The European Investment Banks' Loan
To Hungary's M3 Highway
A CASE STUDY
Walter Hook, ITDP, USA
András Lukács, CAAG, Hungary
Hungary's intercity transportation system is essentially radial with Budapest at its center. Budapest, the capital, home to 1/5 of Hungary's total population, is roughly ten times as large as Hungary's next largest city. The major transport corridors connecting Hungary's capital to other regions are currently dominated by rail. Highways in the key corridors were planned and initiated over 30 years ago, but construction did not get very far until after 1989. Since then, however, there has been a large increase in spending on highway construction in four key corridors: the M1 between Budapest and Vienna, Austria; the M5 connection to the Balkans, Turkey, and the Middle East; the M7 from Budapest to Lake Balaton and into the former Yugoslavia; and the M3 towards the Ukraine and the former Soviet Union. There has also been considerable spending on the M0 ring road around Budapest. The southern section of the M0 has been completed, and further construction on the northern and eastern sections is imminent. At the same time, rail traffic in these same corridors has declined continuously since 1989.
Hungary is divided into two main areas. Western Hungary, or Dunántúl (Transdanubia), has received 2/3 of all foreign investment into Hungary, is much more modern, unemployment is low, and infrastructure is in reasonably good shape. Eastern Hungary, by contrast, is facing severe economic difficulties. Previously the industrial heartland of Hungary, and also the region of the country politically the most resistant to the recent transition, Eastern Hungary has been hit by the twin problems of deindustrialization and a lack of new investment from foreign companies. Western Hungary has enjoyed far more foreign investment both because of its proximity to the West, and because investors feel that public officials in these regions are more sensitive to the needs of foreign investors. Hence, unemployment in the East is extremely high, incomes are stagnant, and the population is falling.
Some 42 kilometers of the M1 to Austria was constructed as a privately-financed toll road, with support from the European Bank for Reconstruction and Development (EBRD) and the World Bank's International Finance Corporation. It is currently the most expensive toll road in Europe, and 80% of the traffic on the road is non- Hungarians. Revenues are 45% below projections, a large share of which is the result of lower than expected truck and bus traffic in the entire corridor, and a greater than expected number of trips being made by alternative routes. EBRD has already begun to reschedule their loan.
The M5 is currently being financed by a loan from the EBRD. It will also be built as a privately operated and financed toll road, but ECU 84.7 million in Hungarian government subsidies, free land, 8 years of tax credits, and guarantees on the private rate of return were required to make this viable. Construction on the M7 to Lake Balaton is also beginning, but the specifics of the financing have yet to be worked out. Finally, the M3 to the Ukrainian border is now being built as a toll road with financing from the European Investment Bank (EIB) and German Government loans from the Kreditanstalt für Wiederaufbau.
The M3 highway in Hungary will be a major link in the planned Trans-European Network's Central Europe extensions. It is part of the Trieste-Ljubljana-Budapest-Lvov-Kiev priority corridor identified at the Second Pan- European Transport Conference in Crete. Some 60 km of the M3 highway has already been constructed, from Budapest to the city of Gyöngyös. The next section under construction will reach Füzesabony, about 20 km south of Eger, a small wine-producing city surrounded by some of Hungary's finest vineyards. The plan is to upgrade the existing motorway to international expressway standards and extend it all the way to the Ukrainian border. The currently proposed route of the motorway will pass some 30 km to the south of Miskolc, the second largest city in Hungary with a population just over 200,000, on towards Fényeslitke, and Eperjeske near the Ukrainian border.
The political pressure for the construction of the M3 highway is coming primarily from 40 Socialist Party Members of the Parliament from Eastern Hungary, the Ministry of Industry and Trade, the so-called 'concrete lobby' of firms with a direct interest in road construction, local mayors and Socialist Party organizations, and the biggest association of trade unions. The perception of the Ministers is that foreign investors and tourists are not coming to the region due to its relative inaccessibility, a problem made worse by the lack of highway infrastructure in the region. Thus, from the perspective of the Hungarian government, their interest in the highway stems primarily from concerns about regional economic development and the need to create jobs, rather than from any perceived need for the highway per se.
