McKinsey & Company, the global business consulting giant conducted a study on the slow pace of infrastructure development and financing in Africa and found overwhelmingly that: “More than anywhere else on Earth, Africa has huge unmet needs for infrastructure, reflecting a long history of underinvestment. Today the continent has the opportunity to build the infrastructure its people and businesses need—at speed and scale. The funding is available, together with a large pipeline of potential projects. To ensure that the money is spent where it is needed, and delivers high-quality infrastructure on time and on budget, governments and private sector players need to step up to prepare, plan, and manage projects with a new level of rigour and robustness.”
One of the findings from their research is that despite the pertinent need to develop infrastructure to be competitive globally African countries lag behind their worldwide counterparts when it comes to infrastructure spend.
This situation presents what the consulting group termed the ‘African infrastructure paradox’, where there is little expenditure in this field despite there being funding available to support it.
A question then arises of how African nations can raise the requisite funding to develop infrastructure that is needed for economic transformation and assures them of global relevance in terms of global business competitiveness and sustainability.
What are the traditional methods of funding infrastructure development?
There are two methods relied on by governments and these are “Pay as you go” and “Pay as you use”. Bear in mind that infrastructure projects often involve large or lump investment outlays and they benefit both current and future taxpayers. This phenomenon has serious implications for the choice of funding methods a government must select. The most appropriate choice when it comes to financing these projects is long-dated capital as investments of this nature often tend to have long gestation periods.
Pay as you go involves using cash and other current assets/resources in place of debt issuance to fund capital projects. It is most appropriate where capital projects that are small, or where project sponsors have limited access to debt markets or where the government in question is reaching the limit beyond which it cannot borrow further where there are prohibitions on the use of debt. It is perhaps interesting to note the following examples where this kind of funding is most apt.
Wealthy nations can fund their infrastructure development from internally generated cash resources. On one hand the countries and city states that make up the Middle East and United Arab Emirates were poor 60 years ago; however, with the discovery of oil and other natural resources they were able to develop into the advanced economies some of them are now. Oil revenues provided an ample source of finance to fund infrastructure projects on a pay as you go basis and to this day most of these countries do not need to access the debt capital markets to finance the development of their projects. They have built up immense resources of US dollars to call on in development projects. The only possible exception to this is Dubai. The city state realized the need to diversify its economy away from oil when it became apparent that the black gold would soon run out. It stepped up its efforts to create other industries in the services sector like hospitality, banking, and finance as well as healthcare. All of these required further development of infrastructure necessary to support their activities. The emirate invested heavily and even borrowed to fund its activities and when it could no longer honour the obligations it had created it had to be bailed out through a financial package arranged for it by other emirates, chief among them Abu Dhabi.
At the other end of the spectrum you have less wealthier nations like Zimbabwe that have restrictions on their ability to borrow for a myriad of reasons. The southern African nation is burdened with debts it owes to external creditors which has made it even more difficult to access fresh lines of credit. There is also the issue of sanctions and/or restrictions that add further difficulties for the nation to borrow. As a result, the country must muster its own cash resources to engage in the development of its infrastructure which is badly dilapidated. Cash resources and current assets are also scarce. This is the reason why restoration and further development of its instruction is occurring at a very slow pace as the country relies on financial support from China and other similar nations.
Pay as you use refers to issuing long-term debt in the form of general obligation bonds or revenue bonds to fund capital projects. Debt financing is justified in part or only in so far as the rationale of spreading out the costs of public infrastructure investments throughout the life of the asset is being developed. Again, with this option there are many facets and moving parts that need to be considered before it is engaged. It has been established by numerous scholars and development financiers that the type of project needs to be assessed against the funding method. Where the infrastructure project will generate specific revenues in the case of airports, roads and tolls such projects must be engaged in conjunction with the private sector provided the said projects meet specific risk-return considerations. Government must only participate in or fund purely only those projects that are viewed as less profitable like dams and bridges.
The funding sources
Regardless of the funding choice taken sources for funding infrastructure generally come from general taxes, special funds like user fees, government grants, bond proceeds or a combination of these.
This is the most used infrastructure funding method. It is the simplest to raise. General taxes refer to broad based taxes on business and residents and may consist of sales tax, property taxes, local government income, or wage taxes. These are collected through the respective tax collection or revenue authority of the respective country and submitted to treasury. The funds are then used to finance infrastructure projects that yield community-wide benefits such as roads, transits, parks, bridges, and the like.
Tax revenues have the advantage of being stable and predictable sources of revenue where such a tax base even exists. In the case of southern Africa that is not always the case. Countries that make up this bloc are plagued by problems like unemployment, subdued business sectors and informalization which have adverse implications for the tax base from which their governments can finance their infrastructure needs.
