uncomfortable with the formation of the IFC Asset Management Company, which will buy shares in emerging markets companies and will initially manage the capitalization fund, as well as a $1 billion private equity fund, with the intention of attracting third party funds such as national pension funds and sovereigns. Bretton Woods is not alone in this: Aldo Caliari from Center of Concern, another NGO, has said: “Access to credit [for developing countries] has traditionally rigged the playing field against developing country companies. Now, instead of fixing those asymmetries, this device will allow foreign investors to help themselves to any company they might have in their sights, bearing little or no risk, courtesy of IFC-provided public money.”

If you want a microcosm of the bad habits global capital got into as the credit crunch hit, go to Brisbane. The story of Brisconnections there has everything you need, and its conclusion – unresolved at the time of writing – will have major ramifications for the way infrastructure is funded in Australia and beyond.

BrisConnections was set up by Macquarie Capital Group and the construction firms Thiess and John Holland to design, build, operate and finance a A$4.9 billion airport toll road in Brisbane, under a 45-year concession awarded by the state of Queensland in May 2008. BrisConnections floated two months later at A$1 a share, lost 60% of its value in a day and by November had hit one tenth of an Australian cent, the lowest possible price on the Australian Securities Exchange. The A$1.2 billion float, underwritten by Macquarie and Deutsche, used an instalment model in which investors paid A$1 up front, with two more payments to come in subsequent years, meaning they remain on the hook for two instalments which will each cost 1,000 times more than the trading value of the stock today.

How did it get to this? There are many components to the BrisConnection story and they all speak to the way infrastructure has become commonly funded in western markets.

The wrong assets for listed markets. When infrastructure first started to make its way to stock market investors, it was typically when a government sold an operational power plant or road: a tangible asset, throwing off consistent cash, and something you could go and see if you felt so inclined. BrisConnections was typical of a trend to list projects that were not yet built. “Listed markets are a natural home for assets when they’re more mature and yielding,” says Lachlan Douglas, director of Principle Advisory Services, which structures private market investments for institutional investors. “They don’t tend to go a good job of being a home for assets going through significant transformation, and there’s no greater transformation than when the thing’s being built.”

Worse, retail investors who in Australia had come to see infrastructure as a safe haven failed to note the difference and thought they were buying a cautious yield play. Nor did they ask where dividends could be coming from when there was no asset yet to generate them: the answer was from borrowings. These things get away in the good times but as BrisConnections was launched at a time of quickly changing attitudes to debt, institutional investors (including Macquarie itself) quickly jumped ship, triggering the share price falls and putting most of the stock into retail hands.

Financial engineering. The source of the dividend was only one example of common financial engineering structures that have since backfired. The most obvious was the instalment method.

People buying into the float knew clearly that there would be three separate payments of A$1 each, a year apart, and while the method is unusual it is certainly not unheard of. The problem was that some small investors in the secondary market don’t appear to have realised this and inherited huge obligations when they bought in. One investor spent A$600 on the stock at 0.3 cents per share without realising that doing so committed him to A$400,000 of subsequent instalment payments. Others are up for millions. So it was that a housewife called Fang He found herself becoming the biggest individual shareholder in the company by mistake, followed more recently by a 26-year old Melbourne entrepreneur called Nick Bolton, a lank-haired bohemian figure in designer stubble and a beanie. (The sting in the tale was that Bolton used his shares to launch a series of motions to wind up the company in order to get out of paying the later instalments – then at the last moment sold his voting rights to the contracted builder, Leighton, for A$4.5 million and voted all his shares against the very resolutions he had proposed.)

At the time of writing it was still not clear if Macquarie and Deutsche were going to pursue small investors for the later instalments, suffering the crushing PR of putting people out of their homes by doing so, or wear the costs of the shortfall on the two scheduled A$390 million raisings themselves by taking the vehicle private.

October is going to be a big month for Papua New Guinea. It doesn’t sound much on paper: it’s the deadline for the final investment decision on a liquefied natural gas and pipeline project. But it’s a project that will change the country dramatically – economically and socially. In fact, it’s hard to think of another example anywhere in the world where so much, good and bad, might depend on a single investment decision.

The project in question is known as PNG LNG, and it is an attempt to commercialise undeveloped petroleum and gas resources in the highlands and western provinces of Papua New Guinea. The gas has to go through a 470 kilometre pipeline across rugged terrain to a liquefied natural gas facility 20 kilometres outside Port Moresby, the capital, for liquefaction; once there, about 6.3 million tonnes of LNG product a year will be loaded into tankers to be shipped to offshore gas markets worldwide. ExxonMobil, with its Esso Highlands subsidiary as operator, is the driver of the project with a 41.5% interest; also in there are Australia’s Oil Search (34%) and Santos (17.7%) and Japan’s Nippon Oil (5.4%) among others, with the PNG state expected to join as an equity participant at a later date.

The numbers attached to this project are extraordinary in any context, but particularly so in an economically small country where 85% of the population exists on subsistence agriculture. The development costs are put at between $11 billion and $14 billion, figures confirmed to Euromoney by the Investment Promotion Agency (IPA); once completed in 2013 or early 2014, it is expected to double Papua New Guinea’s approximately $12 billion GDP.

The consortium signed a gas agreement with the Papua New Guinea government in May and has since moved to what is known as the front end engineering and development (FEED) part of the project – a sufficiently big step that many seem to think the project’s development is now a foregone conclusion. “They are spending $400 million on FEED, so it would be silly to spend that kind of money and not have the project go ahead,” says Ivan Pomaleu, who heads the IPA. One foreign banker says he senses “100% certainty among local people that it’s going to happen.” But in truth it won’t be until October that the deal is confirmed. “That’s basically the point where we say yes, no or defer,” says Pomaleu. “That’s the moment when we can say: yep, we have a project; no, we don’t have a project; or we will have a project but not immediately. It’s a big project and we want to be sure.”

So big that those involved tend to use great understatement in describing it. “The scale [financially] will depend on commodity prices but if it doubles our current GDP, that’s quite big,” says Simon Tosali, secretary for the department of treasury. “It will be the biggest project this country has ever undertaken in its 34 years of independence. So it’s going to be quite big.”

The knock-on effects will be varied, and not entirely to the good. An increase in wealth on this scale obviously has enormous potential for budget revenues and the ability to fund badly needed spending on schools, hospitals and roads, among other things. There’s also the demonstration effect to consider: if a project like this is shown to be not only possible but practical then a host of other possibilities come to the surface in this remarkably resource-rich country. But there are real questions about Papua New Guinea’s ability to cope with this sudden influx of money and development. “There is already a strain on all infrastructure: telecoms, security, power, skilled labour,” says one banker. “There are lots of business opportunities but the capability of the local market to provide that support is already sorely tested.” Foreign banks – there are three of note, the Australians Westpac and ANZ and the Malaysian Maybank (Malaysia is the most active foreign nation in Papua New Guinea, particularly in areas like forestry and palm oil) – should stand to do remarkably well out of the development of Papua New Guinea, using their own global or regional networks to help serve the multinational companies who are coming in. But it’s the on the ground presence, from the 7500 construction workers required for PNG LNG, to the hotels and schools they will need and the roads they will drive on and the power for their businesses, to the local accountancy and legal professions, that are really going to be under stress.

