INFRASTRUCTURE FINANCE MECHANISM AND CHALLENGES IN
NIGERIA
Emenike Kalu O.
Rhema University Aba, Nigeria
E-mail: emenikekaluonwukwe@yahoo.com
Submission: 27/03/2015
Revision: 08/04/2015
Accept: 19/04/2015
ABSTRACT
Infrastructure
financing plays an important role in addressing chronic deficiency of
infrastructural facilities in developing economies. Inadequate infrastructural
facilities discourage investments and retards economic development. Traditional
methods of financing infrastructure through budgetary provisions and execution
by direct contract award has proven to be inadequate and most often
unimplemented creating a financing gap for execution of infrastructure projects
in developing countries. This paper assesses the nature of infrastructure financing
in Nigeria and highlights the major models of PPP as well as some of the
challenges encountered in the mobilizing this type of financing. The paper
concludes with some suggestions on the policy measures to be adopted in
addressing the identified challenges.
Keywords: Infrastructure finance,
challenges of financing, development policy, Nigeria
1. INTRODUCTION
In
recent decades, the importance of infrastructure finance on economic,
industrial, technological and social development of a country has dominated the
policy discussions of developing countries, international donor agencies and
developed countries. Financing infrastructure projects remains a major
constraint in the delivery of efficient and improved infrastructural facilities
across developing countries in general and Nigeria in particular.
Infrastructure
finance may be defined as all means or methods available for mobilizing the
resources required to finance physical assets and services which are
fundamental to the growth and development of an economy. Provision of good infrastructure can
accelerate economic development and prosperity in developing countries just as
maintenance of existing infrastructure can ensure that developed countries
remain developed. The level of
accumulated infrastructure facilities is, no doubt, one of the major indices
for measuring development of an economy.
With
the rising demand for infrastructure co-moving with the accelerating pace of
globalization and urbanization, the total global infrastructure investment requirement
by 2030 for transport, electricity generation, transmission and distribution,
water and telecommunications, according to the OECD, amounts to $71tn. The
European Commission estimates that, by 2020, Europe will need between euro
1.5tn and euro 2tn of infrastructure investments.
Kawalya-Kwaga
(2014) emphasizes that the infrastructure gap in Africa per annum is $93
billion. Every month in the developing world more than five million people
migrate to urban areas (Schwartz et al, 2014). Fast growing populations and
rising urbanization rates in developing countries have also led to a global
shortage of infrastructure services such as roads, rail, mobile and fixed line
telecommunications, water and electricity, among others (Water UK, 2013).
In
such a rapidly growing and evolving global infrastructure market, there is need
for proper understanding of infrastructure financing and its challenges in not
only Nigeria but globally, since infrastructure finance has become a global
business. While most infrastructure investments are local, the sources of
finance are increasingly global.
More
so, the continuing need for infrastructure investment places huge demands on
financial markets. The aggregate capital sourced by unlisted infrastructure
equity funds (operating internationally) since 2004 is close to US$200bn for
water infrastructure only (Water UK, 2013). In Nigeria road infrastructure, on
an average, the annual funding requirement is estimated at N500b against
an average budgetary allocation of N120bn with a deficit of N380bn.
In 2012, out of the N143bn budgetary allocation for road infrastructure
development only N110bn was released with deficit of N33bn
unimplemented (Federal Ministry of works, 2013).
This
clearly depicts the dilemma of infrastructure financing using the traditional
method of government budget. Pearson (2013) observes that if Africa is to
effectively participate in the global trading environment and reach its true
economic potential, it will require a level of investment in infrastructure
that goes well beyond the capacity of the government. The private sector will
need to be involved and if this is to happen then instruments to reduce risk
level and increase returns will need to be developed – that is the
public-private partnership (PPP).
PPP, according to Brusewitz (2005),
is a medium to long-term venture in which there are key contractual or legal
relationship between the public and the participating private sector. PPP
therefore refers to a project in which there is cooperation between the public
and private sector(s) in one or more of the development, construction,
operation, ownership or financing of infrastructure assets, or in the provision
of services. Under a PPP arrangement the private sector is typically contracted
to design, build, operate, manage and finance new infrastructure and meet
government obligations for a set period of time.
The
major objective of this paper, therefore, is to present an overview of
infrastructure finance through PPP and to examine some its challenges to the
infrastructure development in Nigeria. Immediately preceding this introduction
is section 2, which provides an overview and methods of financing
infrastructure. Section 3 presents some of the challenges of infrastructure
finance, and Section 4 provides the way forward.
2. INFRASTRUCTURE FINANCE MECHANISM
2.1.
Traditional
Infrastructure Financing Mechanism
The
traditional mechanism for infrastructure financing is the use of government
budget as the primary source of financing infrastructural facilities including
provision of portable drinking water, roads, transportation energy, etc. This
traditionally method of financing of infrastructure are executed by traditional
method of direct contract award.
This
method has proven to be inadequate and most often unimplemented creating a
financing gap for execution of infrastructure projects. Severe budget
constraints and inefficient management of infrastructure by public entities
have led to an increased involvement of private investors in the business.
