All governments, at all levels, want for infrastructure. They recognize that infrastructure supports development and enables economic growth. They understand that infrastructure improves quality of life and helps build social cohesion. And they know that their citizens and businesses will continue to demand more (and better) infrastructure access and services.
Yet all governments are also struggling to secure the capital they need to deliver on their infrastructure agendas. The biggest problem — in the developing markets and the mature markets — comes down to funding. Simply put, who is going to ultimately pay for the infrastructure.
Governments recognize that some infrastructure (such as utilities) can be funded entirely through user-pay mechanisms, while other infrastructure (such as community centers and public hospitals) must be funded through the public budget. It’s the broad basket of projects that lie in the middle that are causing the biggest problems; those that require a mix of funding sources (and therefore some level of private investment) to deliver.
Some are taking measures to unlock new sources of capital, often through sales of existing assets where the capital is reinvested into new assets without adding to the public balance sheet. But it is clear these sources of capital will not be sufficient to deliver all of the assets that are currently needed.
We believe that — on the whole — governments have been too conservative in their attempts to create and encourage infrastructure markets. In part, this is because most governments have become overly focused on allocating risks to the private sector and have lost sight of their primary objective: to get deals done and infrastructure delivered. Far too many good projects have failed to reach development because procurement authorities misunderstood the private sector’s risk tolerance and nit-pick over the commercial terms.
In much the same way, governments also often seem disinclined to inject their own capital into projects with user paid revenues in order to get them into development. But in waiting for a completely ‘off-book’ solution (in the developed world through a private investor; in the emerging markets through a multilateral loan), viable and much-needed projects remain stuck in the pipeline.
Governments need to recognize that the ultimate benefactor of infrastructure is the public. Yes, the private sector will seek to achieve a profit from its participation. But we believe that governments need to focus more on the bigger picture — delivering on the longer-term economic, social and environmental requirements of their citizens — and less on the shorter-term goals of absolute risk mitigation and cost avoidance.
For many governments — particularly those with non-existent or less-developed infrastructure markets — this may require the public sector to assume larger portions of risk, until such a time as investors become more comfortable with assessing and managing those risks for themselves. In the emerging markets, this could include land acquisition risks, political risks, currency risks or environmental risks.
Other governments may want to consider creating new support mechanisms designed to instill confidence in their markets. Many, from the UK to Indonesia, have developed Infrastructure Guarantee Funds to help investors tap into higher credit ratings or implicit financing guarantees for certain projects. Some, like the US, have updated their tax regimes to offer additional support to foreign pension funds investing into infrastructure.
While the development of these types of measures are to be encouraged, governments should also think clearly about how they structure their participation in order to maximize their balance sheets and encourage ongoing investment. Simply put, while the benefits should be long-term, the investment of public funds should not be.
Those investing capital directly into infrastructure projects, for example, will want to ensure they include clauses that permit the government to exit the deal at a time when alternative financing becomes available. New deals should be structured with potential exit strategies built-in to allow the government the flexibility to recycle their capital into new projects.
Those creating support mechanisms such as Guarantee Funds will want to consider pricing their initiatives in such a way that encourages owners to seek out competitive options rather than simply defaulting to the Guarantee facility, or to repay the facility once better financing options become available.
By taking this approach, governments can help to encourage their national infrastructure markets, drive projects out of the pipeline and protect their longer-term balance sheets. And, in doing so, they can build longer-term confidence in their markets that, in turn, will help reduce the requirement for government incentives in the first place.
To be fair, not all of the responsibility falls onto government shoulders. Multilaterals should continue to play a major role, particularly in encouraging the flow of private capital and helping build institutional capacity within markets. The bigger challenge will be in creating some form of currency risk insurance, similar to the Multilateral Investment Guarantee Agency’s (MIGA) political risk insurance that helps investors overcome the biggest barrier to emerging market investment.
At the same time, private investors will also need to work harder to find ways to work with governments to get projects out of the pipelines. More debt financing will be needed. More capacity building will be required. And best practices and viewpoints will need to be shared.
However, at a time when so much infrastructure is so dearly needed — governments, multilaterals and private investors need to increasingly work together to take a more active role in unblocking infrastructure pipelines.