Infrastructure Finance in Developing CountriesDr. Alma PekmezovicMOOCDigital Artifact

Development Finance The key question is: how to increase the availability of all sources of finance in developing countries?

Different types of finance must be used holistically and complimentarily to support sustainable development and economic growth in developing countries.

The main types of finance available are: domestic public, domestic private, international public finance and international private finance.

Sustainable development finance must be designed to maximize synergies across all these financing sources.

Foreign Direct Investment (FDI) Developing countries are increasingly the recipients of FDI FDI has the potential to contribute to developing countries‘ economies

FDI is an important source of investment in infrastructure Countries can adopt policies which either encourage or restrict FDI either generally, or in particular sectors of the economy

Foreign Direct Investors: Concerns FDI investors are concerned about political and policy instability

(as well as macro-economic instability) Where investments are sunk, subsequent governments may have incentives to behave opportunistically towards FD investors who lack direct political voice in host countries by ex post facto re-specification of terms on which the inivial investment was made

Other concerns: weak protection of property rights, ineffective enforcement of contracts, rule of law and corruption

Developing countries compete for FDI, and seek to provide legally enforceable protections to FD investors for their investments

FD investors may look to BITs (bilateral investment treaties) for supra-national legal protections (BITs may substitute for weak domestic legal protections)

Foreign Aid Most developed countires have committed themselves to increasing levels of foreign aid

Foreign aid is mostly government-to-government aid About 70% of aid is provided on a bilateral basis, and 30% on a multilateral basis

Three fundamentally different perspectives on the efficacy of foreign aid: Jeffrey Sachs: advocates substantially increased foreign aid (limited efficacy

of aid to date has been largely a function of the limited scale of foreign aid) William Easterly: is critical of increasing foreign aid Dambisa Moyo: suggests that foreign aid has undermined development

Foreign Aid (cont). Aid works best in good policy and institutional enviroments Paul Collier: foreign aid should be concentrated on the 60 or so developing

countries comprising the poorest billion citizens of the world and suffering from traps such as: the natural resources trap, the landlocked-with-bad-neighbours trap, the civil conflict trap, and the poor governance trap

Aid-institutions paradox: providing aid to countries that need it most is unlikely to have the desired effects because of institutional and policy failures in recipient countries

Co-ordination problems: multiple donor agencies working on similar projects and making funding decisions on the basis of imperfect information about the overall funding levels in a country, or a particular sector of a country

Foreign Aid (cont.) Problem of „tied aid“ – whereby donors require recipient governments to commit to purchasing inputs, goods or services from firms in donor countries

Tied aid diminishes value of aid by 15-30 per cent relative to the amount of aid could purchase on the open market (freezes out local suppliers)

Tied aid accountages for approximately 50% of bilateral aid. OECD has made substantial progress, however, in reducing this percentag (See R. C. Riddell, Does Foreign Aid Really Work, Oxford University Press, 2007)

Foreign Aid (cont). Aid conditions may not be met by recipient countries Aid conditions may be at cross-purposes with one another It is thus important to unlock the aid-institutions paradox Who should be the recipients of aid? Governments, constitutencies outiside of the government, or NGOs? Shall we privatize the recipients of aid? To what extent, should be important to extract meaningful reform

commitments that enjoy support from substantial domestic constitutencies? Should foreign aid be an important agent for institutional reform? What should be the most effective bundle of „carrots and sticks“ to drive

institutional change and infrastructure project financing?

Infrastructure Financing Developing countries, and especially low-income countries, face challenges in attracting infrastructure financing.

The infrastructure investment needs in these countries will be substantial for the next two decades. Over 1.3 billion people—almost 20 percent of the world’s population—still have no access to

electricity.  About 768 million people worldwide lack access to clean water; and 2.5 billion do not have adequate sanitation; 2.8 billion people still cook their food with solid fuels (such as wood); and one billion people live more than two kilometers from an all-weather road. (See

http://www.worldbank.org/en/programs/global-Infrastructure-facility)  By 2030 the world will most likely need 40 percent more energy and face a 40 percent shortfall of

water—pressures that may well be further accelerated by climate change However, there are significant barriers to infrastructure investment in developing countries. This presentation, therefore, highlights the importance of improving investment in infrastructure, and drawing on both MDB and private sector finance to facilitate economic growth.

Why does infrastructure matter? “Overcoming the infrastructure bottleneck would boost long-term economic growth. Infrastructure is an input to a wide range of industries and, as such, an important driver of long-term growth. At the same time, delays in the realisation of infrastructure projects pose potentially large economic and social costs. And those projects which are realised are sometimes badly designed and cannot deliver the expected performance. In some emerging markets, the lack of well-performing infrastructure holds back economic development. But also in advanced economies, a lack of investment in well-designed transport, renewable energy, and social infrastructure is becoming more evident.” - BIS Working Papers No 454, „Understanding the challenges for infrastructure finance“, page 2.