Dailami
and Leipziger (1986) show that out of the $1.3 billion infrastructural
financing raised by developing countries, only $100 million is sourced from
private sector sources. But by 1995, the private sector provided $15,607
billion of the $22,297 raised, whereas public sources accounted for only $6690
billion. These show that private sector, in recent years, has attained the role
of domineering financiers of infrastructure investments through the
public-private partnership (PPP) model.
2.2.
Public-Private Partnership (PPP)
Infrastructure Financing Mechanism
One
of the modern methods of infrastructure financing is private sector initiative.
The history of private sector participation in infrastructure development is
quite old. Private sector participation in the transport sector, for example,
dates back to seventeenth century canal and road concessions in Europe and the
United States of America. Private companies built the American railways in the
nineteenth century. Many early public transport systems in European and
American cities were also developed in this century by the private sector under
various municipal charter or franchise arrangements with revenues coming from
fares and land development.
Another
method of infrastructure financing that has been adopted in recent times in
Nigeria is public-private partnership (PPP). It involves construction of a
project or provision of services in cooperation between the public and private
sector(s). In the view of Trabant and Allard (2008), PPP first emerged in the
United Kingdom in the wake of the conservative revolution of Margaret Thatcher.
Beginning
in the early 1990s, the government began to explore avenues of co-production of
public services with the private sector. PFI, as it was called in the UK
(Private Financing Initiative) spread quickly across sectors and took various
forms, depending on the exact role that each project assigned to the private
and public sectors.
PPP
project generally fill a gap between traditionally procured government projects
and full privatization. PPP or P3 model describes a government service or
private business venture which is funded and operated through a partnership of
government and one or more private sector companies. Typically, one or more
private sector companies form a consortium and are generally described as
“Special Purpose Vehicle”. The consortium may mainly consist of a project
sponsor, Bank lender etc. More so, the consortium will be developed in a manner
as to account for the technical, financial, legal, environmental and social
aspects of the PPP transaction.
The
proponents of PPP posit that it bring forward the delivery of infrastructure
projects, draw on private sector expertise and offer an alternative financing
vehicle to traditional government procurement. They also submit that bundling
of PPP services for major infrastructure projects provide whole-of-life cost
savings, and increased efficiency by delivering services of a higher-quality or
at a lower cost.
Two
major surveys of PPP projects conducted by the British government, according to
Trabant & Allard (2008), estimated average savings of 17% on the completed
projects, due mainly to the avoidance of cost overruns in the construction
phase. They also discovered that 80% of PPP projects had met their initial delivery
time targets, compared to 20% for comparable public-sector projects.
The
reports concluded that the main source of the savings was that risks of delays
or overruns had effectively been transferred from the public to the private
sector. This effective reallocation of risks is the main benefit of PPPs and is
the issue that must be addressed most effectively when PPP contracts are
negotiated. The opponents of PPP, on the other hand, argue that PPP contracts
involve high transaction costs and efficiency is undermined by limited
competition in the bidding process.
They
also claim that PPPs do not offer value for money because the premium required
by the private partner is in excess of the risk they assume, and that
inadequate risk transfer has occurred in some projects and government, and
ultimately the taxpayer, has had to bear the financial consequences.
The
following are the models available for PPP transactions in Nigeria:
Table 1: PPP Models
s/n |
PPP Model |
Description |
1 |
Design-Build (DB) or Turnkey Contract |
The private sector designs and builds infrastructure
to meet public sector performance specifications, often for a fixed price.
The cost of overruns is transferred to the private sector. |
2 |
Service
Provision Contract |
A private operator, under contract, operates a
publicly owned asset for a specified period. Ownership of the
asset remains with the public entity. |
3 |
Management
Contract |
A private entity contracts to manage a Government
owned entity and manages the marketing and provision of a service. |
4 |
Lease
and Operate Contract |
A private operator contracts to lease and assume all
management and operation of Government owned facility and associated
services, and may invest further in developing the service and provide the
service for a fixed term. |
5 |
Design-Build- Finance Operate (DBFO) |
The private sector designs finance and constructs a
new facility under a long term lease and operates the facility during the
term of the lease. The private partner transfers the new facility to the
public sector at the end of the lease term. |
6 |
Build-Operate-Transfer (BOT) |
A private entity receives a franchise to finance,
design, build and operate a facility (and to charge user fees) for a
specified period, after which ownership is transferred back to the public sector. |
7 |
Buy-Build-Operate (BBO) |
The transfer of a public asset to private or
quasi-public entity usually under contract that the assets are to be upgraded
and operated for a specified period of time. Public control is exercised
through the contract at the time of transfer. |
8 |
Build-Own-Operate (BOO) |
The private sector finances, builds, owns and
operates a facility or service in perpetuity. The public constraints are
stated in the original agreement and through on-going regulatory obligations. |
9 |
Build-Own-Operate Transfer (BOOT) |
This is an extended version of the BOT model where
the private sector builds, owns and operates a facility for a specified
period as agreed in the contract and then transfers to the public. |
10 |
Operating
License |
A private sector receives a license or rights to
build and operate a public service, usually for a specified period. Similar to
BBO arrangement. |
11 |
Finance
Only |
A private entity, usually a financial services
company, funds a project directly or uses a mechanism such as long-term lease
or bond issue. |
Source: Obuzuwa (2011).
