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HOW TO MEET THE CHALLENGES OF PPP DEVELOPMENT IN THE CURRENT FINANCIAL AND ECONOMIC CRISIS 1 By Noel Eli B. Kintanar 2

INTRODUCTION Good morning honored guests, fellow participants, ladies and gentlemen. I would like to thank UNESCAP for giving me this opportunity to share my thoughts on Public Private Partnerships (PPPs) and Build-Operate-Transfer Projects (B-O-Ts), in the context of the global economic turmoil we are facing, in front of such a distinguished group of international experts in the field. As a PPP practitioner in the Philippines for close to a decade, I have gathered quite a number of reflections, insights and war stories on the topic. Unfortunately, as many practitioners know, we are constantly immersed in the day-to-day battles to move projects forward, and are focused primarily on fire fighting to get these projects implemented on the ground and on schedule. As such, many of the insights and reflections of the PPPs practitioners, on how projects can be developed better and made to work better, are often, only left to passing discussions during the short breaks from the salt mines, or, during the informal policy meetings by the coffee machine and water cooler. And as a practitioner, I always appreciate the opportunity to step back and take a look at PPPs from a broader policy perspective, learn from fellow project developers from all over the world, and gain knowledge and insight from scholars in the field. Unfortunately, this happens too seldom, and only occurs occasionally, during conferences like this. So again, my thanks to international development agencies like the UN, for giving me the opportunity to reflect on real-world experiences of PPPs in a more structured and systematic manner. Particularly, let me thank ESCAP for the excellent arrangements that have led up to this conference, and the warm hospitality in hosting this meeting.

ARE PPPs STILL RELEVANT IN AN ENVIRONMENT OF TIGHT CREDIT AND ECONOMIC MELTDOWN? Let me begin with the simple reflection: Are PPPs or B-O-Ts still relevant in our current environment, when economic meltdown is governments primary concern, and, where people on the street are focused on very basics concerns, such as keeping their jobs? Is there still an opportunity for privately financed infrastructure and B-O-Ts in a global economy where the financial crisis has led to tightened credit, which is critical to financing these capital intensive PPP projects?

A paper delivered at the Interregional Experts Meeting on Public Private Partnerships, UN ESCAP, Bangkok Thailand, February 17-19, 2009 2 Assistant Vice-President for Public Sector Partnerships and Infrastructure Projects, Ayala Land Inc., former head of the Build-Operate-Transfer Center of the Republic of the Philippines, and President of the Philippine Infrastructure Corporation

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I would venture to answer that, in the face of such adversity; all the more PPPs have become relevant! The financial crisis and economic meltdown has not changed the fundamental infrastructure gaps, which millions in our populations face as they struggle to stay in the mainstream of trade and industry, and are forced to suffer in their everyday lives. Although the crisis in Wall Street has affected the lives of many in the developing world, it has not changed the fact that for many, the problems in Wall Street are furthest from their mind. The street that matters to them is the dirt road outside their home, farm, or small business that they hope to see paved by government sooner rather than later. In fact, just a basic street or potable running water, is their infrastructure aspiration, so they too can join the economic mainstream, and be able to eek out a respectable living in these times of crisis. But what do mega infrastructure projects, which characterize most PPPs, have to do with the poor in the developing world? Let us go back to the basic principle of privately financed infrastructure. When developing countries encourage private sector investment in infrastructure, through PPPs, this policy provides government additional resources so that they can re-allocate scarce public funds towards delivering basic needs to the majority of the population. With additional infrastructure financing from the private sector, government is able to direct scarce public resources, freed up by private investments in PPPs, towards funding infrastructure rural projects that could never interest the private sector. These public projects are of the type that would never generate operating revenues, or realize a financial return on the project investment. These public projects are the rural road projects that see 35 ox-drawn carts a day, on a good day. These are water projects that bring the first taste of piped water for women who once had to walk 2 kilometers to fetch 5 gallons that they carry home on a clay jar on their heads. These types of projects are unlikely to attract private infrastructure financing. Yet, these small public projects can be made possible by PPP investments in some other infrastructure sector, where the beneficiary of the infrastructure is able, and willing to pay user fees. And if PPPs, which charge fees from those willing and financially capable users, enable these rural public projects that are designed to assist the marginalized sectors, then society as a whole realizes the highest economic and social impact from both the PPP project and public infrastructure.