Due to Hungary's severe public debt problems and hence lack of investment capital, this extension of the M3 was originally going to be built as a build-operate-transfer highway, where a private contractor would be hired to construct the road and maintain the road, and in exchange would be allowed to levy tolls on the entire length of the motorway, including the section which has already been constructed. They entered into negotiations with private contractors, who counter-offered to repair the existing road, build only a small piece of new road, and collect toll roads on the entirety. The Hungarian government found these conditions unacceptable, as little of the new road would be constructed.
At this point, the Ministry of Transport decided to set up a public highway authority which will build and collect tolls on the motorway. Initially, the Socialist Party government tried to use a surplus in the Privatization Fund to finance the construction of the new highway, ie. the funds collected from the sale of public enterprises. This was blocked primarily by the Ministry of Finance, who wanted to use this money for debt reduction, with support from environmentalists, other Free Democratic Party members, and initially the opposition parties.
Unable to finance the new road from the Privatization Fund, the Hungarian Government sought loans. The reaction of various funders to the request for financing from the Hungarian Government is revealing. The World Bank was first approached. They refused on the grounds that Hungary is spending far too much money on new roads and not enough on road maintenance and safety, and that this road in particular could not be justified by a sufficiently high economic rate of return. According to their Transport Sector Project Completion Report No. 15445, p.9,
"The Hungarian Government's 1995 road maintenance expenditures were only about one quarter of the amount required to prevent further deterioration of the existing road network, or one-half of what is required to catch up with maintenance backlog in ten years, due to budget constraints and perhaps too rapid implementation of the competing motorway program. This threatens the future sustainability of these road investments unless it is resolved."
Hungary has an annual maintenance expenditure shortfall of HUF 39 billion (around $300 million), and currently the economic rate of return on road maintenance projects in Hungary is as high as 60%, compared to under 20% of new construction projects, according to the World Bank.
The World Bank's position on the Trans-European Network extensions more generally has been that each link should be judged based on its own merits, rather than accepting as viable all links in the proposed network.
The Hungarian government then entered into negotiations with the EBRD. The EBRD was willing to finance the project, but due to its own requirements of using 60% of their funds to finance the private sector, they were insisting in a level of private sector participation in the project which the Hungarian Government felt wasn't viable in this case.
The Hungarian government then found two willing partners, the European Investment Bank, and the German Kreditanstalt für Wiederaufbau (KfW). The loan from the EIB is for ECU90 million, at the very favorable interest rate of LIBOR +1, or around 5.8%, repayable in 19.5 years, with no repayment beginning until after the first three years. The loan from the KfW is for DM125 million, at similar interest rates with a 17 year repayment period, and is part of a DM1 billion loan from the German Government. The Hungarian Government will finance all the new construction costs with HUF20 billion from the treasury (some US$153 million in 1995 prices), and provide HUF30 billion in sovereign guarantees.
Under the terms of the loan agreement, a new public sector controlled motorway company is created to build and operate the motorway as a toll road. The toll rates are to be set at roughly 1/3 the toll rates on the M1 highway between Budapest and Vienna, which at 900Ft per car (roughly $6.00) is the most expensive toll road in Europe. At this level of tolling, the EIB's financial analysis projected that revenues from tolls would be sufficient to cover the costs of ongoing maintenance and operation of the toll facility, KfW's commitment fee, the payment of interest and the repayment of principle on the loan. The plan is to complete the construction of the M3 as far as Füzesabony by 1998. The plan is for the regional government to finance the expansion of an existing road from Miskolc to the M3, and by 2003 reach the river Tisza.
According to the EIB, their own economic analysis of the M3 highway concurred with that of the World Bank, showing that projected traffic on the highway would not be high enough to justify the new road in economic terms. While the World Bank refused to fund the road, however, the EIB did another economic appraisal on just the short section of the M3 actually covered by the EIB loan. This small section, much of which is simply a reconstruction of an existing highway, they found to be economically justifiable. As documents from the EIB are classified, however, this new Economic Appraisal was not open for public review.