You had to go a long way in September to find anyone who thought it was a good idea to launch a US$300 million debt programme. Specifically, you had to go to an upstairs side-room of the State Palace in Ulaanbaatar, Mongolia. In world capital market terms you can’t get much further off the beaten track than that.

Here, on September 10, Khan Bank CEO J Peter Morrow announced that his bank was growing so aggressively and successfully that it needed international funding to keep up. And if that seemed a contrarian sentiment at the time – this was the week Lehman Brothers’ share price began its final plunge towards bankruptcy – then Morrow certainly wasn’t alone. The following day ING, the sole lead on the global medium term note programme for Khan Bank, formally opened its first office in Ulaanbaatar. And that night, crowds of foreign bankers and investors were treated to a show of contortionists and throat singers at a party celebrating the launch of a whole new Mongolian investment bank, by Eurasia Capital Management, which earlier this year launched a Mongolia-dedicated fund.

To judge the mood in Ulaanbaatar, it was as if nobody had heard of the credit crunch or the crisis on Wall Street. So what’s so special about Mongolia?

Chiefly, the fascination with Mongolia comes down to mining. Although the commodities boom has flagged recently, the last few years have been a very good time to be a quarry for the world. Mongolia has commodities in abundance: 100 billion tons of coal reserves (ranking fifth in the world, and with the largest reserves of coking coal), 1.5 billion barrels of oil reserves, 8% of the world’s potential copper, and plentiful gold, silver, uranium and other minerals.

This bounty prompts Tim Condon, ING’s chief economist and head of research for Asia, to note: “Mongolia’s rich resource endowment should make it Asia’s fastest growing economy.” It’s already right up there, as the attached chart shows: GDP growth was 8.4% between 2002 and 2006, 9.9% in 2007, and 10.2% in the first half of 2008. Even allowing for a slowdown in the second half, the official growth forecast for 2008 is 8.7%. That, notes Randolph Koppa, president of the Trade and Development Bank of Mongolia, “is now on par with Asia’s strongest: China, India and Vietnam.”

But has Mongolia blown the advantage of its natural resources? These opportunities have been well-known to foreign investors for years yet the biggest mines look no closer to getting underway than they did then. Take Oyu Tolgoi, which ought to be the poster-child of Mongolian mining. Discovered in 2001, it is being developed by Ivanhoe Mines and Rio Tinto in the South Gobi, and when completed is expected to produce an average of a billion pounds [lbs] of copper and 330,000 ounces of gold a year over 35 years. Peak production rates, reached about six years after initial production, would be higher still, creating one of the world’s largest copper and gold producers.

The impact of Oyu Tolgoi on a small economy should be extraordinary. It is expected to be a $4 billion build-out taking place over 25 months, suggesting spending of $160 million a month; it’s likely to involve 10,000 people, with a permanent staff of 5,000 when the mine is built, most of them Mongolian. Ivanhoe has stated that the mine should produce an average increase of 34.3% in Mongolia’s real GDP up to 2043, as well as an average increase in nationwide employment levels of 10.3%, nationwide real per capita disposable income of 11.5%, and a total contribution of US$7.9 billion to the government. (Quite what those figures would end up being depends in part on the final negotiated agreement.)

And Oyu Tolgoi’s not the only mine: also on the table is Tavan Tolgoi, a $2 billion project to mine the world’s biggest coking coal deposit, and a number of smaller projects.

Yet getting on for a decade after their discovery, the investment agreements to get them going beyond the exploration stage are still not in place. The problem is, the sheer scale of the potential windfall to Mongolia has prevented it from ever being realised, so severe are the consequences of botching the mining agreements. Before anything can move forward, revisions have to be passed to Mongolia’s mining law, designed to ensure the state participates in the benefits of its own minerals.

Ballarpur Industries

An acquisition and financing for an Indian company could prove to be an influential model for others to follow.

In 2007, Ballarpur Industries (also known as Bilt), India’s largest paper maker, bought a Malaysian company, Sabah Forest Industries, for US$261 million. It was a distressed asset, purchased from the Lion group, and it was a potentially transformative transaction for Bilt: it gave it access to pulp and fibre, a more scarce resource in India than in southeast Asia. Sabah Forest operated the largest pulp and paper mill in Malaysia, alongside a concession for 289,000 hectares of forestland from the state government of Sabah, valid up to 2094. The deal turned Bilt into a fully integrated play, covering the value chain from the forests to the end product.

It looked good, but as Rajeev Ahuja, head of debt capital markets for Citi in India, notes: “The story in the equity markets was not getting translated. There are very few obvious comparables in the pulp and paper business in India; and people were not attributing a great deal of strength to the acquisition, although it was a very high cashflow generator over time.” Integrated players in Europe or in other Asian markets were being much more highly valued.

Also, the transformed business needed a better approach to financing. “You need a lot of financing flexibility,” says Ahuja. “If you have the ability to do longer term debt over a couple of economic cycles, you can manage the volatility of pulp and product prices and get cashflow flexibility.” But in India, there are tight restrictions around raising foreign currency debt.

Citi and Bilt worked together on a major corporate reorganisation to get around these issues. First Bilt injected three manufacturing plants into a subsidiary, BILT Graphic Paper Products, for Rs19.5 billion. Then another subsidiary called Ballarpur Paper Holdings, which crucially is incorporated in the Netherlands and which owned 97.8% of Sabah Forest, bought BILT GPP, also for Rs19.5 billion, with Bilt using Rs 10 billion of the funds to pay down debt and conduct a share buyback. Doing so put the Indian and Malay assets into the same vehicle. This Dutch-incorporated subsidiary then brought in new investors, selling 21% of itself to Government of Singapore Investment Corp and JP Morgan Special Situations Asia for US$175 million.

The restructuring, and the reorganisation of the debt structure, “is more integrated and gives lenders more comfort,” says Ahuja. “Down the road, they will be able to leverage in a more coordinated manner than at the piecemeal local levels.”

On the financing side, a US$200 million leveraged buyout and capex loan was signed in June 2007, before this year Citi set about putting together a US$560 million financing. This five to six year financing was launched into sub-underwriting in late May and at the time of writing was about to enter general syndication. Citi was joined by ING Bank, Rabobank, State Bank of India and West LB as joint leads.