PPPS IN GOVERNMENTS INFRASTRUCTURE SCHEME More and more, governments and multilateral funding institutions acknowledge that the public sector alone cannot meet the funding requirements to bridge the local, national and global infrastructure gaps. To provide a quick country snapshot to illustrate this point, in the Philippine Medium Term Development Plan 2006-2010, close to 50% of infrastructure spending is dependent on Public-Private Partnerships and Build-Operate-Transfer projects. Without these projects, especially during times of economic crisis, the cash strapped government would find hard to mobilize both the financial and technical resources to stimulate the economy through public infrastructure spending. And for many countries, the economic crisis further highlights the urgent need to address, both the immediate basic needs of the poor, and, the long-term infrastructure gaps of the economy, that will serve as the basis for a sustainable growth.

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But for PPPs to continue to be relevant, we must identify ways to build on their strengths; focus on the projects that can reap quick gains, so that they may get the necessary share of public policy attention, and the critical government financial resources that can make a project viable, in order to pursue the policy in the challenging years ahead.

FOCUS ON ITS STRENGTH: THE SPEED-TO-MARKET OF PPPs So what could differentiate PPPs from the host of other infrastructure projects during this financial crisis, and therefore, give government the impetus to push these investments forward? I believe that one thing that can differentiate PPPs is its potential Speed to Market. Simply put, Speed to Market means that, once the contractual terms of the PPP project are agreed on with the public sector, in a clear and measurable way, the private sector can implement and opertationalize projects faster than government. Just to underscore the premium that governments put on the need for speed in infrastructure spending, as a vital component of stimulating a sagging economy, it caught my attention that under President Barrack Obamas stimulus package, one of the main criteria for allocating funds would be the timing in which these infrastructure projects could be implemented. I highlighted some provisions of the bill that underscore this point. The package repeatedly uses the criteria: Priority of awarding such funds (from the stimulus package) will be given to projects that can commence promptly after approval The secretary shall give priority to projects that are expected to be completed within 3 years of enactment of this act Clearly, the US governments stimulus package awards a premium to projects that can impact the economy quickly. Unfortunately, the fiscal policy tools available to the US, such as unprecedented public sector spending, are not necessarily available to governments in the developing world. Developing countries, already mired in national debt would find it most difficult to further mortgage the future in order for government to undertake spending programs like that of the US. But nevertheless, the principle is the same. We need infrastructure spending to stimulate the economy, and we need it fast. With this simple policy statement in the US governments economic stimulus package in mind, PPPs can differentiate themselves from other infrastructure programs by showing that they can be implemented faster that purely publicly financed projects. PPPs must demonstrate that against other forms of infrastructure development and financing, it can provide the speed-to-market. If well structured PPPs can drive home this point, then this would be enough reason for governments to support and finance these projects above all others to stimulate our global economic recovery.

