Catalog

	Table of Contents
p. 6 of 32 BACK | NEXT I. Introduction II. Assessment of Past Performance A. Country and Sector Coverage B. Impact of Private Sector Operations C. Financial Performance D. Risk Exposure E. Portfolio Administration F. Lessons Learned III. Rationale and Role IV. Operational Strategy V. Operational Improvements VI. Resource Requirements VII. Conclusions and Recommendations

Private Sector Operations: Strategic Directions and Review : II. Assessment of Past Performance

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D. Risk Exposure

23. In PSO, ADB faces the possibility of financial losses brought about by a failure to fully recover loans and equity investments. These losses can be due to risks that are either “systemic” or project-specific. Systemic risks arise from the general exposure of ADB’s private sector projects to country risks in terms of the overall investment climate. These risks are exacerbated by the lack of effective fiscal, monetary, and exchange rate policies; weaknesses in the corporate governance framework and practice; and deficiencies in the regulatory environment. In this regard, the countries targeted by ADB for PSO are mostly seen as “high risk.” Very few of these countries have an investment grade rating for cross-border obligations from the international rating agencies, and many are not rated at all. ADB’s exposure to systemic risks could thus be quite significant. Sector diversification within a country and country diversification across the region may, to a limited extent, help mitigate these risks.

24. Regionwide systemic risks are also a concern in PSO. As the recent Asian financial crisis has shown, a sudden outflow of capital from one country could become a regionwide phenomenon due to “contagion effects” and could result in a wholesale devaluation of currencies in the region with serious consequences. The crisis, for instance, has adversely impacted ADB’s equity investments in all affected countries. ADB automatically suffered an immediate decline in the US dollar value of these local currency denominated investments as local currencies devalued, regardless of the inherent strength or weakness of the underlying investee companies. In some cases, projects that were already experiencing market and financial difficulties have lost the chance of recovery as a result of the rise in interest cost or currency losses during the crisis.

25. Project-specific risks are those that are peculiar to individual projects. In infrastructure projects, these could range from weaknesses in sponsorship and management, construction delays, and cost overruns to failures to meet performance standards. With proper analysis, project-specific risks can usually be mitigated and are thus more easily manageable than systemic risks.

26. The degree of risk borne by ADB could also be affected by its explicit strategy, e.g., to give preference to pioneering projects.²³ ADB’s policy of providing loans with significantly longer tenors than its commercial cofinanciers, also increases risk exposure. As a development institution, ADB should be prepared to assume the risks associated with its development objectives and manage these risks accordingly.

27. No doubt, ADB has to contend with a much greater risk in PSO than in public sector lending where there is recourse to the host government in case of “project failure.” Precisely because of this, ADB requires a dedicated unit such as PSG to identify, assess, and mitigate risks associated with private sector investments and to manage these investments as a portfolio. In PSO, the due diligence exercise in project processing and the implementation and supervision work after project approval are all geared to risk management. The prudential limits observed by ADB on PSO exposures to a single project, business group, sector, and country also help control risks. Finally, analytic exercises, such as, Operations Evaluation Department’s project performance audit reports and PSG’s review of investment funds,²⁴ provide lessons that help enhance risk mitigation measures in future project design.

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