Pfandbrief system, Latin America offer viable infra financing models

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By Pradeep Kumar Panda

Bhubaneswar, March 4: The rapid urbanization calls for out of the box infrastructure development financing in the country. Issues such as problem in clearances, difficulty in land acquisition, delay in decision-making, pricing model of infrastructure projects; inadequate dispute resolution mechanism, etc., need to be addressed, to make infrastructure a lucrative investment.

There is also a need to create a facilitating atmosphere and set up suitable protections to encourage bigger participation by the private organizations in infrastructure projects. An elementary prerequisite for advancement of investment in infrastructure sector is a favourable policy environment, helpful in appealing private and overseas investment, while shielding community welfares and benefits.

Given that most infrastructure sectors exhibit some public good characteristics, investment can be maximized through public private partnerships. If the achievable return to an infrastructure activity through the levy of user charges is, say, 70 per cent of market returns, a public subsidy of 30 per cent would elicit market based private investment, and the enterprise can then run on commercial basis.

Viability gap funding mechanism may attract Rs 600 billion in the infrastructure sector through public-private partnerships. Under the new scheme, for Built-Operate-Transfer projects in the road sector, the government will provide a subsidy in the form of an annuity flow to meet the shortfall between anticipated revenue and loan repayment obligations. The shortfall may arise out of various types of risk involved in the project.

Armed with Government’s guarantees to bridge any revenue shortfall, the executing companies will find it easier to tie up with financial institutions to raise resources. In developed countries, power infrastructure projects raise finances from institutional investors (insurance companies, pension funds, endowments, etc.) either through bonds markets, or through direct private placements.

In India, the contractual savings institutions (LIC, GIC, PFs, EPF) that have long-term liabilities make natural investors in private power projects. Apart from these institutions, other institutional investors such as charitable and religious trusts can also be a source of substantial funds. With the development of an active and liquid market for securitised corporate debt, mutual funds, commercial banks and financial institutions could also emerge as potentially large investors. All this calls for substantial reform in the debt market.

The Pfandbrief system in Germany is an effective example of private financing of public infrastructure. In this case, it is large mortgage banks that pool local authority debt into “pfandbriefs”, which is effective credit enhancement of entities that may not otherwise be creditworthy. Pfandbriefs have succeeded in keeping up their credit quality for more than a hundred years, through hyper inflation and two world wars.

There is a complex system of government guarantees that underlies this system. Thought needs to be given to how such innovative systems can be derived to generate greater private financing of infrastructure. In the United States, municipal bonds, having been made tax free by the Federal Government enable local governments to tap the large U.S. capital market to finance local urban and other infrastructure. Because of the tax free status recognising the public good element in urban infrastructure, they could raise finances at lower cost, thus keeping user charges at affordable levels or municipal taxes at acceptable rates.

The institution of municipal bonds provides internalised incentives for local authorities to be fiscally prudent: defaults on municipal bond servicing causes great hardship. Chile represents one of the best environments in the world for private investment in infrastructure.

A World Economic Forum report on private infrastructure financing in Latin America gave it the top ranking, far above any other country in the region, due to its macroeconomic and political stability, but also due to its extremely well-developed e-government services, clear information on policy changes, transparency and openness of statistics publications, and dialogue and decision-making process. The financial sector is relatively well developed, with a stock market capitalization of around 144 per cent of GDP, a reasonably well developed corporate bond market, and a liquid market in interest rate derivatives. The financial sector has developed in tandem with Chile’s privatized pension system.

China’s infrastructure construction picked up in late 1980s, and accelerated dramatically after 2000 as the authorities aimed to increase domestic demand and reduce bottlenecks to the booming economy. In the past decade, fixed asset investment as a share of GDP has almost doubled, about one quarter of which is related to infrastructure development. Local governments have been the one of the major drivers behind China’s infrastructure boom since obtaining economic autonomy in the reform process begun more than 30 years ago.

Following a 1994 tax reform that allocated a greater share of taxes to the central government, they have become eager to promote economic growth to generate additional revenues. Local authorities have thus poured resources into infrastructure in an effort to accelerate economic activity and productivity. To achieve these objectives, local governments are actively involved in mobilizing financing for infra structure projects.

For example, they provide guarantees—implicit and explicit—for bank loans to infrastructure projects, and in some cases provide subsidies directly for infrastructure SPVs to boost these entities’ profits and credit ratings. These factors may partially explain the rising share of infrastructure loans in the total loan portfolios of the state-owned commercial banks.

A great deal of work needs to be done to devise methodologies for the development of public private partnerships: this also requires excellence in public sector management. None of this is possible unless infrastructure is productive: it must either improve productivity so that the gains result in higher tax revenues, or directly through the collection of user charges. (Concluded)

The first part of the series was headlined ‘District roads cry for attention amid infrastructure financing challenges’ Link: https://theraisinahills.com/district-roads-cry-for-attention-amid-infrastructure-financing-challenges/