US$560 million is a lot of offshore debt to get past an Indian regulator: sums above US$500 million in any given year are typically very difficult to approve. Consequently the Netherlands domicile of the holding company was vital. “Because this is an offshore company, even though it has Indian and Malaysian assets, we really are not impacted by the Indian regulatory requirements,” says Ahuja. “It allows them to be flexible in how they raise debt and deploy capital, and it evens the field compared to Asian and European players.”

While the circumstances of Bilt’s reorganisation are clearly very specific, the broader idea of a restructuring through an offshore holding company to improve access to the debt markets may have wider utility in India. “Each situation will be unique, based on assets and ownership and the market environment,” says Ahuja. “But if you look broadly at how Indian companies have grown in the last two years, a lot more investments have come from the large industrial groups going offshore. Often companies are finding the cashflows they generate offshore are bigger than those in India.”

Ahuja adds: “We are in discussions with a number of groups, not necessarily on templating Ballarpur, but saying: the markets are not giving you the value for your global business, how do you capture value and avoid dilution?”

CHINA SOUTH LOCOMOTIVE

The pattern of the moment for A-share/H-share combinations is to do the A-share first, then the H-share three days later. That’s the approach China Railway Construction took for its IPO back in March, and it was still in vogue by the time China South Locomotive Rolling Stock (CSR) launched its own float in Shanghai and Hong Kong in August.

CSR is the largest manufacturer of rolling stock in China, and one of the largest globally. Its output includes locomotives, passenger carriages, freight wagons, rapid transit vehicles, and more recently high speed trains (known in industry parlance as EMUs), where it is considered a leader. Apart from its scale as a manufacturer, it stands out for its R&D expertise, and has the largest facility for electric locomotives in China. It owns a National Engineering Research Centre for converters, a laboratory for high-speed multiple units engineering, five state-accredited technology centres and four post-doctoral working stations, among other things.

It’s in a fascinating sector, with the PRC government committed to developing the nation’s railways, and active in many ambitious high-speed train projects. “Also, the management team are excellent,” says someone who has worked with them. “They have been in the industry for many years. It’s not like some of the telcos or life insurers where they’ve been shuffled around; a lot of them are engineers by background and have been manufacturing trains all their professional lives.”

The A-share offering was handled by CICC and Industrial Securities, raising RMB6.54 billion. As is often the case with A-share issues, the fervour was something remarkable: it was 365.5 times oversubscribed on the retail side, 273 times on the institutional. It priced at the top of its range, equivalent to a 2008 P/E of 16 times, but even so it captured some attention for its rational pricing, opting to go for what it is by international standards a quite sensible valuation rather than taking advantage of the huge demand to push the price much higher.

While this seems a kind thing to do to investors, there was no doubt a pragmatic consideration as well. Since China Railway, the norm from the China Securities and Regulatory Commission has been to insist that H-share offers are priced either equal to or at a premium to the H-shares. Keeping the A-share valuation reasonable therefore gave the H-share deal a much better chance of getting away.

That H-share, led by CICC and Macquarie, raised HK$4.16 billion. Again, there was clearly an intent to make sure the deal didn’t plummet in the aftermarket, with the deal pricing around the middle of the HK$2.49-2.76 range at $2.60, despite the Hong Kong public offer being 13 times covered. “It could have been priced right at the top,” says someone close to the deal. “It was an extraordinarily strong book.”

Three cornerstone investors were aligned for the deal: China Life Insurance, General Electric Capital and Mirae Assets Financial, the Korean pension fund. Each bought US$30 million of shares, under a six-month lock up. The book is also believed to have included a number of Hong Kong tycoons and some sovereign wealth funds, although they were not formalised as cornerstone investors. On the H share deal, 60% of the book went to Asia, 25% to the US and 15% to Europe; by investor type, more than 60% went to institutions (mostly mutual funds and pension funds, with some hedge funds), 30% to private banks and high net worth, and the balance to corporate investors.

The deal took 16 months from start to finish, which is a short timespan for a deal of this scale. It was also challenging to get a deal away in August, a time when many potential investors are not around – and this particular August featured the Olympic Games as an additional distraction. Despite this it has been perceived as a success: the H-share priced at 18.5 times 2008 earnings and, amid roiling markets, it was up more than 10% by September 5.

Structurally, this appears to be the way A- and H-share combinations will be managed for the foreseeable future, rather than the truly simultaneous offer approach taken by ICBC and others. One problem with the simultaneous model – something that came up with Citic Bank’s IPO – was that the CSRC typically asks institutional investors for guidance on what the price of the A share launch should be, and uses the responses to help calculate the launch price. Consequently, institutions naturally tend to suggest low prices, meaning the A-share starts low and climbs steeply. If the H share is obliged to match that price, it leaves a lot on the table. Holding the H share launch three days later at a similar or higher price to the A-share gives more freedom, although it doesn’t necessarily make life easier for the H-share bookrunners, who have a greater set of constraints on them around pricing and regulation than they otherwise would.

RELIANCE PETROLEUM

These are hard times for emerging markets borrowers, but there are always exceptions. And they don’t get any more exceptional than the Reliance group.

The US$500 million loan raised by Reliance Petroleum, signed in April, is illustrative of the group’s appeal. In the middle of a global credit crunch, RP successfully borrowed a seven-year loan with no less than 19 banks at the MLA level – a sharp illustration of its popularity. “The biggest reason [for taking part] was the profile of the deal,” says Tajinder Singh Setia at ABN Amro in India, one of the 19 banks. “The fact that it was from the Reliance group ensured wider participation.”

The loan will finance the second phase of a 580,000 barrel a day refinery in Jamnagar, Gujarat. It follows a US$2 billion hybrid corporate and project finance loan signed in October 2006 which financed the first phase. The latest deal was effectively an extension of the first, with an average life of six years, and what Setia calls a “plain” structure. It paid 155 basis points over Libor, which he describes as “very competitive in this environment.”

Initially six banks were mandated on the financing: Banc of America Securities Asia, Bank of Tokyo-Mitsubishi UFJ, HSBC, Mizuho Corporate Finance, Sumitomo Mitsui Banking and West LB. It is understood that a signing among those six took place on March 19, and that RP had been keen to do so before March 31 because of India’s external commercial borrowing guidelines. In any fiscal year (in this case running from April 1 to March 31) an Indian company can seek approval from the Reserve Bank of India to borrow up to US$500 million in offshore funds. Sealing that approval before March 31 freed up the company to borrow that amount again from the offshore markets in the new fiscal year if necessary, perhaps to refinance existing deals in brighter market conditions.

However it was after March 31 that the broader banking group – by now adding ABN Amro, Arab Bank, Banco Bilbao Vizcaya Argentaria, Bank of Nova Scotia, Calyon, Credit Industriel et Commercial, DnB NORBank, KBC Bank, KfW, Natixis, NordLB, SG and Standard Chartered – came in to the deal, signing in Beijing on April 28. With all of those in, there has been no need to go to general syndication.