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But is there truth to this assertion? As a former official in the Philippine government and a member of the governments cabinet committee that approved both PPP and publicly funded projects, I often heard criticism from government colleagues that privately funded projects have a long approval process and implementation schedule. But I would always ask the question, long compared to what? To put this in perspective, let us anecdotally compare the length of the PPPs implementation period vis--vis comparable projects funded by the public sector. In my country, I always use the example of two light rail lines almost equal in distance and complexity, whose planning basically started simultaneously in the early 90s. The PPP project, called MRT3, from the concept stage was able to start construction first and was completed and operational by early 2000. In comparison, the purely publicly financed project (LRT2), funded with the support of Official Development Assistance (ODA) came on stream four (4) years later. By the time the public project came on board, the PPP rail line had practically reached peak operating capacity. From my own personal experience in approving and monitoring toll roads, power generation plants, water distribution or bulk water systems, health services, airports and other infrastructure projects, PPPs clearly lead with respect to the speed in which these projects can be delivered to the market and completed. And the reason is fundamental: Private proponents, once their concession is effective and they are financially invested in the project, have to internalize the cost of money during design and construction. And, since properly structured PPP projects should predominantly require investors to recover this capital expenditures (CAPEX) and cost of money from future project revenues, then realizing operating revenues at the earliest possible time is in the interest of the investor. In comparison, public projects often do not need to repay CAPEX from project revenues, and government need not realize a financial return on the capital investment of the project. This CAPEX is absorbed by all taxpayers, both users and non-users of the project, through the national budget. Although I must admit, I have not had the opportunity to conduct an empirical study on this thesis, nor have I come across detailed comparisons of the speed to market of PPPs vis--vis publicly funded projects, anecdotally, there are numerous big projects that jump out and make a compelling argument. In Manila alone, we have the MRT 3 project I mentioned above. Another example is the Manila Water and Sewage System privatization project, where the private proponent was able to achieve 24 X 7 services in the existing areas, expand the service coverage area, introduce waste water treatment and reduce non-revenue water to international standards in less than a decade. In comparison, other large water districts in the Philippines that rely mainly on government funding, are unable to address simple investments like bulk water supply and installing waste water treatment facilities. Looking a little further back to the 90s, the privately funded power projects, or what were known as Independent Power Projects (IPPs) turned a power grid that suffered 12-hour brownouts in 1991 to 1992 in the capital city of Manila, into a network with adequate power reserves within 6-years of allowing the IPPs to invest in power generation. Finally, toll roads in the Philippines are still implemented faster and cheaper by the private sector. And in the event that there is delay in privately financed project, on most occasions it is caused by the approval of the concession agreements of the proponent or

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securing Road Right of Way for the project, both of which are deliverables of the public sector. It would be interesting to see a more structured study comparing the speed-to-market of PPPs and publicly financed infrastructure. Maybe ESCAP in fact would be the right international agency to conduct such a study, as it would have a more objective perspective to make such a comparison, it not being a lender to the large public sector projects pursued by government.

GOVERNMENT SPENDING IS FASTER Again, critics of such a thesis may argue that government investment, rather than PPPs, is the fiscal policy needed to spend our way out of crisis. It is faster and more direct. But, assuming we all agree that government spending is the right economic policy out of the crisis, it was also my experience while I was in the bureaucracy, that speed is not something commonly associated with government. This is especially true in the Philippines where bureaucrats are paid a fraction of private sector managers, engineers and analysts. Thus, many government infrastructure agencies in the Philippines are severely constrained by human resource capability and hindered by political intervention in selecting and developing projects. Also, I believe that for many developing nations, fiscal policy measure to stimulate the economy through infrastructure spending is limited by their national budgets and access to global credit during this crisis. The private sector on the other hand, is much more nimble in the project development process. They have much larger business development budgets available to pursue PPPs. Moreover, unlike in government, there is no need for legislative approval from Congress to spend these budgets. If the market opportunity exists for a return on their investment in the provision of infrastructure and public services, the private sector can quickly respond.

PROJECT DEVELOPMENT: A FLIGHT TO QUALITY BY GETTING BACK TO BASICS But in as much as speed to market may be viewed as an advantage of PPPs in this crisis, the underlying difficulties in developing these types of projects remain. And it is the flight to quality that will ensure that PPPs get the opportunity to play the role of economic stimulant in developing countries. But what are some of the basic elements of developing good quality PPPs? 1. Project filtering A basic challenge in developing quality PPPs has always begun at the very start during the filtering of projects between those that have a revenue potential, and are therefore more suitable for private investment on the one hand, and identifying projects that are clearly best implemented by the public sector, on the other.