In Zimbabwe for example, unemployment is stratospheric with figures as high as 90% of the potential workforce out of work. A substantial port of economic activity takes place in the informal sector where tax authorities cannot collect revenue which means that there is a source of revenue the government cannot make use of because it cannot collect it. Subdued business characterized by company closures over the last eight years has also meant that the tax pool is steadily dwindling.
Tax revenue is proving to be a less viable avenue of raising funding for infrastructure development especially in isolation. Again, in Zimbabwe a substantial portion of the national budget is made up of recurring expenditures like remuneration of civil servants leaving little room to allocate funds to any other use besides government wages. This is however expected to change somewhat with the arrival of SDRs from the IMF.
This is where fees are imposed specifically on road users and businesses for the use of utilities and other public services. This is advantageous in that it functions to recover partial and full costs of the government services.
Infrastructure projects like these can generate funds from operations and as such open scope to raise funding from the private sector as well through public private partnerships (PPPs) or on a purely private basis. Government’s role in such an instance would be to provide guarantees and assurances around critical legal, financial and land issues. On government’s part it is politically expedient to apply user charges to fund revenue generating infrastructure projects as opposed to using or raising general taxes.
Capital reserves and fund balances
Ideally governments should regularly save and accumulate money in capital reserve funds and then designate the funds to pay for recurring and/or small projects. The obvious advantage of this funding method is that it reduces reliance on debt issuance and gives the government flexibility in future operating budgets. Saving substantial amounts of money to engage in the development of infrastructure takes time. Reserves by their nature are used for many purposes and not only for the development of infrastructure and may be called on during difficult times to support other government operations.
Capital reserve funds for less wealthier nations will subsequently be confined to less expansive projects. For instance, according to the World Bank and CEIC Data South Africa has US$43 billion in reserves which gives it some leg room in terms of embarking on infrastructure development projects. For sub-Saharan Africa South African reserves are impressive but that figure pales into insignificance when one considers China’s reserves that are as high as US$3 trillion!
The rest of the bloc has smaller amounts in their reserves: Botswana has US$5.2 billion and Zambia has US$1.1 billion. Zimbabwe has just over US$ 33 million (excluding the recent SDR allocation) which is interesting in that a few years ago monetary authorities when asked the state of the country’s reserves would always respond that the country has at least three weeks of reserves without actually mentioning an explicit number.
Where capital reserves are not substantial or have not been developed to where they are substantial enough to fund infrastructure development on a grand scale, nations must consider other options when comes to financing this area.
State and provincial grants
In advanced countries like the United States grants represent a major source of financing at the state, provincial or municipal level. This is where the state or federal government allocates funding on very concessionary terms to its municipalities or states so that they develop their respective infrastructure projects. For example, in the US there is what is known as Fix America’s Surface Transportation Act of December which legalizes the allocation of grants to its states for them to develop transportation systems. It extends funding for highway construction projects and transit projects from 2016 to 2020.
This is the key type of long term borrowing that governments use to raise money for building long lived infrastructure assets. According to the International Capital Markets Association (ICMA) the SSA, which is the market for sovereign, supranational, sub-sovereign, governmental or agency debt instruments regardless of structure of credit risk and exclude sovereign debt issued in a country’s local currency is estimated to be worth in the region of US$199 billion bond market. The market consists of 370 issues in US$ and Euro currencies. The US$ issues make up 85% and Euro denominated issues make up 14%.
From this infographic the countries making the most of foreign currency bond denominated markets are in northern Africa except for South Africa. This method of funding offers a great deal of scope for most of the countries in southern Africa. Of all the countries presented in the infographic Zimbabwe’s share or participation in the bond market is miniscule when compared to Egypt which is the largest borrower of foreign currency.
In the United States an estimated 90 per cent of state and local government spending is financed by debt issuances. The advantage of this funding mechanism is that capital is obtained immediately without delay as in the cases of capital reserves and grants. Debt can take the form of private bank loans and bonds as described before. Referring again to the US bank financing of public infrastructure by 2016 had risen to as much US$155 billion. At municipal level bank financing is advantageous for local governments that have limited resources in the bond market or those that cannot afford the costs of bond issuances.
In comparison with the bond market however, the private loan financing market is less transparent and does not disclose information to the same degree that participants in the bond markets do. Zimbabwe could access funding from the international bond market and structure them in a tax efficient manner so that they attract a lower interest rate than say, corporate bonds with the goal of minimizing the cost of issuance. The minister of finance in September initiated a road show with the intent of issuing a US$200 million bond locally from investors he said were hungry for yield but were concerned about risk. The bond issuance would be priced at 6 per cent to 9 per cent interest and would be ring fencing the bond issue by setting up escrow accounts for servicing coupons. It is the first and most significant step to accessing this market. The bond will be listed on the Victoria Falls Stock Exchange.
