Miyamoto, K. 2013. Support to enhance private investment for developing country infrastructure. GREAT Insights, Volume 2, Issue 4. May-June 2013. Maastricht: ECDPM
Private investment is critical in financing the significant infrastructure needs of developing countries. This requires a sound financial sector, enabling environment, and risk mitigation instruments. These can be supported by multilateral and bilateral donors.
The Need for Private Investment in Infrastructure
Infrastructure is critical for the delivery of public services and economic development. Road networks, energy, and ICT ease constraints to doing business by reducing transport costs and linking local and global markets, particularly when combined with appropriate trade policies. Infrastructure supports the development of the private sector, which provides the majority of jobs in developing countries. Improving infrastructure is also key in addressing the needs of the poor by enabling better access to safe water, electricity as well as health and education services. The Millennium Development Goals (MDGs) include targets to improve water and sanitation infrastructures as well as ICT, recognising their importance for human development.
As developing countries see infrastructure as key in achieving development, their governments have been allocating their own public funds to build, operate and maintain it. In sub-Saharan Africa for instance, between 2002 and 2006, more than half of the amount spent for infrastructure came from the developing countries’ public sector. At the same time, many developing countries, particularly low-income countries (LICs), also rely on aid for their infrastructure financing. In this respect, traditional bilateral and multilateral donors have been increasingly supporting developing country infrastructure, amounting to roughly US$44 billion in 2011.
However, developing countries still face a large financing gap for infrastructure. For instance, 1.3 billion people still lived without electricity in 2011. In the target year for the MDGs of 2015, 605 million and 2.4 billion people will still not have access to safe water and sanitation facilities, respectively. The private sector will also need reliable sources of energy in order to thrive. Thus more funds are needed: in sub-Saharan Africa, an additional US$50 billion a year is required to meet all the infrastructure needs. In order to minimise environmental damage, build resilience and avoid costly renovation at a later date, massive investment is also required to establish low-carbon, climate-resilient green infrastructure. While the BRICS have recently agreed to create a development bank to provide funding for infrastructure project initially worth US$4.5 trillion, the actual establishment of this bank may take a few more years.
Therefore, as developing country governments and donor countries are struggling to mobilise further public resources, increased private sector participation and investment will be indispensible to meet the infrastructure financing gap. This approach is in line with the Monterrey Consensus on Financing for Development, the G20 High Level Panel on Infrastructure, and the more recent agreements at the High Level Forum on Aid Effectiveness in Busan. At the same time, both developing country governments and donors need to ensure that the profit incentive of the private sector do not undermine governments’ pro-poor and other development objectives. As the ultimate objective is sustainable development, private investment for infrastructure should be pursued when it is deemed to contribute to the former.
Private sector participation in infrastructure includes: management and lease contracts; concessions; greenfield projects; and divestitures. Through these modalities, private investment in infrastructure projects in developing countries increased from US$18 billion in 1990 to US$114 billion in 2006. Between 1990 and 2011, Latin America received almost 40% of private investment for infrastructure, followed by East/South Asia and Europe/Central Asia, which received between 15% and 20% respectively. The Middle East and North Africa (MENA) and sub-Saharan Africa accounted for a little more than 10% of total investment. Here, while large multinational investors from OECD countries used to be dominant, emerging market firms are increasingly becoming prominent.
Challenges in the Financial Sector and Enabling Environment
At the same time, many developing countries still face challenges in accessing international and local finance, which depends on a sound financial sector that provides adequate banking services, mobilises savings, and allocates financing to firms wanting to invest. In particular, local commercial banks are often too small to provide funding for large infrastructure projects. They are also often risk-averse with excessive collateral requirements, making loan tenures too short for long-term projects. In turn, this limits them in building relevant experience and skills to undertake project financing or to participate in project identification, design, negotiation with capabilities equal to the investors. In addition, non-bank financial services such as bonds and guarantees are also limited in LICs.
On the other hand, there is growing interest in tapping into local and regional sources to overcome the dearth of financing with maturity terms that are commensurate with long term horizons of infrastructure projects. While not suitable for all countries, substantial sums could be available for investment if successful pension reforms were undertaken, as they could spur the development of capital markets. Furthermore, foreign institutional investment in infrastructure, although still very limited, is rapidly growing in some developing countries.