On first sight the absence of American houses bar Banc of America is striking, although Setia says the lenders don’t look dramatically different to the way they would have done before the credit crunch. “I wouldn’t say the banks are significantly different, it’s just the participation of banks has been widened,” he says. This naturally reflects banks wishing to spread risk.

While the scale of the lending group looks unwieldy, it is not uncommon, as was illustrated by a deal from another part of the Reliance Group, Reliance Industries, when it launched a US$1.2 billion five-year bullet loan in July with 19 banks in its arranger group and, by late August, 24 banks in total. “In the space of three months they have raised $1.7 billion,” says Setia. “That’s a significant achievement given the credit conditions. It’s unlikely many borrowers could do that in this market, as is evidenced by the number of deals from the Indian corporate sector. There’s been just a handful of deals in the last six to eight months.”

There’s likely to be still more. Market talk is of a $2 billion reserve-based lending deal, which is a project finance facility backed by Reliance’s known oil reserves. Also, Reliance Petroleum itself will at some stage refinance both of its loans ahead of step-up margins from the original financing coming into effect.  

The plant being financed by the RP loan is expected to be a groundbreaking facility. It will be able to convert heavy crude oil into fuels sufficiently clean to be sold in jurisdictions worldwide, which should increase gross refining margins. As a general rule, so-called sweet (or light) crude is easier and cheaper to refine than sour (heavy) crude, but the fact that far fewer petroleum companies can convert sour crude to a level that meets strict western standards gives them pricing power. It is also ahead of schedule: it was originally slated for project completion by the end of December but is likely to be ready at least two months earlier.

TATA GROUP

If this is the sort of market that scares borrowers away, nobody told the Tata Group. Across its disparate businesses – motors, chemicals, power – it has been active both in syndicated lending and debt capital markets, at times seeming as if it is keeping the markets moving almost on its own.

Tata has been active chiefly because of the acquisitive nature of its group companies. No group more than Tata illustrates the trend for Indian companies to acquire businesses overseas, and each of them has required funding. The hardest part has perhaps been to keep these raisings from competing with one another.

Tata Motors, for example, has been busy putting together the funding for its US$2.3 billion acquisition of Jaguar and Land Rover from Ford. In June it closed a US$3 billion bridge loan, under eight original MLAs: Bank of Tokyo-Mitsubishi UFJ, BNP Paribas, Citi, ING Bank, JP Morgan, Mizuho Corporate Bank, Standard Chartered and State Bank of India. All told a further 15 banks later came in to the deal.

Refinancing that bridge has created one of the most interesting stories in the Indian capital markets this year, with Tata Motors originally setting out to raise Rs72 billion through a rights issue, made up of three different components:  a straight issue of ordinary shares, another of convertible preference shares, and a third of differential voting rights shares, which carry only one tenth of the voting rights of the ordinary shares. The proposed deal, through JM Financial and ICICI Securities, has proved highly controversial because of the vast dilution and the fact that the differential voting right shares have never been attempted in India before, but at the time of writing pricing was expected to be established any day. The planned Rs30 billion convertible preference issue, though, was scrapped in August; instead that part of the cash will come from monetising some investments, likely through inter-group sales.

Elsewhere, Tata Chemicals has been active, seeking financing for its US$1.1 billion buyout of General Chemical Industrial Products, a US company. A US$850 million acquisition financing includes a US$350 million bridge loan, which has not gone into general syndication; and a US$500 million 75-month term loan. This loan, launched into general syndication in April, was mandated to ABN Amro, Calyon, HSBC, Mizuho Corporate Bank, Rabobank, Scotiabank and Standard Chartered. Since then commitments have come in from ANZ, Aozora Bank and Intesa Sanpaolo. In a sign of the company’s strength, it was believed in early September that this deal would be completed without market flex being applied to the terms.

Then there’s Tata Steel, which in May became the first private Indian company to issue unsecured domestic debt of significance, with a Rs20 billion bond sole led by Citi. Originally planned as a Rs7.5 billion raising, the deal attracted about 20 investors, mainly mutual funds and private insurance companies. Getting the deal away unsecured left assets available as collateral for further borrowings if required. This one involved three tranches, of seven years, three year fixed and three year floating.

Finally, Tata Power allocated a US$950 million financing in April to fund its acquisition of a 30% stake in each of Kaltim Prima Coal and Arutim Indonesia from Bumi Resources. This included a recourse and non-recourse tranche; the US$350 million recourse tranche had an average life of 6.5 years, and the non-recourse section, with nine mandated leads, an average life of 4.1 years.

Tata Power then completed a Rs5 billion 10-year bond in April, fully secured and underwritten by Standard Chartered. It needs capital to almost quintuple its power generation capacity by 2012, and won a bid to set up a 4000MW power plant in Gujarat, a Rs200 billion project.

For the future, Tata Steel Global is believed to have been working on a private placement worth between US$500 million and US$1 billion. The company has even been linked with a London listing. Tata Sons, the investment holding company of the Tata group, is understood to be considering a Rs5 billion bond, although plans have been put on hold by rising Indian bond yields.

It’s unsurprising, given its activity, that the group is moving into investment banking and private equity; Tata Capital, floated last year, has been hiring heavily from groups including CLSA and Centurion Bank of Punjab. It has a memorandum of understanding with Mitsubishi UFJ to cooperate in cross-border investment banking including global offerings of Indian equities. The Tata Group itself is likely to be a big part of the client base, particularly at first, although the Securities and Exchange Board of India (SEBI) dictates that Tata Group deals will have to be done in combination with other independent advisors, not sole led by Tata Capital.

Picture two countries. One has an infant mortality rate of almost one in 10, a male life expectancy of 47, and 40% of the population in poverty. The other has $3 billion in a burgeoning sovereign wealth fund fuelled by oil and natural gas reserves, a figure that will reach $20 billion before long even in the worst case scenario. The curiosity of East Timor is that it is both of these places at the same time.

There is surely no country in the world where the sovereign wealth fund is so utterly key to the future of the country, the very sustainability of its people’s existence. The world’s newest nation, a sovereign state since just 2002, its oil and gas fields in the Timor Sea really are its only shot. Consider this: the government estimates $1.39 billion in revenues for 2008 – all but $27 million of it from oil and gas. Coffee, the second-ranked contributor, accounts for $8 million, 170 times less.

All of which makes the story of the Petroleum Fund, founded in 2005, so remarkable. The Peterson  Institute for International Economics, a Washington DC-based independent research group, ranks it the third best run sovereign wealth fund in the world based on structure, governance, transparency and accountability, behind only New Zealand and Norway. (The Abu Dhabi Investment Authority ranks 32^nd on the same list.)

