ASi" kUCTURE FlOR DEVELOPMENT

Box 5.8 Look before you leap: limiting government exposure to contingent liabilities
.When a guarantee Is limited to contractual complianoe antees are sometimes desirable, they also create pervse
by goverunent agendes, the government has significant incentives that can lead to project mismanagenent.
control over events. Such guarantees can be made -_.Guarantees make sense when intemational investors'
calable, for instance, when governent agencies inhibit perceptions of country risk am poorer than economic
the supply of inputs to a project, fall to honor purchase conditions warrant, so that the guarantees are a stricdy
commitments, change pricing rles, or disaUow remit- transitional measure for attracting broad, and ultimately
tance of foreign exchange to service a p s private selfsustaining. investor interest.
loans. Unike blanket loan guarantees, this Idnd of agree- Government guarantees are not always necessary, as
ment does not commithe government toprect lenders demonstrated by. the financing of ProElectrica, the
and investors against such conmercial risks as cost and Colombian power plant A significant part of the foreign
time overruns, adverse movements in exchange rates. diect investment and portfolio flows to developing
and inefficient operatiorns Contractual compliance guar- countries has not been guaranteed-the underlying ecoantees
have-the added advantage of creating incentives nonic environment is what drives the flows.
-for government agencies to stidc by their commitments Thus, when offering guarantees to private. lenders,
and of limiting government liability to times when gov- governments need to determine whether such guaranermunent
agencies are outof compliance:
tees are truly required, what form the guaranty should
Governments may also issue guarantees.to ensure a take, and how they should be accounted for in governcertain
rate of rezurn- lype of guarantee that produces ment accounts. At the same time, governments need to
the worst incentives-or to lengthen maturities of loans. set policies to enable the development of private insur-
In both cases, the govemmentakes on a- commercial anceumarkets.
risk A centuy of experience shows that, although geartake-or-pay
formula. This becomes necessary be- sovereign risk, with exporters or bankers responsicause
market risk is intermingled with the danger ble for commercial isks. In mos' cases, these guarthat
financially troubled power purchasers (trans- antees are extended to both types of risk, in part bemission
utilities) or water users may not honor their cause it is difficult to distinguish sovereign from
commitments. Overall sector reform is required to commercial risks. As the prmary motives for setelminate
policy-induced risks and thus reveal the ting up such insurance schemes are supporting exnmarketnrisk
port industries (and thus domestic employment),
export credit agency prermums have been highly
COWINW Rsx Where govemments do provide subsidized, although they have been increased folguarantees
against sector policy or even commercial lowing losses incunred in the 1980s.
isks, these may not always be acceptable to private The Hopewell-Pagbilao independent power prointernational.
lenders, who may look instead for ject in the Philippines marked the first time that a
guarntees from creditor countries or from multiLat- loan from an export-import bank was not badced by
eral banks to imsure against "country" risks. The a govermment counterguarantee, placing the bank
role of the borrower goverment does not disappear on the same footing-as private lenders. Nonguaranin
such situations, since counterguarantees are typi- teed lending by export-import banks exposes them
cally required. . to the same nsks as other lenders, which-gives them
Export credit agencies in OECD countries off-er reason to improve their project appraisal, -assessguarantees
against risk of nonrepayment to their na- ment of borrower creditworthiness, and monitoring.
tional exporters or banks that extend credit to over- To attract international private capital to develseas
importers of goods and services. Typically, oping countries, several multilateral development
these agencies underwrite.overeign risk by provid- banks, induding the World Bank and the Asian
mg insurance on commercial credits and by extend- Development Bank, have developed guarantee
ing finance directly. Dunrng the period 1983-91, schemes. The World Bank's capital-market guaranexport
credit agencies did $53.1 billion worth of tees are used to facilitate the access of developing
business with a maturity of five years or more. Of countries to tlhe international capital markets by
this, 60 percent applied to infrastructure finance lengthening the maturity of related borrowing. The
linked prncipally to the import of capital goods. hi proceeds from such loans can be used for infriastructheir
most limited form, export credit agency guar- ture investments. The World Bank also issues guarantees
or insurance may be extended only against antees -for project financing-under the Extended
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