Enabling infrastructure investment – a focal point for South Africa’s depressed economy

As we face a significantly depressed economic outlook with the urgent need to revitalise our economy and create jobs, infrastructure investment once again becomes a focal point to stimulate economic growth. It is an asset class that marries well the economic benefits of growth and returns with a tangible social impact.

Traditional measures of risk and return are no longer the only considerations when evaluating investments. The impact of the investment on the environment, human lives and the value being created for future generations is becoming increasingly important to investors. Looking at the UN’s sustainable development goals (SDGs), a large majority of these are met through infrastructure investment. Infrastructure investment thus fits very well into the drive for sustainable investing with environment, social and corporate governance (ESG) considerations being more prevalent in infrastructure financing. Where project finance has been used to fund infrastructure assets, these have been subject to equator principles, providing a framework for managing environmental and social risk within these projects.

When talking about sustainable investing, we cannot ignore just transition. As we grow our renewable energy market, there needs to be increased focus on localisation, policies and requirements around local manufacturing, the re-skilling and upskilling of workers that will be impacted as we move towards a greener economy. Localisation must be done on a sustainable basis that transcends the independent power producers (IPP) bid windows so that South Africa becomes a permanent partner in the global supply chain. An overall policy framework to encourage a transition to a green economy and a clear, predictable and stable policy environment can create the confidence required to stimulate private investment.

Over the past few years, there has been a significant under-spend on infrastructure, far below the National Development Plan target, which has not only impacted the country’s economic growth pre-Covid but also the quality of life of those living in South Africa. The answer is not widescale roll-out of infrastructure projects but on sustainable and quality infrastructure that is properly designed and delivered, reliable and resilient with equitable access to its benefits. As a country, we cannot afford another Medupi or Kusile.

While investors are open to infrastructure investing, there is a lack of availability of bankable projects. Infrastructure projects can be plagued by red tape with mis-alignment of development plans between different spheres of government delaying roll-out, but we are seeing some traction in this regard. Recent engagement between Government and the private sector has been encouraging, specifically around the creation of the Infrastructure Investment Office (IIO) to coordinate various stakeholders with the aim to fast track infrastructure development and reduce bottlenecks within the system. The inclusion of the Presidential Infrastructure Coordinating Commission (PICC) Technical Task team within the IIO to form what is called Infrastructure SA creates one umbrella and avenue under which infrastructure projects requiring funding from the fiscus will be considered.

Development of infrastructure is complex in nature and requires proper structuring, implementation and management to ensure adequate mitigation of risks and attraction of funding, with the IIO recognising their constraints and calling for assistance from the private sector to bolster the capacity and skills to fulfil their function as well as improve the quality of projects submitted for consideration from the provinces. To date, 50 projects in key sectors of water and sanitation, human settlements, and energy, have been gazetted, funding secured, and necessary approvals fast tracked. Increasing the capacity of this office will assist in creating a greater pipeline of bankable investments.

The establishment of the Infrastructure Fund managed by the Development Bank of Southern Africa (DBSA) will seek to utilise R100 billion of government support over 10 years to crowd in private capital. The fund will consider blended financing, instruments include provision of subordinated debt to increase the first-loss buffer for senior debt providers, increased capital commitments to reduce elevated debt levels for riskier projects and interest-rate subsidies to reduce total debt costs. The aim of blende financing would be to enhance the fundamentals of a project that would otherwise not be bankable.

The creation of a pipeline of projects is not solely a Government responsibility. Institutional investors are also asking questions around direct benefits created for their members. This is an area where the private sector could get involved with the development of infrastructure services in areas where the majority of beneficiaries live or
will retire.

On the funding side, historically Government has largely funded infrastructure development. Given the significant infrastructure gap, of approximately R2 trillion per the NDP plan to 2030 as well as the impacts of the pandemic with rising debt to GDP
levels, it can no longer be the case. Development finance institutions (DFIs) and commercial banks play an important role, with DFIs providing much needed project preparation facilities to assess feasibility and develop bankable projects, and the commercial banks being best placed to take the construction risks. Commercial banks, though, are constrained by capital requirements, with their balance sheets not suited to holding long-term assets. On the other side of the coin, institutional investors are concerned about the illiquid nature of this asset class, with more work needing to be done around increasing access to liquid infrastructure projects. Once an infrastructure project is operating, it has been substantially derisked and can be refinanced into a listed project bond, creating a more tradeable instrument.

A listed bond does come with greater transparency to the market and increased reporting requirements that may be met with apprehension from project sponsors. This however needs to be balanced with the funding capacity of the capital markets to meet infrastructure needs, longer tenors that can be issued through a project bond as well as the benefits to sponsors to access diverse pools of capital at reduced rates.

To get around the reduced flexibility of a listed project bond versus unlisted debt, a managing agent with the necessary skills, appointed by the bondholders to manage the project from a debt perspective, could address this challenge with certain events of default still subject to noteholder consent. This would ensure that bondholders’ rights and interests are protected, while maintaining flexibility that is required for these types of dynamic projects.

Financiers could further encourage sustainability by considering pricing ratchets, sustainable financing can cater for downward ratchets in the margin reducing financing costs if agreed sustainable targets, verified by a third party, are met, incentivising attainment of these targets. Ultimately a sustainable business or project creates a greater return profile for investors over the long term.

Lastly, there needs to be standardisation on definitions and measurement to allow investors to assess the relative attractiveness of sustainable investments.

Overall, South Africa is really at the edge of an economic cliff but we have investors that are keen to - and understand the need to – invest in infrastructure however hurdles need to be overcome and addressed through collaboration between the public sector and private industry players. We also need to acknowledge that we cannot do everything at once, so there should be a focus on investments that can create the most significant impact from a financial and ESG perspective.