This article focuses on international experiences gained in financing infrastructure through local currency revenue bonds and the applicability of such methods to Africa.
Financing the much needed investment in Africa’s infrastructure is one of the crucial challenges facing the continent. The African Development Bank and the World Bank estimate the financing needs to be in excess of $93 billion per year (1). A Program for Infrastructure Development in Africa (PIDA) study on key regional projects estimates investment needs of $68 billion per annum until 2020 for regional projects alone. These numbers are daunting, but the challenge – to build sustainable infrastructure in Africa – has to be met. And one of the ways this can be done is by the continent taking ownership of this challenge, rethinking infrastructure financing, and mobilizing resources already available on the continent – to promote inclusive growth.
As Africa has been growing, so have its financial resources. African countries have been growing at rates in excess of 5 percent. Indeed seven of the ten fastest growing countries in the last few years are in Africa. This has created a growing middle class and a flourishing financial sector. Savings are accumulating with institutional investors such as pension funds and insurance companies, and the capital markets in several countries are doing very well. The current state of the market is such that it is sure to welcome an opportunity for further innovation in the financial sector.
Understanding infrastructure bonds
The interest in financing African infrastructure projects with infrastructure bonds has recently increased., prompted in part by certain unique features of the bonds.
An infrastructure bond is a debt instrument issued by governments or private companies to raise funds from the capital markets for infrastructure projects. The interest payments associated with infrastructure bonds (and repayment of the principal) are typically funded with a direct linkage to the cash flow revenue generated from the underlying infrastructure project – such as a toll road. Infrastructure bonds can be issued by private companies without a need for government assistance.
Bonds such as these can also benefit from credit enhancements such as viability gap funding, or partial guaranteed to make projects more bankable. Credit enhancements can be especially useful where there is a project with strong revenue potential and good management structure but where the issuing entity may have institutional or credit weaknesses. The underlying project itself can therefore be structured to assume its own standalone risk profile which is distinct from that of its sponsors.
Thus, infrastructure bonds in their broadest sense can mean any structured debt raised through local or international capital markets secured by or serviced from the cash-flows of a specific project or a portfolio of projects, without recourse to the sponsors. Fully non-recourse project bonds for infrastructure are much less common however.
As infrastructure projects involve a capital-intensive construction phase that must be financed, loan structures are more common in infrastructure project finance than bonds as they are more flexible. Loans can be drawn down gradually during construction (avoiding so-called “negative carry”). For syndicated loans, borrowers are generally given a call option for free, whereas bonds are difficult to refinance. Loans are therefore more efficient for smaller financings, since bond issuance involves greater overheads associated with getting a credit rating, documentation and governance.
Nonetheless, there are benefits to bonds over loans: (i) it is cheaper to finance with bonds, (ii) bonds are available for incremental funding, (iii) they normally have longer maturity dates and (iv) they are sometimes available in different currencies.
The state of the infrastructure bonds market in Africa
If we consider the definition of an infrastructure bond per se, those from African countries such as Kenya, Cameroon, Chad and a large part of the transactions in South Africa are strictly speaking not infrastructure bonds. They are general government bonds with some promise to spend the money in infrastructure investment. They have no income stream associated with the underlying asset, and cash flows for the bonds are paid directly out of government tax revenues. There is also no guarantee that the money raised goes into the project as promised, and neither is there a dedicated Fund Manager, raising concerns about the ability of central government to channel the funds to actual development of infrastructure projects. In such situations, government credibility becomes critical to ensuring investor confidence, particularly in the issuance of future bonds and in creating a viable infrastructure bond market.
South Africa, with a large and sophisticated investor base totaling $600bn (more than the other countries combined), stands out on the continent in terms of local market liquidity, capital market development and experience with project finance. However, local currency infrastructure bonds have not been considered to date as the government feels that such bonds are too far removed from projects, preferring that parastatals issue bonds and the government provide guarantees for certain projects.