In order to have a modern financial sector, it is essential to have a sound and enabling environment that ensures fair competition, information transparency, and security for the rights of borrowers, creditors, and shareholders. This enabling environment includes high standards of public and corporate governance and the rule of law. As underlined in the Organisation for Economic Co-operation and Development (OECD)’s Principles for Private Sector Participation in Infrastructure, fiscal discipline and transparency must always be safeguarded when engaging with private partners.
These elements are still challenges especially in Sub-Saharan Africa. Many African countries have limited resources for public audits, deficiencies in oversight functions by parliament and lack of co-operation by the executive branch which together compromise budgetary and fiscal monitoring. More generally, civil servants lack administrative capacities to deal with project identification, project preparation and the awarding process when engaging with the private sector. Furthermore, policies, regulatory bodies and laws to prevent anti-competition and anti-corruption practices are often in their preliminary stages.
Development Partners’ Support to Infrastructure
As many developing countries face challenges in mobilising private investment to finance their infrastructure needs, bilateral and multilateral institutions are providing financial instruments such as investment funds, blending, risk mitigation instruments (guarantees and insurance), and Output-Based Aid, with the objective of attracting private investors who might otherwise be deterred from entering risky markets. Furthermore, they give support to help improve the enabling environment, especially for public private partnerships (PPPs), when suitable. In Africa, for example, donors disbursed in 2008-10 roughly 22% of official aid for infrastructure to support the enabling environment, with the rest going to the hardware.
Emerging economies also contribute to infrastructure development in developing countries. China is now one of sub-Saharan Africa’s biggest partners for infrastructure, outpacing the World Bank: between 2003 and 2007, it allocated a total of US$16 billion compared to the US$8 billion by the World Bank, although 70% of its activities were concentrated in Nigeria, Angola, Sudan, and Ethiopia. China provides many types of financial instruments going beyond aid to enhance Chinese private investment in the continent. Its Development Bank provides non-concessional loans to partner governments who are then bound to contract Chinese companies to build infrastructure and to extend rights to extract natural resources. The Chinese Eximbank provides export credits and concessional loans to developing country governments or Chinese firms for their investments as well as export guarantees to sellers and buyers.
Other emerging economies also contributed to a large share of infrastructure financing in Africa. Seven Arab Funds committed a total amount of US$3.3 billion to Africa’s infrastructure in 2010. Other actors included India in power projects and telecoms and Brazil in Lusophone countries. In Africa, stakeholders perceive emerging donors as more effective than traditional donors, for example, by being less bureaucratic and interested in setting policy conditions. On the other hand, traditional donors are seen as having a comparative advantage in helping improve governance and human capital, thereby being potentially complementary with emerging partners that provide more support towards hard aspects of infrastructure.
Development Assistance Committee (DAC)’s Contribution
Development co-operation to support conventional procurement for infrastructure will continue to play an important role in fragile states or some least developed countries where conditions for private investment may still remain unfavourable in the medium term. At the same time, the DAC is considering ways to use development co-operation more effectively in leveraging private investment, support partner government efforts to create the appropriate enabling environment, as well as engage with the emerging economies that provide significant infrastructure financing in developing countries. The DAC and the Investment Committee are also jointly trying to dialogue better with the private sector to learn how development co-operation could support their investment
With this objective, the DAC is currently gathering information on what key bilateral and multilateral agencies, as well as possibly some emerging economies, are doing to encourage private investment for developing country infrastructure. This will cover, by each agency: data such as the share of ODA infrastructure projects that involve private investment among total ODA infrastructure projects; views and approaches towards private investment for infrastructure; and institutional co-ordination among the development co-operation agency, development finance institution (DFI), export credit agency, and other relevant ministries. Once this compendium is put together, two or three case studies of specific infrastructure projects will be carried out in order to document good practices in leveraging private investment.
The DAC is also implementing, inter alia, a new work stream to improve the quality and analytical value of its statistics on resource flows to developing countries beyond aid, including in the infrastructure sector, such as foreign direct investment, export credits, national and international DFIs’ operations. For example, in this context, a special survey on guarantee schemes for development has been recently launched to estimate the scale of these mechanisms in DFIs’ portfolios and the amount of private investment mobilised through them.
Based on this information, guidance will be developed on how donors can become more effective in supporting private investment for developing country infrastructure.
This article is largely based on “Support to Enhance Private Investment for Infrastructure in Developing Countries” by K. Biousse and K. Miyamoto. Footnotes are included in this document.
Kaori Miyamoto is a Senior Policy Analyst in the DAC Secretariat of the Organisation for Economic Co-operation and Development (OECD).
This article was published in Great Insights Volume 2, Issue 4 (May-June 2013)