3. CHALLENGES OF INFRASTRUCTURE FINANCE IN NIGERIA
The
major challenges of infrastructure finance are as discussed below.
First,
exposure to currency risk is a critical feature of infrastructure financing.
Infrastructure project revenues are often generated in local currencies, while
servicing of foreign capital, whether debt or equity, involves payment in
foreign currency. Fluctuations in the exchange rate of the domestic currency,
as well as capital controls limiting currency convertibility and
transferability, pose a particularly difficult problem for foreign investors
and financiers.
Second,
infrastructure investments are typically up-front, with a high degree of asset
specificity and risky revenue streams stretching many years into the future.
Investors are hesitant to make investments in such circumstances without
adequate contractual protection.
Third,
the scope for divesting equity holdings in infrastructure investment through
IPOs is limited in many developing countries. As a result, project promoters
would be locked in their investments for several years.
Fourth,
there are very few bankable projects. The project preparation process is not
yet sophisticated enough to address bankability issues from the onset.
Challenges in the project preparation stage include securing funding for costly
feasibility tests and limited project precedents due to the short history of
PPP projects in Nigeria.
Fifth,
inadequate legal and regulatory framework hinders infrastructure financing. The
Federal government and a number of state governments have made significant
strides to create a suitable legal and regulatory framework that will encourage
private sector participation in infrastructure development projects. However,
this framework is yet to be fully established and tested, which may create
apprehension and reluctance in the private sector.
Sixth,
there is high preference for ‘Quick Win’ Sectors. Most private sector
investments in African infrastructure have been in quick return sectors such as
telecoms. Telecoms projects have a quicker gestation period whilst investment
in concessions will be recouped over a much longer period ranging from 25 – 30
years.
Seventh,
relatively high cost of projects discourages infrastructure financiers. Due to
economic and political factors, the cost of undertaking PPP projects in Nigeria
is relatively higher compared to costs of similar projects in other countries.
Thus the opportunity cost of financing infrastructure development projects in
Nigeria is relatively high.
4. CONCLUSIONS
The
paper appraises infrastructure finance through Public-Private Partnership (PPP)
initiative as well as examines its challenges to the infrastructure development
in Nigeria. The need for this appraisal arises from dwindling government
resources which has resulted in ineffectiveness of the traditional methods of
infrastructure financing through budgetary provisions and execution by direct
contract award.
Thus,
has created gap in financing infrastructural projects in Nigeria. The paper
highlights importance of PPP projects in covering the infrastructure lacuna as
well as some challenges investors encounter in the mobilising PPP financing.
Finally, the paper proffers policy measures to address the highlighted
challenges. In general, the conclusion is that inadequate infrastructural
facilities discourage investments and retards economic development.
5. RECOMMENDATIONS
Granted
that financing the much needed investment in Nigeria’s infrastructure is one of
the critical challenges facing the country, the government as well as the
private sector proponent can take certain steps to enable a greater number of
infrastructure development projects attract adequate financing. These steps,
which are the way forward, include:
·
Proper Project Appraisal. In deciding which
infrastructure development projects to undertake, emphasis should be laid on
indentified public needs which can only be met by direct public private
partnership intervention. These are the types of projects that will provide the
requisite cash-flows from which private sector investment will be recouped.
·
Government Intervention. Government can provide
support in a number of ways including giving guarantees on the continuity of
the project, which acts as an assurance to investors. Some State Governments in
Nigeria such as Lagos State, Imo State and Delta State have also adopted this
approach, raising state bonds for infrastructure development.
·
The Viability Gap Fund. Government can provide active
financial support through schemes such as the Viability Gap Fund. The Viability
Gap Fund is a sovereign grant to close the commercial gap on a PPP
infrastructure development project. This is necessary where the cost of
infrastructure financing is so high that the revenue stream therefrom may be
insufficient to yield sufficient returns
·
Excellent Legal Framework. The Government must
establish and implement a coherent and comprehensive framework for such
projects at both the State and Federal level covering recurring issues including
risk allocation and mitigation strategies and government support and
guarantees.
·
Policy makers has to ensure that infrastructure assets
are structured to an investment grade level, hedged against macroeconomic risks
and are regulated or licensed in some form.
·
Enhance the capacity of Nigerian capital
markets to supply long-term debt capital in form infrastructure bond, which is
critical for the financing of infrastructure projects with long-term assets
whose costs may take 10 to 30 years to recoup. The Infrastructure bond could be
issued in the local or international capital markets secured by and serviced
from the cash-flows of a specific project or a portfolio of projects without
recourse to the sponsors.
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