“We cannot end poverty and we cannot deal with financing for development, without putting infrastructure front and center,” - World Bank Group CFO Bertrand Badré 

Infrastructure plays a critical role in driving growth, competitiveness, job creation, poverty alleviation and promoting sustainability

What are the barriers to infrastrucure financing? Matching the supply of finance from the private sector with investable projects Banks have mostly short-term liabilities and are not well-placed to hold long-term infrastructure assets on their

balance sheets for an extended period of time Possible suppliers of finance: Pension funds, insurance companies and other long-term institutional investors But very little of their financial resources is allocated to infrastructure Political risk is among the greatest concerns of private investors (OECD (2014)) Also, investors expect adequate returns and compensation for the risks Infrastructure projects only generate positive cash flows and positive financial value after many years (long-term

assets) Constraints on existing sources of infrastructure finance, particularly in the public sector: Governments - by far the largest source of financing for infrastructure projects – supported the infrastructure and project finance markets with cash and/or guarantees. But this model is no longer sustainable due to significant deficits and sovereign debt levels in developed countries (See http://www.pwc.com/gx/en/industries/capital-projects-infrastructure/financing.html)

The MDBs along with state-owned infrastructure banks will thus continue to play an important role in financing infrastructure projects

Mobilising the necessary funds to satisfy the growing demand for infrastructure investment will also require new sources and instruments of finance

E.g. Infrastructure investment funds, can help to tap some of the vast resources of international capital markets pension funds and sovereign wealth funds can take direct stakes in infrastructure projects and companies

Infrastructure and the debt markets“In the present climate, the key challenge for the debt markets remains attracting institutional pension fund money. Whilst prior to the global financial crisis institutional money was invested directly into projects with monoline credit enhancement, or helped to relieve banks’ balance sheets through collateralised debt obligations, these structures are no longer a realistic option.Large infrastructure debt portfolio sales by banks to institutions will continue; however, all market participants will continue to try to create multi-investor institutional debt funds or find structured products that mitigate the risk of senior debt. The capital debt markets need to be the prime source for infrastructure refinancing; the rollover of bank debt can’t be counted on to meet current and future needs.” (See http://www.pwc.com/gx/en/industries/capital-projects-infrastructure/financing.html)

Infrastructure Financing Structuring MDB/private sector co-investment platforms: MDBs have a strong record of cooperating with the private sector in infrastructure projects.

The resources-for-infrastructure (RfI) financing model has adopted in a number of developing countries: In a RfI, oil or mineral extraction rights are exchanged for infrastructure. Rfis are intended to overcome obstacles related to limited capital markets access. Infrastructure financing is backed by future oil or mineral revenues. Projects may include roads, regional railway lines, water supply

projects, telecommunications, hydropower dams and plants, and other electrical power infrastructure.

Mobilizing public-private infrastructure projects Strategies for mobilizing public-private infrastructure projects for the long-term:

Here, the issue is the quality of finance provided. Long-term projects will require long-term funding rather than short-term financing.

National development banks can play an important role here, particularly because infrastructure projects are often not viewed as commercially viable by potential investors.

The development of suitable legal and regulatory frameworks to support a favorable climate for infrastructure financing and to reduce the risks infrastructure investors face is essential.

Mobilizing public-private infrastructure projects Strategies for mobilizing public-private infrastructure projects for the long-term:

Here, the issue is the quality of finance provided. Long-term projects will require long-term funding rather than short-term financing.

National development banks can play an important role here, particularly because infrastructure projects are often not viewed as commercially viable by potential investors.

The development of suitable legal and regulatory frameworks to support a favorable climate for infrastructure financing and to reduce the risks infrastructure investors face is essential.

Global Infrastructure Facility (GIF) Private commercial lenders and institutional investors have joined with MDBs and donor countries to create the GIF

The GIF is a partnership among governments, MDBs, private sector investors and financiers—designed to provide a new way to collaborate on preparing, structuring and implementing complex projects that no single institution could handle on its own

The GIF became operational in April 2015, with an initial capitalization of US$100 million Between 2015-2018 GIF operations constitute a “pilot phase,” during which the GIF concept, activities, and partnership model will be tested. GIF model will be tested across a range of project sectors and types, geographies and country environments.

The GIF works with client governments from emerging markets and developing economies to support infrastructure projects or programs that will be structured to attract substantial private capital

GIF supported projects may be implemented by privately-operated entities (as under a PPP modality), or

by public sector entities operating on a commercial basis—provided in either case that they are providing infrastructure as a public service

Airport Infrastructure Financing in Africa

Airport Infrastructure Financing in Africa (cont.) African countries face an infrastructure challenge There is a growing demand for new and better infrastructure services. BUT How to finance infrastructure services such as airport facilities or services to meet this growing demand ? Possible sources of finance: Commercial bank loans Bonds from capital market (General airport revenue bonds GARB) MDB loans World Bank Group

- International Bank for Reconstruction and Development (IBDR)- International Development Association (IDA)- International Finance Corporation (IFC): investment arm of WBG- Multilateral Investment Guarantee Agency (MIGA)

Regional Development Banks- African Development Bank (AfDB)- East African Development Bank (EADB)- European Investment Bank (EIB)- Islamic Development Bank (IBD)- Arab Fund for Economic Development in Africa (BADEA

Possibility of co-financing Two or more MDBs or other financing institutions together financing the same project. development

Sources of co-financing:

- Official cofinancing usually concessional comes from donor governments and their agencies (mainly through bilateral assistance

programs) and multilateral financing institutions (e.g. the regional development banks).- Private cofinancing financing from such private sources as commercial banks, insurance companies, or other private lenders, for a Bank-

supported project

Public-Private Partnerships Why PPPs are attractive?

PPPs have become attractive to governments as a mechanism for airport development as:

They enhance the supply of airport services.

They may not require any immediate cash spending.

They allow transfer of many project risks to the private sector.

They promise better project design, choice of technology, construction, operation and service delivery.

How to promote foreign investment in African aiport infrastructure projects? Circumstances encouraging foreign investment- Expected high traffic growth in Africa, up to doubling traffic till 2030- Quasi-monopole nature of an airport

Circumstances not encouraging foreign investments- Increase of competitive situation among airports- Passenger charges in Africa above global average, partly caused by fuel taxes that are 50% to 100%

higher than the global average- African aviation industry behind the rest of the world, accounting for just 3% of global passenger traffic- Travel restriction between African countries- Lack of passenger volume at African airports, mainly regional airports- Lack of experience with non-aeronautical revenue generation

- >Important to deal with above constraints via policy and regulatory change