Determinants of the public’s sector participation in an investment project and financing options

In the previous post, we showed that at an aggregate level most countries have an observed capital to output ratio below its optimal level, and a marginal productivity of capital above its replacement cost, therefore giving a rationale for further capital accumulation.

The attached presentation shows that at a project-level, a country should evaluate if the analyzed project has a positive economic or social net return. Then it should evaluate if investment is better executed by the private sector, or if there is a clear rationale for the public sector’s involvement, either in support of the private sector or doing it by itself. Then, a country should verify if, given preferences and resources constraints, the project represents the best available use of resources. In this sense, to determine which investments should be carried out first, it is important to prioritize projects based on the highest economic/social net return, relative to the size of the required investment. If the project represents the best use of resources, the country needs to determine how to execute the project.

If the public sector decides that it is in the country’s best interest to participate in the project, it should determine if the selected investment should be financed with the public sector’s own resources or if it needs to borrow to cover the unmet requirements. It needs to consider the opportunity cost of using the resources, which is part of the cost-benefit analysis of the project selection process. If borrowing is needed, it should evaluate the available options to select the most convenient one. The debt management strategy requires covering the funding needs at the minimum borrowing costs with an acceptable level of risk. This requires selecting a debt portfolio according to preferences considering the cost-risk trade-off.

If the government needs to borrow, it has different alternatives. Regarding instrument types there are loans and bonds. The supply of funds could come from domestic and international markets. The borrowing conditions could be market based or concessionary if provided by another country or multinational organization with development objectives. The use of funds could be unrestricted or restricted as in thematic bonds. Therefore, in addition to a Public-Private Participation, with 4 different characteristics and two options per characteristics, there are 16 possible financing combinations. Borrowing should be in line with the Debt Management Strategy and if it should comply with Debt Sustainability. Borrowing could have different characteristics regarding market, restrictions, tenor, currency, etc.

Finally, the attached presentation presents the financial preparatory work for issuing sovereign bonds in international markets, the stages of the development of the sovereign bond market and the preparatory steps to issue thematic bonds.

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