Infrastructure financier Dr Tony Merna discusses the infrastructure gap and the asset procurement strategies available to governments.
Infrastructure is the cornerstone of economic progress. Road, rail, ports, airports and telecommunications are the conduits of trade and productivity. Electricity fuels production and clean water underpins public health. Social infrastructure such as hospitals and schools maintain a healthy, educated workforce. Investment in all these sectors is a necessity for economic growth.
Governments are typically responsible for financing social infrastructure projects and have used an array of contract strategies or arrangements in an effort to meet budgeted costs and provide an equitable risk share. Strategies and arrangements employed range from direct procurement through design and construct contracts or managing contractors to public private partnerships.
Infrastructure finance options for governments
Since the early 1980s, there’s been growing realisation of the limitations of public funding for infrastructure development, in both the developed and the developing countries.
Besides problems of accountability and inefficiency often leading to high cost of provision for the consumers, the pressure on government budgets worldwide has increasingly led to the adoption of private funding for infrastructure projects. One of the ways in which this is being achieved is through project financing.
Project finance involves the financing of standalone infrastructure assets. The principle is simple – lenders provide finance for a standalone infrastructure asset and the debt raised to fund the construction of the asset gets repaid only from the revenues generated by that asset with limited-recourse to the investors that own the project. This has opened a number of avenues for the funding of new ventures that have no track record.
The logic for privately financing infrastructure projects is simple. In most cases, such projects would be severely delayed or perhaps would never be implemented if they were to wait for public financing from tax receipts.
The private sector is much better placed to deliver construction projects and using project finance as the vehicle to deliver infrastructure assets has many advantages; the main one being that risks are transferred to the private sector from the public sector. The private sector is much better placed to evaluate, price and mitigate construction and operational risks.
Rationale for investment in infrastructure
A large proportion of investment in developed and developing countries is for the provision of new infrastructure with population growth continuously increasing the demand.
The existence of a decent level of infrastructure services helps determine one country’s success and another’s failure in diversifying production, expanding trade, coping with population growth, reducing poverty or improving environmental conditions.
Good infrastructure raises productivity and lowers production costs and it should expand fast enough to accommodate economic growth.
Today the world invests approximately US$3.1trn per annum in the transportation, power, water, social infrastructure, and telecommunication industries across the world, and this is expected to increase to US$4.2trn by 2020 and US$94trn by 2040.
Key factors driving the need for infrastructure capital expenditure and ultimately widening the infrastructure gap include:
- By 2040, the global population is forecast to grow by 25% - rural to urban migration continues with the urban population growing expected to grow by 46% triggering demand for infrastructure support
- The world’s greatest infrastructure needs will be in Asia, which will require US$52trn by 2040 to meet demand
- It’s estimated that closing the global investment gap will require annual infrastructure investment to increase from the current level of 3% of global GDP to 3.8%
Financing infrastructure projects
Infrastructure plays a significant role in the development and the future of society.
The message is clear – procurement strategies for infrastructure assets are wide and varied. Governments across the globe need to analyse and understand their procurement options and increase infrastructure development, thereby decreasing the infrastructure gap, or face decreases in standards of living with a high opportunity cost in terms of unrealised economic growth.
Increasing strains on government budgets worldwide has meant that public funds haven't been sufficient to finance all needed infrastructure projects for a long time.
The growing demand for higher levels of infrastructure services has reinforced the now mature model of private finance for public projects, rather than the traditional methods of public funding. This has resulted in a considerable number of infrastructure projects being funded using project finance in developed and developing countries around the world.
An understanding of ‘how’ infrastructure projects are procured or financed gives civil engineers a background of the whole process - from inception and the design and construction to the finance structure facilitating the procurement of an infrastructure asset.
Without private finance, infrastructure development will stagnate and standards of living will decrease with the taxpayer picking up the burden.
Financing Infrastructure Projects, written by Tony Mema and Faisal F Al-Thani, is a clear and accessible guide to the different methods and strategies that are used to finance infrastructure projects.