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My stint in government allowed me to review some pretty outrageous PPP proposals, which obviously could never generate revenues to even pay for operations. Many of the proposals I saw, often those supposedly initiated from within the public sector, but in fact were developed through the encouragement from material suppliers and contractors, relied mainly on underlying government financial guarantees on revenue streams through take or pay concession agreements. 3 But under these take or pay agreements, the private proponent is insulated from most of the market risk, when in fact, market risk is one of the project risks better managed by the private sector. On the other hand, I have seen projects that clearly had the potential to generate investment returns, even in a regulated market, and where the private sector had expressed interest to invest in them. But as the projects went through government filters, these projects were redirected away from the private sector, and not surprisingly, pursued as projects of government and in the process, incurring additional public sector debt in an already strained national budget. At the end of the day, these projects which have the potential to generate revenues and even financial returns to private investors, end up under the management of public sector institutions or state owned enterprises. More often than not, under the public sector, where pricing of the infrastructure or service is highly politicized, the potential to raise the revenues to at least ensure proper operating expenses and capital replacement is lost. Deterioration of publicly operated infrastructure assets, well within its economic life, is not uncommon because they are unable to generate adequate revenues for basic maintenance of the facility. The filtering of potential PPP and publicly financed projects in many ways boils down to the political will of governments to deliver infrastructure and services, even though this entails requiring direct beneficiaries of the service to subscribe to the principle of users pay. The popular approach would be to provide the facility for free, and then bury the true cost of the infrastructure in the bowels of the national budget. In this case vocal users, who expect free service from government, are kept silent, and unpopular policies on public finance are avoided. 2. Efficient project design If structured as a Build-Operate-Transfer type of project, the engineering design of infrastructure is more likely to be designed efficiently and the project can be expected to be scaled and phased properly. This is largely because the project has to recover capital expenditures from operating revenues in a regulated environment. As such, projects are forced to provide the level of service that approximates what the market is prepared to accept, and the government regulator is prepared to support through tariffs. Approved PPP infrastructure projects in the Philippines tend to be simpler in design, yet very much focused on operating efficiencies. On the other hand, publicly financed projects, are less clear in their design criteria and are scaled larger than what is actually required by the users. Is some occasions, when driven by suppliers, publicly funded projects are notorious for being over designed and employing technologies that developing countries may not necessarily afford.

Take or Pay concessions oblige the public sector to pay the private proponents guaranteed payments whether or not the infrastructure is used or not. Such an arrangement usually insulates the PPP proponent from any market risk.

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The operating expertise and efficiencies of the private sector should also be captured in PPPs. Publicly operated utilities are notorious for systems that are unable to provide good service to the consumer. PPPs on the other hand are more service oriented, especially when the service levels expected of them are clearly articulated in their concession agreements, and failure to meet these service levels result in financial penalties. Combined, efficient design and operating expertise are basic elements of the PPP that should be emphasized to ensure the quality of the projects if they are to gain the support of the public sector. 3. Managing Public Sector deficits. Getting back to basics also means not losing sight of one of the most compelling arguments for PPPs, that is, it is a financing strategy of public infrastructure targeted at managing public sector budgets, by passing on the development cost to the private sector, and the payment of the project to the end-user, if not totally, at least partially. Unfortunately, some PPP projects do not assume an appropriate amount of market risk for the projects commensurate internal rate of return that is reflected in the PPP contract. As mentioned above, market risk is something the private sector understands better than the public sector. Also, PPPs may appear favorable to the public sector, but what may appear advantageous may have more imbedded in them that what appears on the surface, especially for projects that are unmindful of the contingent liabilities incorporated in some concession contracts. Again as an example, the independent power producer (IPP) contracts entered into by the Philippine Government in the mid 90s to address the acute power crisis, did put an end to 12-hour brownouts through massive spending from private investors. But this was not without a painful price. Many of the IPP contracts contained take or pay agreements that did not anticipate, and could not adequately manage cyclical changes in the market, as the projects were implemented. When the 1997 Asian Financial Crisis hit the country, resulting in a general slowing of the Philippine economic growth, the government was left saddled with payment guarantees to the IPP, and no consumer demand to off-take the power. Of course, in hindsight, it is easy to say the authors of the contracts were wrong in assuming so much risk on the part of government. But at the same time, a prolonged period of 12-hour brownouts in the capital city was neither economically nor politically viable. So governments were forced out of necessity to contract the private sector through IPPs. From the private sectors perspective, no investor would be foolish enough to enter into such capital intensive project, like a power plant, without some form of guarantee from government, especially in a regulatory environment where the rules were still unclear. But when the projects were already operational, they were then subjected to extreme political pressure as government guarantees were being called on otherwise idle plants. This scenario resulted in huge direct and contingent liabilities from these projects which ultimately impacted the public deficit and threatened the viability of the PPP project for political and social reasons.