It gets this accolade for its peerless transparency and its commitment to build for the future rather than to spend today: a bid to make sure there’s something left for the country when the oil runs out. On its website one can find up to date reports detailing everything it holds, how much it manages, even thoughtful responses to public queries about things like bond valuations – a far cry from some of its Middle East contemporaries. Its mandate states that in any one year it can only withdraw what it calls estimated sustainable income, which in practice means 3% of the likely near-term assets of the fund, on the grounds that a 3% reduction should be easily replenished by prudent investment. This display of discipline tends to win it applause from overseas commentators, but is a source of considerable friction from people on the ground wondering why they don’t have enough roads and hospitals while oil revenues sit in long-term investments.

It’s a discipline that comes from having watched others fail. “Where poor countries like Timor-Leste have quickly attained vast amounts of money very quickly, while their human resources and infrastructure still needs to be developed, the outcome is usually a failure,” says Alfredo Pires, Secretary of State for Natural Resources. “I don’t think I could name a single good example in the world. The challenge is for us to be the first ones to avoid the oil curse.”

As of June, the fund had $3 billion under management, a product of revenues from the Bayu-Undan oil and gas field being exploited by a team led by ConocoPhillips. East Timor gets 90% of the taxes and royalties from this field, with Australia taking the other 10.

This field ought to be good until 2023, and has proven reserves of around 4 trillion cubic feet of natural gas and about 500 million barrels of condensate. Pires estimates it ought to bring about $10 billion to East Timor over its life.

Then there’s the Greater Sunrise field, with almost twice as much natural gas and about 300 million barrels of condensate besides. It would take a book to describe the painstaking negotiations between Australia and Timor over the development of this field and the maritime boundaries affecting other, still-to-be-found fields (indeed, one has been written: Shakedown by Paul Cleary, who advised the Timorese on the deal) but the outcome was a 50/50 split with the Aussies on royalties and taxes. Still to be decided, and an increasingly fractious issue, is how it will be developed: although the field is closer to Timor than to Australia, there is a trench more than 2000 metres deep on the Timorese side, a geological curiosity that has been at the heart of decades of dispute about maritime law. One side wants the pipeline to go to Darwin, the other to Timor, while the site operator, Woodside Petroleum, is believed to be leaning increasingly to another option altogether, with a floating LNG plant. Development won’t start until they decide. But whatever the outcome, Timor’s revenues from this ought to generate at least $10 billion.

That’s before anything else is considered. For any funds within an area called the Joint Petroleum Development Area, Timor will take 90%. There are proven fields, albeit small, within Timorese waters. And nobody has really started looking onshore yet. So, although unpredictable oil and gas prices don’t help with projections, the worst case is really that this fund is going to enjoy $20 billion of revenues, and it is common to hear people talking about $50 billion, and sometimes even twice that.

That creates all sorts of whacky statistics: since the national population is barely a million, Timor could end up with a theoretically higher per capita GDP than Australia (although since it has the world’s highest fertility rate of more than seven children per woman, that imbalance is unlikely to stay in place for long). But suffice to say the management of the fund is of vast responsibility and importance. It is, as David Edwards, vice president in worldwide securities services at the fund’s custodian JP Morgan says, “basically all they’ve got.”

So far, the methods used to invest this wealth have been deliberately passive. The Petroleum Fund law insists that 90% of funds must go into US treasuries, bank bills, term deposits or other similar securities; the law dictates a minimum rating of AA-, or that the securities be guaranteed by a sovereign of that rating or higher. The law allows 10% to go into other assets, provided they are issued abroad, are liquid and transparent and are traded in a financial market of a high regulatory standard; in practice, though, the whole lot has stayed in the safe treasuries, and indeed no investment has yet been made in anything rated less than AAA.

The fund’s mandate requires it to track the Merrill Lynch 0-5 year government bond index; its duration must be within 0.2 years of the index, and it is only allowed to drift within 25 basis points of the index’s return, which so far it has managed, lagging it modestly. “The idea was to start with something simple and safe,” says Venancio Alves Maria, executive director of the Petroleum Fund. “At the time we Timorese didn’t have any expertise at all in the fund management area.”

It’s an approach that has served them rather well in a year when sovereign funds from Abu Dhabi to Singapore have found themselves billions of dollars out of the money on investments in American investment banks. But there are signs that the relentless caution may be about to give way to a slightly more daring approach.

The first signs of this change in approach have come with the fund’s first appointments of external western experts. Last August, Mercer was engaged as asset consultant. Then, in June this year, JP Morgan was appointed as the custodian for the fund. JP Morgan is also an advisor to Norway’s sovereign wealth fund, which is a clear model for Timor’s (Torres Trovik from Norges Bank is a member of Timor’s five-person Investment Advisory Board). JP Morgan’s role will cover settlement, administration, accounting, and in future will include performance measurement, mandate compliance monitoring and fund performance services. It’s the clearest sign yet that external managers will be appointed in due course. “This is an early step to accommodate the government’s intention to diversify the fund,” Maria says.

Edwards at JP Morgan in Sydney has high hopes for the fund. “When we initially received the [tender request], the first concern was going to be the stability of the country, how they were looking to structure themselves and invest. We did a lot of due diligence on the individuals, the structure of the fund, the Acts that they passed and made sure we had absolute comfort in what they were trying to do. We do.”

It was, he recalls, quite a moment to step out of a car in Dili for the signing ceremony and face a phalanx of photographers: “my first experience of such overwhelming interest in a contract signing for a custody deal.”

 JP Morgan is believed to have offered a low fee for the work in order to secure this potentially lucrative client. “The value of the reserves, the price of oil and the value they will add through their investment means this is going to be a significant client for us in Asia, perhaps one of the largest,” he says. “On the fee side, for every client that we want to have a relationship with, we will price that very aggressively.”

He too expects a change in investment approach. “They’re at US$3 billion and growing at $180 million a month, and they understand that diversity of assets is going to be very important to them,” he says.

Then there’s the new finance minister. The Petroleum Fund is run by the Banking and Payments Authority of Timor-Leste, which is in every practical sense the country’s central bank and is intended to become it, although it doesn’t have that formal title yet (and doesn’t issue banknotes, since Timor uses the US dollar as its currency). But it conducts the fund’s management on behalf of the Minister of Planning and Finance, and last year, with a change in government, the person in that portfolio changed.

Euromoney’s interview with Emíilia Pires takes place in the Palácio de Governo, the Portuguese-era government palace facing Dili’s harbour, at 9.30pm on a hot evening in July. She looks tired, and a little wild of hair, after spending part of the day dealing with petitioners (earlier in the day a protest has been quelled with tear gas just around the corner) and the rest of it lobbying parliament, but presses on with an interview despite the lateness of the hour. She is certainly not lacking in energy or spirit: the first ever East Timorese graduate of an Australian university (La Trobe), and someone who fought her way from refugee status following Indonesia’s invasion of Timor in 1975 to being a public servant in the Victorian state government, she is one of a number of Timorese who have studied in Australia (Alfredo Pires, a cousin, is another example and the president, José Ramos-Horta, has held Australian permanent residency) and come back after liberation to help rebuild the country.

