Infrastructure Bonds Set to Thrive on PPP

The infrastructure deficit in Nigeria is significantly large and the financial requirements to fund this gap are equally high. Estimated in excess of ₦3 trillion per annum over a 10-year period, the current trend in Nigeria’s government spending indicates a significant shortfall in public investment capacity.

The government agrees that private sector participation in the provision of the required funding is necessary, via public private partnerships (PPPs). However, despite the avowed commitment of the past and current governments at different levels to adopt the PPP approach to filling this gap, the use has been at best marginal. The PPPs mainly concentrated at liberalisation and privatisation of government owned assets in select industries, while focus on infrastructure development has been secondary.

The slow and marginal adoption of the PPP approach, despite the significant investment in setting up the appropriate institutional framework, continues to rob the country of the opportunity to access the capital market. Stock Exchanges around the world allow crowd funding of public investments for efficient infrastructure development. Despite the increasing size, depth and global attractiveness as well as opportunities in the Nigerian capital market, the government appears to have failed significantly at exploring the symbiotic growth opportunity offered by the use of an infrastructure bond and/or specialised infrastructure public equity offering to fill gaps in public investment.

Nigerian Infrastructure Gap
A World Bank report in 2011 conservatively put the cost of addressing Nigeria’s infrastructure challenges at $142 billion per annum over the decade. These funds will be applied to meet illustrative targets in roads, ports, aviation, railways, power, information communication technology (ICT), agriculture, water resources and sanitation. These projects fall within the federal government responsibility. An estimated $10.5 billion (₦1.68 trillion) would be required annually.

The other areas of infrastructure include water and sanitation, secondary and tertiary road networks, and small-scale irrigation. These are assumed to be within the purview of the state and local governments. And it will require an estimated $3.7 billion (₦592 billion) a year. The required annual investment in education and health infrastructure is arguably more than half of the aggregated estimates considering the dire state of Nigeria’s human development indexes (HDI). There is also the evolving need for domestic fuel and gas infrastructure which if factored in may require an additional $2-3 billion (₦320-480 billion) per annum.

In naira terms, Nigeria requires a conservative estimate of ₦3.7 trillion per annum in investment in these critical infrastructure sectors over a 10-year period (starting from 2011) to standardise its infrastructure. In 2011 and 2012, the total federal government capital budget per annum was 31% and 36%. In both years, less than 60% of the capital budget was implemented, partly due to revenue shortfalls. In addition, over the medium term and based on the Medium Term Expenditure Framework and Fiscal Strategy Plans (MTEF&FSP) 2012 – 2015 of the Federal Government of Nigeria, capital spending remains at 56% below the estimated annual requirements. This suggests that the government has no capacity to fund this gap now or in the near future.

At the state government level, 24 of the 36 states and the FCT budgeted a total capital spending of ₦1.88 trillion, 51% of the estimated annual spending requirement on infrastructure. The extent of implementation including adjustments for leakages is also debatable as many of them faced revenue shortfalls in the face of a surge in personnel costs. Hence, an ingenious way to fill this gap, a way that minimises leakages and delivers on schedule is required. Unfortunately, the capital market option has remained sub optimally utilised.

New Commitment to PPPs
At the inception of democratic governance in 1999, government at all levels recognised their inability to fund the huge infrastructure gap in the country and hence made the commitment to private sector participation. It started out with liberalisation of key sectors such as the telecommunications, finance, and the privatisation of government ownership in selected industries. It also commenced the use of the domestic bond market via a programmed issuance of sovereign debts to fund budget gaps. To further provide fillips to its commitment to private sector participation, the Federal Government embarked on the creation of relevant institutions to facilitate the process. These include the Bureau of Public Enterprises (BPE) to manage government divestments and investment in corporate entities, and the Infrastructure Concession and Regulatory Commission (ICRC) to manage and regulate infrastructure concession.