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Moving forward, the real challenge to government and private sector project proponents is to reasonably share the risk and the return of the PPP enterprise. Contracts should anticipate uncertainty and be prepared to manage it, although easier said than done. Governments on the other hand should recognize that PPPs and BOTs may demand less on national budgets, but more on proper regulation of what are often monopolistic enterprises. 4. With private participation comes regulation The previous point brings to mind a simplistic equation that I have coined about the often controversial issue of regulation of PPP contracts. This simple equation is PPP = RRR. Although not a real mathematical equation, this should read Public Private Partnerships = Remember, Regulation is Required! Because many infrastructure projects enjoy some kind of monopolistic power in one form or another, it is critical for governments to establish a clear regulatory environment where these PPPs will operate. PPP projects in poorly regulated infrastructure sectors, where the technical, legal and economic knowledge, as well as skills, are not possessed by the government regulators, often lead to market abuse by the private proponents, at the expense of the consumer. The other side to this coin however is poor regulation can also lead to projects that, once operational, turn out to be financially and operationally unviable because regulation is unable to balance the interests of consumer welfare and financial viability of the private proponent. In situations however when PPP projects go into stress due to unrealistic regulation, and as a result, go into default or termination, it is still the consumer who will suffer from the failure of the project. Unfortunately, weak regulation leads to private sector financial resources that are tied up in complicated project restructuring, instead of invested in some other productive economic activity. And, in some occasions, it is ultimately the government which is forced to bail out the PPP projects when default and termination provisions of the contract take effect. 5. Reform in pricing infrastructure I see the pursuit of PPPs as an opportunity for the government to introduce reform in the infrastructure sector as well. One such reform is the opportunity for transparency and public scrutiny, which PPP are subjected to as they are awarded to a proponent. Because PPPs often entail some form of taxation or charging of fees to the public, as needed to generate the revenues for the return on the investment, these projects are subjected to public scrutiny and careful review, which brings some element of transparency to the investment process. Moreover, the attention and scrutiny to all elements of the project is not limited solely to the review by regulators and the general public. The creditor banks being asked to finance these PPP projects have pretty sharp pencils as well. Project fat, which may be attributed to excessive profit margins by contractors, suppliers and proponents, which the public sector may miss in its review, possibly because they are unfamiliar with comparative costs for similar projects, can subsequently be identified by the creditor banks that will finance the project. Hopefully, in the process of securing financial closure for the project, it is once again subjected to scrutiny and review which may redound to benefit for the economy.

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Also PPPs present an opportunity for pricing reform in infrastructure systems and public services and utilities. PPP toll roads for example, provide the venue to introduce road user fees and charges, whereas otherwise, governments would be hard pressed to introduce such measures using public funds, which may carry an expectation of free infrastructure. Through the PPP projects, governments have the opportunity to introduce user charges and fees, as the general public would better appreciate that any private investment would require some form of return on their investment in providing what is otherwise a public utility. Politically, it may be easier for politicians to accept the backlash of introducing pricing for the use of public utilities, if he has the opportunity to point to a third-party as the collector of such fees. In reality, the charging of users fees is a public policy, and the private sector is only an agent of government in collecting such fees. But in political reality, doing what right still requires that politicians that have to adopt the policy must remain to be politically viable. Although I am sure the private sector may not enjoy it, they will be identified as the boogie man, but as long as they are protected by a concession and clear regulatory environment, they can manage the negative image through social marketing and public relation budgets. But it must be kept in mind that policy reform in pricing infrastructure should best be implemented hand in hand with the independent and credible economic, technical and safety regulation of these infrastructure projects, services and public utilities. This underscores the value of my previous point on regulation of PPP infrastructure projects. 6. Solicited projects versus unsolicited projects