An hour in her presence leaves little doubt of her conviction to get things done, and the Petroleum Fund is on her agenda for change. She appointed a working group to look at the structure and approach of the fund. “When we took over government there were some studies being done on whether we had an optimal investment strategy,” she says. “From those studies it was clear we do not have.” With today’s cautious investment approach, she says the 3% that the fund’s founders believe to be a sustainable withdrawal would not be sustainable at all. “That immediately tells us we need to do something.”

She hasn’t yet decided what – her advisers still have to come back to her with a better strategy -  but she confirms it will involve “more active investment. I hope before the year is over we should have a new strategy, and know what are the areas where we should revise the law, and I should be able to submit it to parliament.” As a first step the fund has initiated contract negotiations with the World Bank and Bank for International Settlements as non-commercial external investment managers.

Pires is also under scrutiny because of another measure her government has taken: it’s started pulling more money out of the fund than it is generally allowed to do.

On May 23, the Council of Ministers approved the final draft of the Mid Year Budget for 2008, allowing for spending of US$773.3 million, the vast majority of it to be taken from the fund. Based on the sustainability calculations, only about $396 million should be taken out of the fund this year; the government is taking an additional $290 million above that level, a figure Emíilia Pires confirms to Euromoney. The Petroleum Law does allow these occasional larger withdrawals provided they are approved by parliament, but some are alarmed that this starts a bad trend.

Tomas Freitas, director of a Timorese NGO called Luta Hamutuk, says “the fund is under threat” because of this approach. The protests on the morning of Euromoney’s visit are partly to do with this budget, and in particular the fact that $1.4 million of it is allocated to the purchase of luxury cars for members of the national parliament. Some external observers, while acknowledging the need for investment now (and especially the impact of food price hikes), privately say they wish the extra money had been taken from World Bank or Asian Development Bank loans, freely available and at favourable rates, rather than from the fund itself, because of the precedent it sets.

Emíilia Pires is characteristically passionate in her defence of the government’s position when asked about commentators who think the funds should not be withdrawn. “I don’t understand how they think that, because right now if you don’t invest in the people, what future have we got? There’s not enough schooling, or quality of schooling. We are suffering from dengue, malaria, you name it.  Should we take more? Of course, logically we have to, otherwise where is the future generation? For me it’s just irrational to think otherwise.”

The approach would probably have attracted less criticism but for the fact that Timor has not previously managed to spend its more modest budgets. In the 2006-7 fiscal year, the budget was set at $328.6 million, of which only $160.4 million was paid – a cash-based execution rate of just 49%. An inability to spend the money it has begs the question whether a greater sum can usefully be employed now. Perhaps the biggest problem is human resources, and there are no end of programs geared towards giving specialist education to a generation of Timorese, notably in petroleum and geology, but it will take time to come through.

East Timor is still a volatile place – Ramos-Horta was shot three times in a failed assassination attempt in February, and it is still rare to go a minute on Dili’s streets without seeing a vehicle marked with UN insignia. But it has a great chance. It is not short of advice: Minister of Economy and Development João Mendes Gonçalves recently set about collating the various macro and economic research and development studies that have been conducted for Timor since 1999, and has so far collected 1700 of them.

But it will eventually go its own way. As Alfredo Pires says: “We seem to have a lot of experts, but sometimes we have experts who have never lived in a poor country. They may have the mathematics and economics right but it’s about individual cases. It comes back to people and the leadership.”

BOX: Banking in Timor

Timor’s banking system is a reflection of its history. There are three banks with a presence, all foreign, one each from the country that colonised it (Portugal), occupied it (Indonesia) and helped liberate it (Australia): Caixa Geral de Depósitos, Bank Mandiri and ANZ respectively.

These banks are arguably seen as a method for capital to leave Timor rather than to come into it. “Apart from the Portuguese bank, the others are not giving any loans to people,” says João Mendes Gonçalves, Minister of Economy and Development. “They claim this is mainly geared to the risks associated with the loan, and we understand all that, our legal framework is not complete yet.” Instead, “they are in deposits from people, transferring money overseas, and getting commission from that.”

ANZ itself, which set up in January 2001 even before Timor’s formal independence, says it supports “both international firms and a fast-growing Timorese client base”, offering savings, transactional banking products, and international services, for personal customers, commercial clients, government and non-government organisations. A spokesman says ANZ “sees a number of opportunities… to play a strong role in the development of Timor-Leste as a nation,” including facilitating foreign investment, lending, and providing banking services to the public sector.

Timor is, though, witnessing the birth of its own banking sector. The Institute of Microfinance Timor-Leste was established under the UN-led transitional administration, with a mandate for poverty reduction. It has grown but been impeded by law, unable to take more than $1 million in total deposits, or to give loans higher than $5000. In July, it changed hands. “We reached an agreement that for the better future of the institution, it would be better if it came to the government,”  Gonçalves  says. “We would strengthen it and ensure they expand into other districts, transforming it into the first national bank of East Timor.”

The country does need a banking sector, because it barely has a private sector to speak of and has no hope of developing one without access to credit. Plenty needs doing before western banks are likely to commit further, though, starting with a bankruptcy law; Gonçalves says he is about to send a draft law to the Ministry of Justice.

For the future, there is also talk of a national development bank to support Timorese entrepreneurs. Gonçalves says he has lobbied the World Bank, ADB, IFC and another group to come in with the government in putting in $3 million apiece to a development fund.

 To see this article in its published form, click here:  http://www.euromoney.com/Article/2017101/East-Timor-The-worlds-most-important-sovereign-wealth-fund.html

Summits come and go, but it was quite something to be at the first Palestine Investment Conference in Bethlehem in May. The investments committed at the event, which Palestine’s prime minister Salam Fayyad put at $1.4 billion, were significant, but it was the conference’s very existence that held the real importance: 1500 delegates, 500 of them from overseas, congregating on the West Bank to talk about investing in it rather than shunning it.

The world wants Palestine to work. That’s evident from the $7.1 billion of donor pledges to the Palestinian Territories (the West Bank and Gaza) made at meetings in Paris in December. The theory is that a stable and economically viable Palestine, eventually as an independent state, would defuse one of the most volatile flashpoints of the Arab world.

But what sort of economy could Palestine be? It has been in a mess since the second intifada, the uprising that began in 2000, prompting the imposition of stricter security measures and a withdrawal both of donor support and of any foreign private sector interest. Per capita GDP fell by 40% between 1999 and 2006.

There are, though, signs of a brighter future. The economy turned modestly positive in the second half of 2007 and is expected to continue to grow in 2008. The optimistic view is that this is the time to get in. “The Palestinian economy is like a coiled spring, a spring that has been pushed down and down and down and is ready to bounce back,” says Ronald Cohen, founder of British venture capital firm Apax Partners but attending in his role as chairman of the Portland Trust (and, as a Cairo-born former refugee of the Nasser administration, well disposed towards Palestine’s plight). “If you look at Palestinian GDP per capita over the last seven years, the curve goes down like this,” he says, motioning steeply downwards. “That is the spring that is capable of surprising the world economy.”

