Blended finance as a strategy for attracting capital to developing countries has been proven to work.

Infrastructure financing has long been identified as a panacea for economic development, both at a project level and at a macroeconomic level, especially in developing countries and emerging economies such as SA. Consequently, the SA economic recovery plan announced by President Cyril Ramaphosa pinpointed the prioritisation of infrastructure spending to reignite an ailing economy, battered by the economic impact of Covid-19, and contracted by the largest amount in a century.

In support of this strategy, there was a 20.6% rise in public sector spend on infrastructure when compared with the previous year. To give further credence to infrastructure spending, the Infrastructure Fund was set up in 2018 and is earmarked to spend R100bn over a decade. The aim is to attract investments from pension funds, institutional investors, development finance institutions, multilateral development banks and other private sector players to the tune of R1-trillion, with the hope of such investments triggering economic recovery.

Adding to the economic downturn brought about by the Covid-19 pandemic, and inference from the Budget Review, it is clear that the government does not have adequate financial capacity to meet the infrastructure requirements of the country. Thus, the question must be asked, how do infrastructure projects get funding in a sustainable way?

The Infrastructure Fund is well set up to provide the enabling platform for private sector investor participation, and it confirms that the government is ready to turn things from “business as usual” and put its money where its mouth is. The fund is earmarked for social infrastructure projects (such as schools, transportation links, ICT, water and so on). Consequently, its aim is to act as a platform to attract private investors for socially uplifting infrastructure projects.

The Infrastructure Fund has a duty to confirm the viability of projects to give private sector investors confidence, and this can be achieved by developing funding strategies per project, including taking equity stakes, providing loans, capital grants and debt guarantees with a private sector investor partnering in a blended finance scheme to fund the entire project.

Infrastructure projects are usually expected to be paid back from tariffs charged (for water, electricity, property rates, tolls and so on). Consequently, for each new infrastructure project, bankable business cases must be built to determine capital expense, evaluate the business case and determine the financial metrics such as internal rate of return to confirm profitability.

Funding models

When such analyses are carried out effectively, funding models can then be developed to determine the best approach to fund such projects. Funding models including public-private partnerships, loans, debt equity, grants and blended finance models are a few of the options available to fund infrastructure projects.

What if there were a way to change the risk-reward equation for emerging markets investors? Might this entice private sector capital into tapping the opportunities offered by the developing world? And, in doing so, turbocharge the fight against poverty, inequality and lack of access to basic amenities? Blended finance describes a financing model for funding infrastructure projects via a combination of the government’s investment capital, and a private sector commercial investment. The blended finance allows the government to correct infrastructure lapses or deficiencies without having to finance the projects entirely.

The initial investment from the government lays the foundation for the project to begin, and for government to accept the outsize risks, thus incentivising private sector investment by making the project more attractive. One way of doing it is for the government to invest in bankable feasibility studies. In this way, only financially sound and viable projects will be presented to the investors, which makes it easier and faster for investors to take decisions for investment. It should not be the case that investors are expected to pay for tricky but necessary regulatory hurdles such as environmental impact assessments, water use licence application, electricity generation and wheeling arrangement applications, especially in infrastructure projects where society at large is the primary beneficiary.

Without a predictable pipeline of investable projects, the fixed costs of building up this expertise are often too high for potential investors.

Blended finance as a strategy for attracting capital to developing countries has been proven to work in several countries. This is because most infrastructure projects in developing countries are below the investment grade of private sector investors, hence private sector investors are not keen on sticking their neck out. With blended finance, the government takes the risk by providing the initial capital for the project, hence creating an avenue for private sector players to come in without as much exposure. An added advantage of blended finance is that it helps to identify opportunities in developing countries, and showcases the profitability of socioeconomic infrastructure projects.

One good thing is that SA’s core socioeconomic infrastructure is relatively fair. The challenge is to maintain the current infrastructure and expand its reach. Given the economic impact good transportation infrastructure, water and sanitation services, electricity as well as social infrastructure offer, the Infrastructure Fund is well aimed to unlock economic potential within SA. Even though the existing literature and experience from past infrastructure investment projects confirm that investment in infrastructure can deliver long-term benefits, caution must be applied. There are several cases where public-financed infrastructure investment delivered poor outcomes in terms of short- and long-term economic growth. The main cause of this being cost overruns, corruption, and poor maintenance.

The supply of properly structured projects is a major obstacle in directing finance into infrastructure projects. Without a predictable pipeline of investable projects, the fixed costs of building up this expertise are often too high for potential investors.

Governments, the concessionaire for blended finance infrastructure projects, have a critical role in setting up investable projects. Countries and local governments which have established proven mechanisms for infrastructure projects, for instance by introducing binding legal frameworks for public private partnerships, or by setting up specialised government agencies, tend to be more successful in closing infrastructure projects. The promotion of private sector infrastructure finance hinges above all, on a sensible transfer of risks and returns. If done properly, the involvement of the private sector can lift efficiency.

• Umeche is an engagement manager at Ntiyiso Industrialisation Consulting, a division of Ntiyiso Consulting.