By Surya Bagchi
IN the world of infrastructure, the funding deficit is a well-established fact. Asia needs US$26 trillion by 2030 for new buildouts, and Africa requires US$93 million a year to scale up projects. Much of the money has so far come from direct government financing or funding support from development banks. Infrastructure projects often have social benefits which are not priced into project revenues, and traditionally considered better addressed by subsidized public finance. While gaining in popularity in emerging markets, private funding for infrastructure projects is still insufficient to meet the ever-growing demand.
During the recent World Bank Singapore Infrastructure Finance Summit 2018, ASEAN finance ministers unanimously agreed on the need for greater private-sector participation to fund the region’s infrastructure. Of the US$3 trillion that ASEAN needs for infrastructure by 2030, only 30% is being met by existing funding. To address this shortfall, ASEAN aims to attract private investors by improving laws and regulations to make infrastructure a more attractive asset class. In addition, better financing coordination can boost public-private partnerships (PPPs).
Private funding sources have in recent years grown in diversity, from commercial banks, specialist infrastructure funds, pension and insurance funds to green bonds. This development has provided ideal conditions for co-finance and blended finance in infrastructure. Blended finance combines grants, budgetary support, and concessional assistance from development organizations with private funds to create a bigger pool of infrastructure financing. Co-finance involves market priced public and private financing in partnership to finance projects. An example is the use of partial guarantees by public entities to increase projects’ bankability and attract private-sector participation.
The preferred creditor status of multilateral development banks (MDBs), alongside the use of grants, subsidized loans, and additional financing from commercial banks and private investors, are a winning combination. However, co-finance and blended finance have yet to take off in Asia. According to the Asian Development Bank (ADB), public funding still accounts for about 92% of the region’s infrastructure investments.
There remain challenges to accelerate the use of the blended finance approach.
Infrastructure stakeholders prefer direct funding on concessional terms, but there is a finite amount of available aid, concessional finance, and budgetary support. MDBs and development finance institutions’ (DFIs) loans and guarantees are defined by country exposure limits. And while private investors are growing more open to long-term infrastructure investments, ineffective projects structuring continues to keep private money at bay. There are also gaps in information flows and coordination between the private and public sectors which inadvertently crowd out private investors.
To crowd in private money, the public sector needs to invite participation from commercial banks which are key intermediaries to help MDBs and DFIs mobilize private capital. These lenders are able to spot on-the-ground opportunities, and they possess local knowledge and project finance know-how to progress infrastructure financing proposals in partnership with development organizations. They can structure, underwrite, and syndicate significant sources of private funds.
MDBs and DFIs need to enhance their current guarantee products to attract commercial banks’ participation. Such products provide partial comprehensive cover to private lenders resulting in lower financing costs and longer financing periods to match project revenues with repayment terms. Guarantees can also be used to cover specific transaction risks, such as backstopping the obligations of government contractual obligations to make projects more bankable for private financing. Such partial risk guarantees have a lower credit exposure that enables MDBs to better leverage scarce resources than direct loans. In developing markets where credit standing isn’t always strong enough to secure the necessary private funding, support from public agencies is crucial.
MDBs and DFIs should also ensure consistency of accountancy treatment, and provide capital relief and free transferability of guarantee products. This will facilitate the issuance of capital-efficient and freely-traded financing instruments that are liquid and competitively priced.
To meet evolving needs, MDBs and DFIs should introduce new products, including interest rate and foreign exchange swap guarantees, local currency guarantees, as well as back-ended and first-loss guarantees. These can mitigate interest rate and currency risks, and help match the earning profile of projects with repayment obligations. While earnings of most large infrastructure projects in emerging Asia are in local currencies, development finance remains overwhelmingly denominated in US dollars. The cost of putting in place interest rate and currency swaps to hedge foreign-exchange risks can be significantly reduced with swap guarantees by MDBs and DFIs. Simultaneously, efforts to deepen local-currency financing markets can be enhanced by making available guarantees in respective local currencies.
These guarantees can blend in private funds under a risk-sharing arrangement and improve the risk-grading of projects, leading to an increase in sustainable and bankable infrastructure projects.
As we strive to generate better infrastructure funding solutions, a platform is needed for governments, MDBs, DFIs, and private-sector players to interact and share ideas about blended finance and co-finance.
The Global Infrastructure Forum hosted by the World Bank is a great start which can be expanded to include regional focus groups. Participants can discuss topics including new products and the harmonization of existing product features. Discussions can also center participants’ focus on increasing the pool of bankable transactions to avoid financing efforts from competing for a smaller subset of already-bankable projects.
While there’s greater demand for direct lending programs in Asia than the use of MDBs’ guarantee programs, this scenario may change as the region’s infrastructure development accelerates. Newer entities like the Asian Infrastructure Investment Bank and the New Development Bank are already actively scouring the region for co-financing opportunities.
Infrastructure is not a go-it-alone initiative. Blended finance built on partnerships between MDBs, DFIs, and commercial banks that leverage the capital markets is the inclusive piece of an infrastructure puzzle that the region needs. Only with its growth can we expect accelerated infrastructure development that will drive benefits for our collective society.
Surya Bagchi is the Global Head of Project & Export Finance of Standard Chartered Bank.