How to finance green infrastructure | Opinion | Eco-Business
In order to spur development and combat climate change, emerging and developing economies (EMDEs) will need huge investments in green infrastructure over the next few decades. But many of these countries have limited fiscal space, especially after the shocks of recent years. Given this, to meet the infrastructure needs of EMDEs, we need to mobilize excess private savings in advanced economies. The question is how.
The first step in bridging private savings and infrastructure investments in EMDEs is to understand investor needs. Institutional investors, like all other types of debt and equity investors, have their own set of incentives, constraints, and goals that affect all of their funding allocations, including the types of projects (greenfield vs. brownfield) they are expected to support, where and when, and at what stage of the project cycle (development, construction or operation). Inadequate risk coverage, a lack of data and the heterogeneity of project structures, regulatory frameworks and contract standards can act as investment barriers.
The challenge is to define “attractive investment opportunities” and match investors more systematically. These efforts should focus on providing a wide range of well-structured investment products, tailored to different types of institutional investors and their risk-return profiles. For example, institutional investors (such as pension funds) might be inclined to invest in earlier phases of a project (before operations) when refinancing risks are covered and construction risks are addressed.
Currency risk is another challenge for investors in EMDEs. This is where ECAs can help, albeit often at great cost.
A lack of appropriate financial instruments – and the cost and complexity of the available instruments – is another potential obstacle to infrastructure investment in the EMDEs. Fixed income instruments – including bonds (project, municipal, sub-state and green bonds, and sukuk) and loans (direct and co-investment loans for infrastructure projects and syndicated project loans) – can help solve this problem. as they could be attractive to a wide range of institutional investors in the EMDEs.
Multilateral financial institutions play an important role in attracting private capital for long-term projects that could spur development in countries and sectors perceived by capital markets as high-risk. By providing funding, guarantees, or both, such institutions can de-risk projects and stimulate private investment. You can also bring partners into specific deals through syndications.
For its part, the private sector has a range of risk management instruments at its disposal. For example, companies can use risk transfer and credit enhancement tools that are currently being piloted by national and multilateral development banks. These include guarantees, insurance policies and back-up mechanisms whereby a provider agrees, for a fee, to indemnify the concessionaire (or its lenders) in the event of default or loss due to specified circumstances.
Insurance against political risks is particularly important here. Some sectors – like telecoms or electricity – are more vulnerable to regulatory fluctuations or the impact of political pressures (including on prices). This implies the need for closer scrutiny by infrastructure investors and tailored risk mitigation mechanisms.
The financial structure of a project is crucial. Experience shows that a diverse mix of financiers for a project – including national, international and multilateral banks and owners – can deter political intervention and act as a buffer against shocks. And just as strategic alliances with foreign companies offer local actors protection against political interference, partnerships with local companies can help an infrastructure manager to overcome the “foreign investor” label.
Both the public and private sectors have important roles to play in transforming today’s savings-liquidity glut into much-needed investment in green EMDE infrastructure. Policy makers need to increase transparency of legal frameworks and achieve political and regulatory stability, recognizing that the public sector will ultimately bear the high transaction costs incurred by private investors when channeling funds to EMDEs.
Institutional investors and other financial intermediaries, as well as non-bank financial institutions, often emphasize the lack of a pipeline of investment-ready projects. To improve their options, the public sector should take more responsibility for project design in situations characterized by significant complexity and regulatory risks, especially when risks are more difficult to identify and measure in advance. The costs of this process can be largely recovered if public-private partnerships (eg concessions) are developed. Public planning and prioritization are essential.
But retail investors also need to take a more active role, including by taking advantage of the risk management tools at their disposal. Sophisticated, developed financial markets and tools would assist in this by allowing financial actors to take risks that matched their appetites and skills.
It will not be easy. But with these building blocks we can build the most important infrastructure of all: the bridge connecting the savings of advanced countries and the financing needs of EMDEs.
Karim El Aynaoui, Executive President of the Policy Center for the New South, is Executive Vice President of Mohammed VI Polytechnic University and Dean of the Faculty of Governance, Economics and Social Sciences. Otaviano Canuto, a former Vice President and Executive Director of the World Bank and Executive Director of the International Monetary Fund, is a Nonresident Senior Fellow at the Brookings Institution and a Senior Fellow at the Policy Center for the New South.
Copyright: Project Syndicate, 2022.
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