Furthermore, the EIB points out that unlike the World Bank which has a policy of not funding projects with an internal rate of return of less than ten percent, the EIB is willing to consider any project where the project will at least repay the costs of capital (ie. the interest rate).
According to the Hungarian Ministry of Transport, the negotiations with the EIB focused primarily on the issue of the financial rate of return of the road. They pressed hard to ensure that the road would be self-financing and to ensure that the revenues would be sufficient to repay the loan. They did not insist on a particular toll rate, but did want a 'proper' tariff.
Due to the way in which economic appraisal is performed on such projects, the higher the rate of return on the financial evaluation, the lower the economic rate of return. Because the imposition of the toll had a large impact on the level of traffic, the higher the financial rate of return of the project, the lower the economic rate of return on the project. Curiously, the current structure of the EIB road loan shows a projected positive financial rate of return, while the projected economic rate of return is too low to justify the project. As will be made clear, however, it is not clear whether the current level of tolling will survive.
Furthermore, no economic analysis was ever performed on the impact of the new highway capacity on the rail line in the same corridor, which is certain to be adversely affected. These additional costs would considerably reduce an already low Economic Rate of Return. EIB staff denied that the construction of the M3 would have any adverse effect on the rail line in the same corridor, claiming that they catered to different markets. No empirical evidence was presented, however, to justify this claim.
The World Bank office was quite unhappy about the EIB's willingness to make the loan to the Hungarian Government. The World Bank is more concerned about Hungary's overall debt problem than the other multilateral institutions. They have a public sector structural adjustment loan to the Hungarian government which is focusing on reform of the Pension, Health, and Social Security sectors. This loan does not deal with transport at all. It was initially going to deal with reorganization of the system of municipal finance, but this was dropped as it would have delayed the loan. In terms of the structural adjustment ramifications of the transport sector, this is dealt with directly in their transport sector lending, which accounts for the focus in their road sector lending on maintenance and on cost recovery in the rail sector. The EIB loan is thus undercutting their efforts at broader structural adjustment.
Unlike the World Bank, which is governed in part by a series of directives which outline how environmental impact assessments are to be performed, how resettlement is to be carried out, etc. according to EIB staff EIB loans are subject to all positions of the European Commission binding on the members of the European Union.
In terms of the Environmental Impact Assessment on the M3, the Hungarian government commissioned an EIA on the entire motorway plan in 1993. The EIA on the M3 was completed in 1995, by a well-respected consulting firm called Öko Rt. As it was done before the concerns about joining the EU, however, it was not performed using the EU's EIA procedures. Now, most new road projects are given EIAs using EU standards for this very reason. It was nevertheless more thorough than was required by Hungarian law at that time. According to the consultants who performed the study, there were three main problems with how the study was conducted. First, it ignored the impact of the road on increased traffic inside Budapest. The M3 feeds into Andrássy út, one of Budapest's most important historical boulevards, passing through the City Park and several residential neighborhoods. Secondly, it ignored increases in traffic on residential areas along alternative routes which would result from traffic trying to avoid the new tolls being imposed on the existing sections of the M3. Finally, the impacts were restricted to the impact on the existing level of traffic, but did not assess the environmental impacts of projected increases of traffic in the corridor. Both of these would have been required had standard European Union procedures been followed. Otherwise, the Hungarian EIA law since 1993, while different from EU regulations, is weaker on some issues, and stronger on others. In one area the EIA showed a major impact on a nature protection area, and after a large fight the road was re-routed.
It was not clear, however, whether the EIA was able to provide information which would determine whether the planned new road would be in violation of the EU's Animal Habitat's convention. While animal impacts were listed, and some mitigation measures were included in the project and in project costs, clearly not all the animal impacts could be mitigated against. This is an area for further inquiry. There was also discussion of the impact of the continuing use of leaded gasoline, although it is being phased out in Hungary, and other emissions, on the produce from the vineyards which will surround the road on both sides.
