Unlocking private investment in infrastructure in developing countries

One of the key takeaways of the GI Hub’s Infrastructure Monitor 2021 is that it confirmed a trend we have observed over the past ten years: private investment in infrastructure across low- and middle-income countries (LMICs) has significant room for growth. In 2020, this investment in those nations decreased 28%, while the same indicator in high-income countries increased by 2%. Whilst there is no doubt that the COVID-19 pandemic has influenced investor’s appetite to participate in infrastructure globally, private investment in LMICs has been falling, and makes up only around a quarter of total global private investment in infrastructure.

These numbers are showing that there is something hampering the mobilisation of private capital into infrastructure in LMICs. The diversity between Asia, Africa and Latin America makes it impossible to envision a one-size-fits-all-solution to attract private capital. But there are, however, certain similarities across these nations which can help us define general actions that can provide certainty to private investors, improve transparency, and promote the development of solid, bankable projects.

We are at a critical moment

The advent of agreements and recommendations aimed at addressing the climate challenge is opening new opportunities to attract private capital. Investors are eager to finance projects in alignment with the Paris Agreement, which promote the United Nation’s Sustainable Development Goals, and foster a more inclusive society – and LMICs are ripe territory for this type of projects. Africa is the most vulnerable continent to the impacts of climate change under all climate scenarios above 1.5 degrees; sea surface temperatures and ocean warming in and around Asia are increasing more than the global average; and high urbanisation levels in Latin America  are exposing an ever growing number of the population to floods and droughts caused by fluctuations in weather patterns.

What are our options?

To seize the opportunities of this critical moment and increase private investment in infrastructure (particularly in public-private partnerships), LMICs can implement a series of actions. For example, the creation of a regulatory and institutional framework which promotes private investment or the development of solid project pipelines. Other suggestions focus on financial issues such as the development of infrastructure as an asset class through the creation of financial vehicles and the support of multilateral development banks (MDBs) and improving the ways we measure the social and environmental impact of projects to crowd in more capital.

Top issues impacting private sector investment

In my view there are two vital issues that hamper investor’s confidence in LMIC’s: (i) enhanced perception of political risk derived from local’s attitude towards private investments, changes in government, deficiencies in contract enforcement measures, etc. and (ii) lack of adequate mechanisms to mitigate financial risks such as fluctuations in exchange rates, the cost of raw material, or more complex challenges such as implementing ways to make local currency financing available.

Addressing political and financial risk by strengthening local capacities

How can we address these barriers to investment in infrastructure? Firstly, political risk is especially critical and mitigating investors uncertainty should be a priority. The creation of a civil service with high technical capacities focused on the development of infrastructure projects can depoliticise projects and provide stability, transparency, and confidence throughout the project lifecycle. National development agencies from high-income countries can offer the expertise and support for the establishment of this type of actions. The Netherlands, for example, has a very solid civil service for the infrastructure and water management sectors which has been viewed as an example of best practice by some European Union countries.

Secondly, when it comes to financial risk a key action that can be undertaken by LMIC’s is the strengthening of their local banking systems or the creation of local infrastructure banks. In the long-term this can help ameliorate the financing costs for the private sector and promote the creation or consolidation of country-specific financial products. It can also have a positive impact on a project´s foreign exchange exposure and make funding available for subnational infrastructure. MDBs can provide financing and technical expertise to give local financial systems a boost. As highlighted in the GI Hub’s InfraCompass tool, countries that take initiatives to improve the technical capacities of their local financial market can often see improvements in their infrastructure enabling environment. Colombia has developed a robust local infrastructure bank system which includes the National Infrastructure Agency and the National Agency for Financing, which play a vital role in mobilising private financing.

In summary, attracting private investment in infrastructure is no easy endeavor with no quick fixes to solve this challenge. When deciding to invest, the first consideration for investors is what their returns will be; certainty, continuity and transparency are crucial factors to help minimise risk and maximise earnings. Similarly, governments should not only look to attract private funding, but aim to boost infrastructure´s developmental impact by incentivising private investment with sustainable social and environmental considerations. For LMIC’s, the balancing of the two sides of this equation passes through the strengthening of local capacities. Doing so will not only have a key effect in the construction of better infrastructure, but it will also increase the chances of achieving long-term growth, creating more jobs, and developing a cleaner and more inclusive transition in these countries.

This and related topics are analysed in GI Hub's Infrastructure Monitor 2021 report and ongoing series of Infrastructure Monitor data insights.