Portland Trust is an example of the vast donor goodwill that has risen for Palestine in recent years (and, as Cohen puts it: “I speak as someone who comes from the private equity world. We are not given to exaggeration in terms of results.”) One can barely move for big ticket commitments from the developed world. The Department for International Development (DFID, an arm of the UK government) is here in force; so is PEGASE, the new European mechanism for support to Palestinians, and USAID. Over here are the Danes, revitalising agricultural services; over there are the Italians, with a credit line facility for small and medium enterprises through soft loans. Even on Manger Square, where Christians come to see the place of Jesus’s birth, the Peace Centre next to the Church of the Nativity was funded by the Swedes.

From this part of the funding world, the invective is powerful.  “A growing economy able to provide opportunities and jobs for the Palestinian people must be at the core of a lasting peace process,” says World Bank group managing director Juan Jose Daboub. “While the difficulties of investing here must be acknowledged, the rewards can be significant.” Robert Mosbacher, president and CEO of Overseas Private Investment Corporation (OPIC), which is in for $250 million of a $500 million affordable mortgage scheme with partners including DFID, is similarly enthused. “If you wanted proof of our commitment to this region you can’t get better proof than the fact we are providing 25-year mortgages at fixed rates,” he says. “That says somebody is confident with what is happening. We are deeply committed and confident that these mortgages are good solid credits.”

It’s a big step from there to bring the foreign private sector in. But that $1.4 billion, which Fayyad says should translate to 35,000 jobs, includes some landmark deals involving foreign money, chiefly from the Gulf. The biggest was the confirmation, after much delay, that Israel will free the frequencies for Palestine’s second mobile phone operator, to be set up by Wataniya Mobile. This company is owned by Wataniya International, which is majority owned by Qatar Telecommunications Company, or Q-Tel. The project is expected to involve $650 million of investment over the next few years. Gulf money is also committed to construction, with Qatari Diar Real Estate Investment Corp signing up with a Palestinian group, Bayli, to build a planned community – Palestine’s first – north of Ramallah.

Clearly, Gulf liquidity is the prize Palestinians need to target: there is the affinity in language and culture, the sympathy for the Palestinian position in the Arab world, the abundance of petrodollars looking for a home and the scale of the Palestinian diaspora around the world, much of it still in the Middle East. Consequently, most efforts to do something new start off by targeting the Gulf. Padico, a Nablus-based, offshore registered investment holding company set up after the Oslo peace accords in 1993 and with investments from finance to agriculture and construction, is in the process of setting up a landmark $100 million offshore fund to invest in infrastructure and real estate in East Jerusalem. Padico has put in a quarter, it has secured another quarter from local and regional banks, and there’s little doubt where the rest will come from. “I think we can easily raise funds for it from the Gulf,” says Samir Hulileh, CEO of Padico. And they won’t be investing for charity. “Participants are expected to attain above average return on investments,” he says. “That’s my firm belief.”

Prime Minister Fayyad is adamant that real money, chasing returns, is coming in. “This is private sector, not funded by the PNA [Palestinian National Authority] or donors,” he says in a small briefing with Euromoney and other journalists in Bethlehem. “It’s based on the concept of investment.” He also refutes the idea that investment in housing and affordable mortgages isn’t the sort of thing to boost economic growth. “It’s not just the immediate construction needs, but all that has to come with it in terms of building materials. And we do need houses.”

Efforts to attract western funds are likely to start with the most frontier-spirited of venture capitalists. Walter Isaacson, president and CEO of the Aspen Institute in the US, says he is working “very closely” with people who want to develop a venture capital fund to invest in the ICT sector in Palestine. Indeed, technology and communications are widely seen as the ideal sectors to invest in since they’re not impeded by freedom of movement restrictions in the same way that manufacturing is.

One would imagine that the investment framework would be in its infancy in this stateless, shell-pocked state, but according to the World Bank it stacks up surprisingly well. Daboub says it ranks 22^nd in the world in terms of tax regimes for business, and 33^rd in terms of the legal framework to protect investors. Earlier this year an amendment to income tax laws went through, giving cuts of up to 15% for people and businesses; there are further exemptions for investment fund projects. A money laundering law has been passed, laws governing the banking sector are drafted and a new corporate law is expected to be ratified any day. It’s certainly needed: corporate law today in the West Bank runs under Jordanian law dating back to the 1960s, and in Gaza, the law dates from the days of the British mandate in 1929.

But there are big concerns about dispute resolution. “Lawlessness has almost ridiculed or sidestepped the court system in Palestine,” says Kamel Husseini, advisor on international relations for Paltel Group, and something of a spokesman for Palestinian commerce. “Militias have taken the law into their hands. You need to bring confidence and respectability to the court system in Palestine, to rulings and their enforceability.”

And there is a big caveat to all of this positive momentum. It’s a 360 square kilometre caveat on the Egyptian border, and it’s called the Gaza Strip. Any Palestinian state will be made up not just of the West Bank but Gaza too, and no matter how business-friendly and sophisticated the remarks of Palestine’s Fatah government in Ramallah on the West Bank, this government does not speak for Gaza. Hamas does and, ceasefire or not, that’s a whole other proposition.

Even in an ideal, peaceful world, Palestine would be a rather wonky state: two separate provinces, several hundred miles apart and separated by a country that fears and resents it. But without Gaza, with almost half the population, there’s just no viable Palestine. The West Bank is land-locked, barring the Dead Sea, which doesn’t have a navigable waterway that goes anywhere else. Gaza is where the port should be, the inlet and outlet for goods and services. It’s where the only international airport is (or would be if the runway hadn’t been cut in half by bulldozers in 2001), and it’s the place from which Palestine can access offshore oil and gas reserves, a rare example of a saleable resource. Today, though, it is under a state of what Fayyad calls “complete siege”.

The impact on business is immense. Hundreds of containers are held at Israeli ports accumulating storage costs; unemployment is colossal and getting worse, with 80,000 workers laid off in 2007 alone; the skilled labour force is becoming more obsolete, machinery is not properly maintained and can’t be repaired because there’s no way of getting spare parts in. And this is therefore the exact opposite of the West Bank: diminishing opportunities for a young workforce rather than credible alternatives, and the sort of anger which drives people to endorse an openly hostile Hamas leadership.

Curiously, Gaza’s share of Palestinian GDP actually grew from 28.7% to 29.2% between 2000 and 2006 (even though actual per capita declined from $1166.90 to $861.68 over the same period, based on constant prices), and a recent white paper on Gaza puts required investment in Gaza construction at more than US$1 billion in the next five years. But, once one gets past donor funding, who in their right mind from the private sector would commit their money here?

