Infrastructure development and innovative finance

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VIADr Shamshad Akhtar
SOURCEBusiness Recorder
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Quality, sustainable and climate resilient infrastructure is a pre-requisite for accelerating and ensuring stability and equity of economic growth and social development. Over the years, infrastructure gap in Pakistan has grown to a great extent. Opportunity cost of years of neglect has been high: contributing to loss of about 4 to 6 percent of GDP, logistical bottlenecks enhance the cost of production of our goods by about 30 percent (State Bank of Pakistan (SBP) making them uncompetitive. Infrastructure deficits and poor quality of public services have also enhanced multidimensional poverty and impacted quality of living.

Infrastructure gaps in Pakistan are likely to grow considerably as population is estimated to rise by another 75 million in next 15 years. In the wake of the past and future demand scenario, country’s investment requirements are estimated to be over $500-600 billion or so equivalent to 8 to 10% of GDP – well above the present levels of 2 to 3% of GDP.

Also Read: Managing operational risks key to infrastructure projects

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To reduce the economic and social distress caused by infrastructure deficit, Pakistan needs to adopt an inclusive infrastructure strategy that embraces the context and dynamics of 2030 Sustainable Development and Climate Agenda with support of sustainable and diversified financing in line with the Addis Ababa Action Plan. Sustainable goals of infrastructure, climate and urban together advocate promotion of balanced regional and sector development with focus on accessibility, affordability and sustainability. In the wake of climate vulnerability and disasters, additional emphasis is placed on building and building back, resilient infrastructure.

In view of this, infrastructure development is no longer a business of concrete and construction but involves re-engineering both in terms of architecture and design to reinforce resilience and smart structures that are cost-effective and efficient factoring in long-term gains. Climate-friendly infrastructure requirements, as estimated by ADB, could range around $1.8 trillion annually, but part of these costs can be offset by quality dividends.

Traditional sources of finance in developing countries are inadequate to fund infrastructure requirements. As anticipated, tax/GDP ratio in infrastructure deficit countries remains low (almost below 11-15% of GDP) and have constrained growth in public investment which ought to be a primary source of funding for inclusive and social infrastructure.

Domestic capital markets in few developing countries have lagged or shown volatility in their market capitalization: Pakistan market cap is now at 25% of GDP relative to Malaysia and Thailand now over 100% of their GDP. Though early stage financing for infrastructure is either funded by budgets or borrowings from commercial banks – later reports barely 9% infrastructure loan assets on their books. Infrastructure and capital market can be mutually reinforcing if infrastructure sponsors raise both debt and equity and green infrastructure funds/bonds from the stock market.

PPPs, as modality for infra-financing, have been in existence for long but PPPs’ share in infrastructure development and finance constitute 20-30% in few key Asian economies. Progress has been good where strong PPP centres or units were established and backed by best practice policy, legal, regulatory and institutional frameworks.

Relative to public projects, PPPs typically require greater scrutiny, coordination, effective analysis of risks and an assessment of who bears what risk, how it priced and clarity of risk mitigation frameworks. So while cost of structuring and expertise required are high, if effectively managed and operated it is offset by efficiency gains.

Private finance plays a critical role in infrastructure development, but as per Overseas Development Institute (ODI) over 2008-2017 only $1.5 trillion private flows were invested in infrastructure. Almost 78% of this was standalone private financing, while 20% was leveraged through co-financing by MDBs whose support for infrastructure post-2008 crisis has been enhanced. Private financing offers diverse sources of funding avenues that offer equity risk capital, project financing, bonds and funds.

Commercial bank loans remain a source of financing, but they may not offer the maturity or exchange risk management needed for long gestation projects. Credit guarantees by the public sector or private sector are warranted to insure against defaults and it is in this spirit Karandaaz is establishing InfraZamin, a credit enhancement company.

Moody’s verdict

To mitigate exposure risks, development banks could serve as mezzanine creditors, take on a subordinate role among creditors, so if the project fails or debt payments to senior creditors cannot be processed, the mezzanine debt can be converted into equity. In return, the mezzanine creditors would be adequately compensated.

Enhancing bankability of projects calls for exploration of innovative financing methods, including land value capture and capital recycling, green bonds, ESG funds and crowd funding, and securitization, result-based and blended finance options, and tax increment financing (TIF) bonds, GDP-link bonds, stapled securities, and (other) spillover capture tax financing modalities. Infrastructure bonds that capture economic growth and tax revenue spillovers of infrastructure projects are especially promising, as they can enhance returns received by bondholders, thus attracting private investment in infrastructure that would not otherwise have been developed.

Such financial instruments could also help reduce the likelihood of default of long-term infrastructure projects, or at least not worsen it as investors have the incentive to closely monitor project performance in order to preserve their earnings. Through such innovative schemes, governments can raise funds without fully carrying the risks and responsibilities commonly associated with the financing of infrastructure projects. Land acquisition problems have consequences for infrastructure development and its complexity in terms of costs involved in acquiring land and years it takes to accomplish, countries have promoted land trusts where land can be leased to the project company over an extended tenure, with original land owners retaining the title. This will not only reduce project cost but will also unlock value of idle land, while monetizing the asset over generations.

To conclude, infrastructure enhancements will pay high dividends to Pakistan as it has potential to revive aggregate demand, generate much-needed jobs and reduce disparities. While investment requirements are steep and could complicate macroeconomic stability, the gap can be narrowed by utilizing innovative financing mechanisms including by broadening taxes and deepening capital markets, and deploying public resources to leverage private capital from domestic and foreign investors. Strengthening infrastructure institutional, policy, legal and regulatory requirements and requisite competence and capacities to process and negotiate complex projects is critical.

(The writer is Chairperson Karandaaz Pakistan, Under Secretary General at United Nations and former Governor of State Bank of Pakistan)

(This news/article originally appeared in Business Recorder on December 5th, 2019)

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