A more serious concern appears to be in terms of the public review process. According to Hungarian law before 1993, no public hearings were required, and even local governments did not have to be notified. This was changed with the new EIA law in 1993. After 1993, however, Hungarian law only required that the national government notify the heads of the local governments. By contrast, standard practice in the European Union requires that public hearings be held and all affected communities be notified.
In the case of the M3, however, only local government heads were notified, and no public hearings were held for affected communities. EIB staff admitted that this was a violation of EU policy, and that in the future any projects funded by the EIB would be required to hold public hearings. The Ministry of Transport contends that had it not been for pressure from the EIB, even local governments would not have been notified.
Local governments generally supported the construction of the M3 but were opposed to the tolls, because they would divert traffic off the highway onto local streets. In response to this, the Ministry of Transport commissioned an EIA focusing on the impact of traffic increases on secondary streets from cars and trucks diverted due to the tolls.
This study, which has still not been completed, shows very serious public health impacts resulting from the diversion of traffic onto secondary streets, which pass through heavily residential neighborhoods. In some smaller towns, the diversion of traffic through the towns will affect up to 50% of the population. At the level of toll for which the EIB's financial assessment was performed (HUF5/km) the EIA shows that residential ambient air quality could be in violation of Hungarian law.
There is thus a major conflict between the EIA, the financial analysis, and the economic analysis. The current level of tolls required to make the loan financially viable make the road project economically non-viable and also drive some impact areas into violation of Hungarian public health laws.
The EIA thus suggests reducing the fee, or removing the fee on areas where the road functions as an urban bypass, or switching from a toll system to a yearly pass system where a flat fee would be used to buy a license which would give access to all the Hungarian national highways; a system apparently used with some success in Austria and Slovakia. In the case of the M3, the main problem with the pass system is that the projected revenues would be considerably lower than those needed to justify the project on financial grounds. It also faces major administrative obstacles to implementation. Traffic calming the parallel routes or slowing travel speeds on these routes is also suggested, but is opposed by the local mayors.
As a result of this EIA, it is possible that the Department of Public Health will hold up its approval of the project unless the toll levels are reduced, particularly on the section of the road leading into Budapest. If this happens, some of the immediate environmental impacts would be reduced, but so would the financial viability of the road project.
The Hungarian Government is currently seeking additional financing for the M3 from PHARE and the German Government.
The above case study indicates the following changes are required in current EIB loan assessment procedures:
1. The Economic Rate of Return (ERR) analysis on EIB loans should include a quantification of possible negative impacts on parallel rail links in the same corridor.
2. Criteria for determining loan viability based on the ERR should be developed to avoid accusations of political bias in their lending.
3. The financial rate of return of the project, and hence the project's impact on the debt problems of the borrower should be quantified.
4. Staff appraisal reports, including the Economic Analysis, Financial Analysis, and Environmental Impact Assessment should be open to public scrutiny.
5. All projects, as a condition of loan eligibility, must hold public hearings open to affected populations and relevant NGOs in a manner consistent with EU norms.
6. All projects, as a condition of loan eligibility, must perform an Environmental Impact Assessment in a manner consistent with EU norms and to determine whether the project violates EU Directives.
7. As all roads are funded on a section-by-section basis, but with the intention of completing eventually the construction of the entire corridor, viability for highway loans should be determined based on an Economic, Financial, and Environmental Appraisal for the entire corridor, not just for the segment of road being funded by the first installment of the project.
8. All EIB loans should be coordinated with the activities of other Multilateral Development Institutions to avoid undercutting the objectives of other multilateral development institutions such as the World Bank.
Institute for Transportation & Development Policy
611 Broadway, Room 616, New York, NY 10012, USA
Phone: +1 212 260 8144. Fax: + 1 212 260 7353
Clean Air Action Group
2041 Budaörs, Pf. 102, Hungary
Phone: +36 1 206 5599. Fax: +36 1 165 0438.