“Palestine cannot thrive with its other half left underdeveloped and unattended, because it will always pull it down,” says Husseini. “You cannot assume a rosy picture in the West Bank and ignore Gaza.”

Even in the West Bank, restriction of movement is a big issue. Mohammed Kamal Hassouneh, Minister for the National Economy, says business could increase by 30% with full freedom of movement. “Everything would be developed if we were free on crossing points,” he tells Euromoney. “All of our private sector suffers from the movement of people and the movement of goods.”

All things in time, though: Israelis have well-founded fears for their own security and it is hoped that a viable West Bank will give Israel comfort to begin to ease the restrictions. Israeli investors did attend the Bethlehem conference and there are signs of some willingness among Israel’s business community, if not its political lobbies, to engage. “We are lobbying the Israeli business community, which is a vocal and important player,” says Husseini. “They will benefit from an environment where Israel is perceived as a neighbour rather than an occupier.”

BOX: ON THE GROUND

While getting 500 delegates from overseas into Bethlehem was an achievement, it was rarely easy. Euromoney entered Palestine from Jordan, crossing the border at the Allenby Bridge over the River Jordan. (There is no airport of any consequence on the West Bank.) The border crossing took four hours, two of it spent detained in a small room being quizzed by three separate members of the Israeli army on why Euromoney wanted to attend.

Having got through the border and taken a bus to Jericho, Euromoney hailed a shared taxi to Bethlehem and received a quick lesson in movement restrictions. The taxi had white Palestinian number plates rather than the yellow Israeli ones; that meant the driver was compelled to leave the pristine freeway that would have taken us there in minutes through the outskirts of Jerusalem, and instead take a 14 kilometre detour on a disintegrating highway through barren hills punctuated by the tin shacks of the Bedouin. That’s because Palestinian cars can’t use half the roads even in the supposedly Palestinian West Bank itself.

Checkpoints can take hours, especially when entering Palestinian Territories through the vast and controversial eight metre high wall that separates Israel from it, but also within Palestine itself. It’s no way to run business. And that wall cuts the West Bank off from East Jerusalem, which Palestinians believe to be their capital; among the institutions sitting dormant and unreachable there is Palestine’s Chamber of Commerce.

BOX: BANKING SECTOR

One would expect the banking sector to be a shambles in Palestine but it is instead in a period of dynamic growth.  According to the Palestine Monetary Authority, the central bank, the sector grew by 22% in 2007; total assets are $7 billion, client deposits $5 billion, compared to $150 million at the time of the Oslo Accords in 1993, according to the Bank of Palestine.

There are 21 banks in the Palestinian Territories, compared to three at the time of the establishment of the Palestine Monetary Authority in 1994. Ten are local, 10 Arab (with Jordan particularly well represented) and one bold multinational – HSBC, which runs a branch in Ramallah. All are privately owned and between them they run 175 branches. “They’re incredible resilient,” says Michael Essex, director of the Middle East and North Africa at the IFC.

They don’t, though, do much. “Due to political uncertainties and border closures, the banking sector has followed very conservative lending policies in terms of absolute exposure,” says Hashim Shawwa, general manager of the Bank of Palestine. “Bank credit penetration is very low, with loan to deposit ratios at 35% compared to 78% in developed countries.” It’s partly for this reason that the likes of the IFC, OPIC and Aspen have trend to build risk sharing and long term financing programs like the affordable housing initiatives.

Banks are active in time and savings deposits, Islamic murabaha and foreign exchange, but getting them into anything longer term, even trade finance, is challenging in this environment. “They are more liquid than they are in other places, because there isn’t a depth of borrowers,” Essex says. “You don’t really have the projects, that’s one of the issues. Then of course they are always affected by their ability to freely move around: that’s a challenge, as some of the loans they have made to private sector companies obviously get impaired when places lock down.” Essex says non-performing loans stand at about 15% compared to 7% on average for the region, although Jihad El-Wazir, governor of the Palestinian Monetary Authority, tells Euromoney that figure is out of date and that it actually stands at nearer 7% today.

Banks themselves say all the right things. “A strong financial sector is the backbone of a country’s economy,” says Shawwa. “The banking sector is secure and fast expanding.” Competitors are similarly optimistic. “We have considerable capital which it is in the interest of the bank to employ,” says Mazen Abu Hamdan, regional manager of Arab Bank, which has the largest share of banking deposits in the Palestinian Territories.”We are ready to finance any feasible projects presented to us.”

But as with everything else, so much depends on the security situation. “Commercially, obviously Gaza is very much challenged these days,” says Essex. “The banks we are working with have branches in Gaza and even in these difficult circumstances are operating. But it’s difficult, very difficult.” Minister of National Economy Kamal Hassouneh adds: “In Gaza now … some of them maybe will close. They are suffering there now.”

The IFC is trying to work with local banks to help. “They’re the ones who have deep contacts across the West Bank and Gaza, and lots of branches,” says Essex. “We want to go through them and reach lots of small companies that way.” Aside from its housing finance initiatives, it has a pilot project in student loans and is also trying to bring Palestinian banks into its global trade finance programme, which has 180 member banks worldwide. Three banks are ready to sign up, though Essex declined to name them in May.

Asked if other foreign banks are looking at opportunities, Jihad says: “We have received some interest from additional foreign banks, particularly coming from the Gulf; we may see more strategic partnership.” With 21 banks for a country of barely four million people, and with half the country effectively frozen, there’s not an obvious need for more players, but if a period of consolidation comes, that may prove to be the entry time for a handful of far-sighted multinationals. That’s clearly going to be a challenge to get past a risk management committee, but Jihad argues it shouldn’t be. “You get the perception in many quarters that Palestinian banks are like the Wild West in the 1900s,” he says. “That’s definitely not the case.”

BOX: THE STOCK EXCHANGE

Yes, Palestine has one. And the remarkable thing is it has stayed open consistently since its launch in February 1997. It’s not the biggest exchange in the world – 38 stocks, and a market capitalisation of $3.1 billion – but it lodged a claim to fame by being the world’s best performing stock market in 2005, returning 306%. Up 30.8% in the first six months of 2008, it’s one of the world’s best performers.

The numbers are partly explained by the complete absence of other effective ways of getting any exposure to the handful of success stories on the West Bank. “At the time [2005’s record year], the stock exchange was the only opportunity for investors to invest in Palestine,” says Kamal Husseini. “It is virtual not physical, there is an exit strategy, it’s liquid. It was the only window.”

Foreigners are permitted to invest in the market without restriction, and some do: Kuwait’s Global Investment House actually has a mutual fund devoted entirely to the Palestinian Territories. The Palestine Dedicated Fund was up 18% in the first six months of the year. “The current environment continues to be supportive of further price appreciation,” says Tala Samhouri, head of MENA asset management at Global. “The first quarter of 2008 earnings have been extremely impressive with aggregate growth of 85% year on year.”