I continue to be biased towards solicited projects vis--vis unsolicited project from the private sector. Projects solicited by government through competitive bidding reflect that the five steps I mentioned above have been undertaken in one form or another. These elements are: Project Filtering Efficient Project Design Management of Public Sector Budgets A regulatory environment Pricing reform in infrastructure Solicited projects encourage greater competition, and can even encourage foreign investment, if the rules of the bidding and the terms of reference of the project are clear and commercially viable. If a project is clearly a priority project of government, then it should invest in the necessary project development documents, such as a full feasibility study, basic engineering studies, tender documents and a well written, and ideally, government approved concession agreement. This investment in project documentation is a small fraction of what the project will actually cost, and what government is asking the private sector to invest. This is the clearest manifestation that the project is in fact a government priority and will most likely pay for itself ten-fold by avoiding costly dispute resolution and contingent liabilities that are not properly budgeted by government.

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But project development takes resources and specialized skills. Things that are in short supply in bureaucracies of developing countries. To try to address this short coming, the Philippine government established a Project Development Facility that was designed to finance project development and recover the cost upon award of the project or financial close. But unfortunately, the success rate was not noteworthy. At the end, the projects faced the basic question of did the government agencies have the political will to tender the projects? In most occasions, the answer was no. Or on some occasions, the agencies were not prepared to pursue the tender in a transparent and competitive manner in which they had been designed to be tendered. This brings me to the window for unsolicited projects, although arguably less desirable than a project solicited by government in a competitive and transparent manner, I do believe that they have a role in PPP project development. The Philippine BOT Law, known as Republic act 7718, has a fairly well defined criteria and methodology to process unsolicited PPP projects. The policy and mechanics can be sourced from the internet should there be interest to see it in detail. The criteria for an unsolicited project are: 1. If the project is NOT a priority of government and/or introduces a new or proprietary technology; 2. If it does not require a government guarantee or subsidy; and, 3. If it does not require government equity in the project These three criteria try to avoid moral hazard when the government reviews and accepts unsolicited projects. Should the project entail a monopoly, and as a result a regulated market, then government has to set the acceptable return prior to implementation. Finally, to check if there are better offers for the unsolicited proposal from other private entities, once government and the original proponent agree on the project and the concession document, a price challenge, or Swiss Challenge must be conducted by publicly soliciting alternative price offers to implement the concession agreement. This allows private competitors to offer a better price than that of the original proponent, under the same terms of the concession. The original proponent however, has the right to match the better offer should there be one, and reclaim the project for itself. Much can be said as to the competitiveness of the Swiss Challenge given the right to match. I believe the ability to establish a credible price challenge is critical in determining the desirability of the unsolicited project. But unsolicited project may have a role in PPPs, given the limited resources of government in developing solicited projects, keeping in mind the criteria identified in the BOT Law in the Philippines in considering and evaluating unsolicited proposal - so as to avoid moral hazards in approving these projects, and the fact that government is under no legal obligation to accept an unsolicited proposal from a proponent, then there may be reason to consider this approach, albeit with strict adherence to the process and

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criteria. Unsolicited proposals, as they capture the entrepreneurial spirit of the private sector, but can be littered with moral hazard, is a possible area for academic study and continuing refinement in PPP project development, evaluation and tendering processes and infrastructure policy in general.

Conclusions How do we meet the challenger of PPPs and BOTs in this difficult economic environment? I would say, first of all, let us build on the strengths of the private sectors role in project development by demonstrating the ability to implement infrastructure projects faster than if they were to be carried out purely by the public sector. This characteristic would differentiate PPPs against the host of other infrastructure projects jockeying for public funds and policy attention. The second step would be to go back to the basic of good project structure and development. Some of these elements I discussed above were: Project Filtering Efficient Project Design Management of Public Sector Budgets A regulatory environment Pricing reform in infrastructure Solicited versus unsolicited projects

In closing, in the midst of economic meltdown, clearly focusing PPPs along these lines would allow projects, albeit of much better quality to progress and play a role in stimulating our sagging economy and introducing the foundations for sustainable growth into the 21st century. The need is urgent. To quote the head of the International Monetary Fund head Dominique Strauss-Kahn, "The question is no more to convince the governments to move today, but for them to implement the policies they need to manage" Thank you and Good day!

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