March 2011

Sub-Sovereign Finance for Urban Infrastracture

Decentralization has made governments and public utilities at the sub-sovereign level increasingly responsible for providing urban infrastructure and services. Governments and donor agencies need to find ways to mobilize sub-sovereign finance for infrastructure through private sector participation, and debt markets. Funding Gaps Urban areas are key drivers of Asias economic growth, with resultant gains in poverty reduction. However, the scale and rapidity of urbanization and mounting fiscal constraints to bridge existing and growing infrastructure service gaps is leading to major shortfalls in coverage, service levels, and quality of urban infrastructure. An estimated $100 billion a year worth of new urban infrastructure is needed to fill prior gaps and keep pace with unprecedented urban growth.1 Total financing requirements for water supply, sanitation, solid waste management and slum upgrading in urban areas was estimated at $25 billion per annum from 2006 to 2010 at 2003 prices. The figure goes up to $50 billion if urban roads are included and to $59 billion if mass transit is added. An estimated $32 billion might still be needed each year to maintain the physical urban infrastructure stock.2 Challenges to Bridging the Funding Gaps Current mechanisms for financing infrastructure rely heavily on the public sector. But sub-sovereign governments and infrastructure development entities in
1 Infrastructure for a Seamless Asia (ADBI, 2009) examines the unfilled infrastructure needs of Asia that grew in the wake of the 19971998 financial crisis and that have increased rapidly with urban migration and rising middle class. Its estimate of $750 billion a year for 20102020 exceeds others by several multiples but agrees with other estimates that over half of the need is for municipal infrastructure. Asian Development Bank. Special Evaluation Report on Urban Sector Strategy and Operations. (Manila, 2006).

ADBs developing member countries have begun supplementing public sector funds with market-based financing. Unfortunately, urban infrastructure cannot seem to generate commercial investment due to lack of enabling structures for private participation and limited scope for cost recovery. Projects that may be financially viable in the long term are therefore starved of capital. Private sector financiers continue to assess as high the risks the financing of local government infrastructure . The supply balance sheets constraints of banks and financial institutions allow lending to have short maturities and high interest rates, which are not conducive for infrastructure projects. Debt through domestic capital markets has not been used significantly by most countries. Borrowing through issue of bonds has been restricted to a few creditworthy entities. Tapping Domestic Credit Markets Public-sector participation must be more effective in using its relatively scarce budget. It must explore ways to attract significantly more private-sector financing to rise above the 2030% share it currently holds3. However, domestic credit markets need to be tapped to help access private domestic savings on a large scale and augment current efforts in financing
3 ADBs Infrastructure Operations: Responding to Client Needs (ADB, March 2007) shows a regional average of nearly 30% over the two decades ending in 2005. Its estimation of annual average needs 20052010 were just under $50 billion a year.

Carbon Credits: Improving Financing and Sustainability of a Landfill Closure Project Carbon credit financing has helped Mumbai transform its vast landfill into greenery with revenue-generating potential. Available: www.adb.org/publications/improvingfinancing-and-sustainability-landfill-closureproject.

Expanding Water Supply and Sanitation Coverage through Output-Based Aid ADB has formulated its first output-based aid initiative. How will it help Nepals water supply and sanitation concerns? Available: www.adb.org/publications/expanding-watersupply-and-sanitation-coverage-throughoutput-based-aid.

infrastructure at the local and regional levels. In designing local credit initiatives to reduce the private sectors perceived risks, ADBs developing member countries have adopted innovative measures that combine the municipal bonds model of North America and that of of Western Europe with access to long-term savings deposits and government contributions. These measures tap quasi-independent municipal credit institutions to channel borrowed and grant funds to local governments; create credit enhancement mechanisms; use special purpose vehicles to raise finance for small municipalities through bonds; and manage specific sectors of urban infrastructure in each of the major cities. The experience has been mixed and these initiatives have had limited impact and crowded out private finance. Local governments and entities can have both bank-based access to infrastructure finance targeted at smaller, less-frequent borrowers, and municipal bond market access for the more creditworthy, sizable issuers. The same municipal financing system and basic legal structure can support both markets as long as neither system is subsidized preferentially. Competition between the two systems will lower the costs of borrowing for local governments and increase information flow about credit quality. The objective is still to raise the cheapest possible funds, lengthen the maturity of borrowing, and improve the pricing factor.

Unlocking Urban Infrastructure Investments Even as progress has been made in ADBs developing member countries to increase the presence of the private sector in urban infrastructure, investments have not matched needs. Major gaps can be reduced by improving the legal, regulatory, and institutional frameworks within which private sector participation via PPPs is enabled and the authorization, treatment, and use of debt is allowed to operate; local variables (e.g., the size, tax base, accounting and debt management) which, in their current form, severely limit local governments ability to tap financial markets; facilitative arrangements (credit enhancement mechanisms, credit rating systems) that enhance the borrowing and repayment capacities of local governments; technical and managerial capacity of cities to become financially credible and accountable; coordination among international agencies; and modalities in financing support for urban infrastructure to catalyze private sector finance in scale.
Priyanka Sood
Read the original thinkpiece at www.adb.org/features/ahead-curve-subsovereign-finance-urban-infrastructure.

contact Knowledge Sharing and Services Center Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines Tel +63 2 632 6710 Fax +63 2 632 5236 knowledge@adb.org www.adb.org/site/knowledge-management/features

Disclaimer The views expressed in the article are those of the author/s and do not necessarily reflect the views or policies of the Asian Development Bank, or its Board of Governors, or the governments they represent. ADB does not guarantee the accuracy of the data included in this article and accepts no responsibility for any consequence of their use. The countries listed in the article do not imply any view on ADBs part as to sovereignty or independent status or necessarily conform to ADBs terminology.