Infrastructure Finance: An Introduction
Traditional economists are of the opinion that infrastructure is the heart of the economy. Empirical data clearly shows that given a choice, investors prefer to invest their money in countries whose infrastructure is more developed. Hence, it can be said that rapid infrastructure development is one of the most basic ways in which a country can take advantage of economic opportunities. It is, therefore, no surprise that countries around the world focus heavily on building infrastructure.
Donald Trump i.e., the President of the United States, has openly announced that his government is planning to spend $1 trillion in order to develop infrastructure within the country.
Developing countries like India have also echoed this sentiment as they have also announced plans to spend billions of dollars in order to build and upgrade their infrastructure. Hence, it can be said that infrastructure and its financing is an important issue all across the world regardless of whether the nation is developing or developed.
Since infrastructure is such a high priority issue in the world, the financing of infrastructure projects is also considered to be very important. As a result, an entire subject called infrastructure financing has been developed. We will study infrastructure financing in greater detail in this module. However, before that, we need to understand what infrastructure definition really is.
Definition of Infrastructure Financing
The formal definitions of infrastructure financing are not very clear. Generally, in most countries around the world, the government issues a list of industries that are to be given infrastructure status. The financing of projects or companies involved in these sectors is called infrastructure financing.
However, this definition is more for the governments internal operations. This definition is used in order to provide tax breaks or subsidies that have been promised to the infrastructure sector.
However, there are certain shared characteristics amongst industries that are classified as infrastructure all over the world. Some of these characteristics have been mentioned below:
- Firstly, industries which are given infrastructure status are considered to be central to the economy. This means that these industries provide the impetus for the rapid growth and development of other industries as well. For instance, industries such as roadways and railways enable faster movements of goods and services throughout the country. This helps the manufacturers in the country become more competitive as compared to other countries. The final result is an increase in exports. Other important sectors such as telecommunications and electricity are also considered to be central to the economy and hence have been provided infrastructure finance all over the world.
- Secondly, since these industries are considered to be of strategic importance, too many private sector players are not allowed to operate in them. This creates a monopolistic market with very few players. As a result, investors are generally very keen on investing in infrastructure opportunities. However, it also needs to be understood that since these markets can be considered to be monopolistic, they are also highly regulated. Since there is only a handful of suppliers, the government fixes the prices that can be charged
- Lastly, infrastructure assets are characterized by low risk and stable cash flows. These projects are generally built in areas where there is high demand. As a result, either the consumers or the government are willing to pay a relatively stable cash outflow for a long period of time.
The bottom line is that the defining feature of infrastructure financing is the sectors to which money is being lent. The different types of loans such as overdraft, term loan, working capital loan, etc. are generally included in the definition of infrastructure financing
Types of Infrastructure Financing
Infrastructure financing has various sub-divisions. These divisions are generally based on the type of industry that the funds will actually be utilized in. The different types of infrastructure financing have been listed below;
- Economic: infrastructure financing can be for purely economic reasons. For instance, when a new port is built in a country, it enables more foreign trade. These projects are generally funded using a public-private partnership. This is because these projects have net positive value. Hence, the value created can be shared between the government and the private parties. Economic infrastructure projects provide benefits to the larger economy of a region instead of providing benefits only to specific industries or people.
- Social: Infrastructure funding is also given to many institutions for a social cause. For instance, several projects are undertaken to provide clean water to the people. Similarly, projects are undertaken to provide healthcare and education services to the people of a region. These projects are different because they have to be undertaken regardless of the fact that they might have a negative net present value. Hence, under other modes of financing, these projects would be left out. However, when it comes to infrastructure financing, the government does spend funds on these projects even though there may not be any immediate returns. Since these projects may have a negative net present value, they are undertaken mostly by the government.
- Commercial: Commercial projects are just like economic projects. Except, these projects provide benefits to a set of people that can be directly identified. For example, toll roads and metro rail projects are considered to be commercial infrastructure projects. They are funded by charging the people who utilize the services.
The bottom line is that infrastructure financing is a vast field that encompasses many industries. Also, the funding models used here are slightly different since projects with negative NPV are also undertaken many times.
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- Infrastructure Finance: An Introduction
- Infrastructure as an Asset Class
- Infrastructure Finance Projects: Major Sources of Funding
- Why Doesnt the Private Sector Invest In Infrastructure Projects?
- The SPV Structure in Infrastructure Finance
- Financing Needs of Infrastructure Projects at Different Stages
- Different Types of Contracts for Infrastructure Projects
- Distribution of Risks in an Infrastructure Project
- Risks Faced By Infrastructure Projects in Emerging Markets
- Bank Loans vs. Bonds: Debt Financing In Infrastructure Projects
- Key Decisions to Be Taken During Infrastructure Bond Issuance
- Parties Involved in Infrastructure Debt Issuance
- External Credit Enhancement in Infrastructure Financing
- Revenue Bonds and the Cash Trap Mechanism
- Managing Revenue Risks in an Infrastructure Project
- Cost Overruns in Infrastructure Projects
- Causes for Cost Overruns in Infrastructure Projects
- Third-Party Risks in an Infrastructure Project
- Vendor Finance in Infrastructure Projects
- Securitization in Infrastructure Finance
- Leasing in Infrastructure Finance
- Strategic Use of Land in Infrastructure Financing
- Usage of Collateralized Debt Obligations (CDO) in Infrastructure Finance
- Infrastructure Investments in Renewable Energy
- Should the Government be an Equity Partner in Infrastructure Projects?
- Lifecycle of Public Private Partnership (PPP) Projects
- Payment Mechanisms in Public-Private Partnerships
- Adjustment Mechanisms in Publich-Private Partnership (PPP) Contracts
- Early Termination of a Public Private Partnership