State Governments & Bond Issuance
While a lot has been achieved in the areas of liberalisation and privatisation of government ownership in several entries, marginal progress has been made in the use of PPPs and special bonds especially in relation to infrastructure development in Nigeria. It is important to note that State Governments are significantly leveraging off the bond market via the issues of subnational Bond. An estimated ₦545.5 billion worth of this bond issued by 15 State Governments are currently outstanding.

Unlike the FGN bond programmes which are only linked to budget augmentation and hence generic federal projects and spending, state bonds are tied directly to specific infrastructure and/or development projects in the various issuing framework. The State Government bond market however still remains shallow with significant room for increased infrastructure linked debt issues. All issued bonds still remain significantly below the 40% of the potential revenue –debt sustainability metrics of the Debt Management Office (DMO). In that regard, the Federal Government at the debt/GDP ratio of less than 25% also has significant room to expand its use of the bond market for this purpose.

The Readiness for More Nigerian Assets
The Nigerian capital market has progressed significantly in terms of depth and sophistication. The Nigerian bond market dominated by the sovereign bonds with over ₦4 trillion in market capitalisation is amongst the most attractive to investors globally in terms of yields. The recent addition of Nigeria’s sovereign bonds to the JP Morgan Government Bond index –Emerging Markets (GBI-EB) and Barclays Bank Emerging Markets –Local Currency Index (EM-LCI) enhanced the attractiveness of these bonds to global investors. The interest in Nigerian assets is clear from the stable yield on the Nigerian $500 million 10-year Eurobond (Coupon: 6.75%). The bond currently trades at an appreciably impressive yield of about 4.05% compared to the yield of 7% at issue on January 28, 2011, notwithstanding the low global costs of funds.

The performance of the Nigerian Eurobond amidst the global liquidity ease engendered the rising preference of the government for external debt. In addition to the proposed $1 billion infrastructure, Eurobond targeted at gas to power infrastructure, the government aims to borrow a total of $7.11 billion in the next two years. The Federal Government got approval for $4.85 billion, while 23 states got $2.26 billion as their shares of the borrowing plan to be founded by the World Bank. The Federal Government also plans to issue a Diaspora bond. However, no one is talking about packaging any of the myriads of infrastructure projects for bond financing.

Lessons from Europe & Emerging Markets
In Europe for instance, despite the challenging economic situation of the Union, the Europe 2020 Project Bond Initiative is set up to stimulate capital market financing for large-scale infrastructure projects; particularly in the areas of trans-European networks in transport and energy, as well as broadband telecommunications. The scheme operates by providing credit enhancement to project in infrastructure needs of the Union in transportation, energy and telecommunication. The European Investment Bank (EIB) provides credit enhancement in form of a subordinate instrument (either a loan or contingent facility) to support the senior debt issued by the project company.

In Emerging markets, the use of infrastructure bonds is on the rise. Indian Railway Finance Corporation Limited (IRFC) has issued its second tax free bond as a public owned finance arm of the Indian Railway Corporation registered as an infrastructure finance company. Brazil has also commenced a spate of infrastructure concessioning to boost its infrastructure with specific focus on infrastructure bond financing. According to Bloomberg, Brazil plans to develop a local bond market to fund its $496 billion in project for roads, factories and airports and wean companies off loans from the state-development bank.

Creating the Right Framework for PPP
The foregoing suggests that there is the need to re-evaluate the framework for PPP in Nigeria. The institutional framework is currently weak and pays little attention to the opportunities that the Nigeria capital market offers. The role of identification and design of infrastructure projects for PPP needs to be reallocated to a focused organisation, perhaps the BPE that may as well restructure projects as Special Purpose Vehicle (SPV) in conjunction with the ICRC and the supervising MDAs.

Targets should be set for the number of projects to be created per annum as performance indicators. Private investment banking and infrastructure finance experts could also be utilised to help in the identification and packaging of infrastructure projects for either PPP or as a project finance deal being a way that  allows either the project company to issue low risk bonds or as an SPV that can issue bond by itself. With efficient use of the Nigerian capital market, the country’s infrastructural challenges can be reduced within a short time frame than with the current approach.

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