Financing Cross-Border Infrastructure Projects - Scale and Certainty of Returns

As outlined earlier in this blog series, private investors are looking for reliable returns to justify the risks that they are taking.

Financing and procurement of cross-border projects will often be more complex than national projects due to the scale of the project and compounded risks, and the financial returns may be more uncertain than for national projects.

The economic, social and environmental costs and benefits of large infrastructure projects must be assessed carefully.

Large infrastructure projects by their nature have large externalities, and it may well be the case that a project has a good socio-economic impact, but does not generate the internal financial rates of return to be a viable commercial investment.

In addition, it is often the case that smaller private investors are more limited in their ability to invest directly in infrastructure projects, due to the sheer scale of individual national parts of a regional project[1].

Due to the issues above, cross-border projects are therefore often likely to require multiple sources of funding in order to leverage private finance. Despite this, there is potential for a cross-border project to service a large market, and therefore have large pay-offs for investors if structured well.

Approaches to leveraging private finance are discussed below:

Public-private partnership (PPP) approach:

The PPP approach enables the feasibility of higher risk projects with lower return expectations, where governments are targeting improved social outcomes. This may include submarine cable systems to more remote or less populated areas, or other strategically important infrastructure with broader impacts.

For example, EASSy is a submarine cable system project connecting over twenty coastal and land-locked countries in East and Southern Africa. The initiative attracted financing from African and international operators, loans from international financial institutions, and grants from project preparation facilities. The cable has since been upgraded by Alcatel-Lucent to higher speeds several times in response to the demand for increased capacity and increased data traffic in Africa[2].

Viability Gap Funding

Viability Gap Funding is typically provided by government to reduce the upfront capital costs of infrastructure, where the revenue from an acceptable level of user-fee is less than what would be required to meet commercial viability. Consideration of viability gap funding from government(s) is likely to be appropriate in cases where the socio-economic returns are greater than the direct financial returns. However, viability gap funds should not be used to prop up a project in which the underlying economic case is not justified.

Blended Finance

Where affordability to the government budget is a challenge, it may be appropriate to consider blending commercial finance with targeted concessional or grant funding from development banks and international financial institutions to make the project viable.

Blended finance is the strategic use of development finance for the mobilisation of additional commercial finance towards sustainable development in developing countries. The OECD have set out a number of the overarching principles of blended finance: OECD DAC Blended Finance Principles for Unlocking Commercial Finance for the Sustainable Development Goals.

Blended finance has been used on a large number of cross-border projects involving international and regional development partners, such as the EU, the World Bank, the German KFW, and African Development Bank including in support of the Programme for Infrastructure Development in Africa (PIDA).

Grants

For all types of finance, the fiscal risks and impact on debt sustainability should be considered. Countries with lower GDPs may have difficulties accessing finance, which may be due to their debt sustainability levels, their credit rating, or for other reasons.

Development banks will have constraints on lending to highly-indebted countries, and commercial banks will not provide debt for countries with a below investment grade credit rating. Grant support may be appropriate for elements of projects with high developmental outcomes.

The Pakistan Economic Corridors Programme (PECP)[3], supported by the UK Department of International Development (DFID) and the Asian Development Bank (ADB), aims to promote regional trade and economic growth in Central Asia through the allocation of grant funding for three components:

Road construction and upgrading of critical links in Pakistan which are part of the Central Asia Regional Economic Cooperation (CAREC) programme.
Developing a pipeline of commercially viable PPP projects.
Providing technical assistance to facilitate cross-border transport and economic corridor planning.

It is hoped that the provision of grant funding for the above components will reduce risk for private sector participants by improving the commercial viability of projects. As of February this year, PPP initiatives are ready to be launched.

Commercially Viable Projects

Although national governments play a key role in making many cross-border projects viable (as outlined in the situations above), the private sector also plays a substantial role in financing cross-border projects and benefitting from expansion into global markets. For example, the ICT sector has attracted private investment to benefit from the commercial opportunity created by growing global demand and consumer willingness to pay.

In 2018, there is believed to be over 1.2 million kilometres of submarine cables in service globally[4], financed by a range of private, consortium and PPP approaches. Private operators, such as content providers (e.g. Google, Facebook, Microsoft, and Amazon), are now the major investors in new cable.

Coordinating multiple sources of funding for both project preparation and for infrastructure implementation, as well as selecting the appropriate financing instruments, is complex.

Currently, there is not much involvement from institutional investors in larger regional projects. Donors, multilateral institutions and project preparation facilities can help in the earlier stages of project preparation and implementation to structure the project—both financially and technically—to help make projects a more viable investment prospect for investors.

Later this year, the Global Infrastructure Hub will develop a reference tool on leading practices in National Project Preparation Processes which will have a strong focus on the upstream stages of the project preparation process and will demonstrate, through the use of case studies, which countries are performing well in this area.

The above-mentioned financing and funding options combined with a stronger focus on project preparation may help private investors to participate in these regional projects. The EDHEC/Global Infrastructure Hub Investor Perceptions of Infrastructure 2017 survey states that 37.5% of investors invest in emerging markets (up from 20% in 2016), and of those already investing in emerging markets, 82% want to increase their investment. The desire to invest is present, but private investors need reassurance that their investment will yield strong and stable returns.

Part five in this blog series—Sharing of Responsibilities and Benefits—is available here.