At the local government or municipal level which is critical in terms of the development of infrastructure, there are two types of bond financing available. It is imperative to note the importance of municipalities where infrastructure development is concerned. Most if not all of southern African countries are structured in such way that you have a central government which provides administrative oversight to provinces that are governed by municipalities or town boards. Municipalities are subsequently responsible for, among other things, service delivery and the infrastructure that enables service delivery. They have a key role to play not only in terms of the development of infrastructure but also raising of finance required to develop the said infrastructure projects.
Bulawayo which is the second largest city in Zimbabwe for example, was for many years the only municipality that generated surplus revenues which it remitted to the central government. Its ability to generate revenues surplus to its expenditures presents an opportunity for that municipality to float its own bond issuances and use the funds to finance its infrastructure projects in housing, roads and related services.
Local governments can raise capital through debt by issuing:
General Obligation Bonds
These are long-term obligations of municipalities and even sovereigns that are backed by the issuer’s full faith and credit. The issuer is then obligated to repay these bonds from their general tax revenues. General obligation bonds can be issued to finance projects that do not generate revenues like public schools, libraries, safety equipment, city halls, fire stations and prisons.
To be issued successfully they require that the issuer has good credit ratings and may be subject to constitutional debt limits to avoid sovereign debt crises like the kind the world saw in 2010 where Portugal, Ireland, Italy, Greece and Spain found themselves in as a result of the Great Recession in 2008 and earned for themselves the unfortunate moniker of PIIGS countries. Greece went as far as to threaten to default by leaving the EU community and to reintroduce the Drachma. General obligation bonds are for these reasons not a carte blanche or blank cheque to raise money for governments and their agents as they have serious financial implications and can cause financial distress in exactly the same way they would to corporations and individuals. General obligation bonds issued by governments, municipalities and government agencies impose a debt obligation on future taxpayers and limit budget flexibility in future years.
These are also known as non-guaranteed debt and are typically issued to finance public facilities that have definable users with specific revenue streams such as utilities, toll roads and bridges, educational facilities and hospitals. Revenue bonds are unique in that they are secured by the pledge of defined revenue streams generated from bond funded projects. Zimbabwe and South Africa offer unique cases for southern Africa where they could raise funding for infrastructure development by issuing this specific type of bond. In Zimbabwe, water resources especially in the north eastern region of the country are managed by a government agency called Zimbabwe National Water Authority (ZINWA) in conjunction with the municipalities that comprise that area. The management of water resources generates definable revenue which can be used to raise capital, and service specific bonds issued to develop infrastructure in that space. The same can be said about the agency that manages the country’s roads – Zimbabwe National Roads Authority (ZINARA). It earns revenues from charging toll fees to road users and the same can be used to issue and service bonds issued to develop and revamp the country’s road network which is in urgent need of repair. The road network is especially critical considering inter-country trade and how it can connect other countries with each other. The power utility Zimbabwe Electricity Supply Authority (ZESA) and its South African equivalent ESKOM are also cases in point where revenue bond issuances are concerned. ZESA has in times past raised capital from private bank loans obtained offshore so it is not unimaginable to envisage a ZESA bond issuance denominated in foreign currency.
The Airports Company of South Africa (ACSA) manages nine of the airports in South Africa and also generates revenues that would enable it to access capital from the debt markets for further development of infrastructure in its space. Umgeni Water, another South African government agency that manages water resources and is a bulk supplier of potable water to Pietermaritzburg and the greater KwaZulu Natal region is a regular issuer of bonds on the capital markets and uses those funds to build and maintain its water infrastructure. The most recent of its bond issuances was in 2018.
It is also not far-fetched to imagine bond issuances by the cities of Johannesburg, Harare, Bulawayo, Gaborone, or Maputo that are specific to housing, roads water and related. The latitude and scope are available.
Private Activity Bonds
Lastly these are a type of municipal bond issued on behalf of a private business to build those projects that benefit private entities but also serve some public purpose like airport improvements. They are a novel innovation that enables private users to benefit government’s status as a tax-exempt entity and bear low interest rates. This type of funding encompasses lease financing in Europe and the US to the extent it has become a popular bond financing tool to fund police vehicles, fire trucks, court houses and prisons.
In this arrangement use and ownership of equipment is transferred for a negotiated period to government and/or its agencies. The lessor then uses the regular payments from government to repay debt service obligations. At the end of the lease period the local government then assumes ownership of the property.
In conclusion it must always be kept in mind that infrastructure and in particular its development, is critical to economic development, transformation, and prosperity. Infrastructure must however, be paid for and while it is accepted that nations in southern Africa may not always have the resources needed to fund the development of these projects there are sources they can call on to raise the said resources. These have been outlined in the foregoing.
The implications that they have for the present and future citizens demand that nations engage them with utmost responsibility.