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The Infrastructure Finance Challenge

Ingo Walter

5. Beyond Economics: Governance and Infrastructure Development

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1In charting a course for financing infrastructure programs globally, many will argue for a focus on stable, democratic states where commercial financing is available, because the results will be more predictable and outcomes more favorable. But as governments address infrastructure development challenges, this perspective turns out to be too narrow. It fails to consider broader national policy interests as well as problems of limited governmental capacity to support development of needed infrastructure.

2In the US, for example, the federal government recognizes the strategic importance of supporting key regional allies in the developing world, where infrastructure is essential to economic growth. So policymakers need to integrate efforts to finance infrastructure projects into this broader policy framework. Plans to increase infrastructure financing must include a mix of target countries, both strategically important developed states as well key strategic countries in less developed regions.

  • 1 See Kahale (2011).

3Substantial investments in infrastructure are essential to economic development. As countries industrialize, the need for infrastructure grows exponentially to meet the demands of increased commercial activity and growing populations.1 Infrastructure can generate predictable, long-term revenues that the host government can use to bolster education, health care, and other basic human rights.

4Models for infrastructure financing differ dramatically, however, in countries with relatively weak governmental structures and safeguards. These countries struggle with poor governance, which results in a lack of public accountability and transparency as well as the absence of clear laws, independent courts, and well-functioning administrative and regulatory agencies. Such governments commonly impose crippling restrictions on civil society organizations and impede freedom of the press. These governance gaps result from years of control by arbitrary leaders who cannot or will not build a sustainable political and economic climate.

5Infrastructure investments can support sustainability in less developed countries by strategically and honestly addressing these critical governance gaps. The inconvenient truth is that governance gaps form the greatest impediment to developing and financing basic physical infrastructure projects in these countries (roads, ports, and electrical power supplies). They create instability and risk that must be built into the cost of infrastructure finance, and these factors sometimes can deter investors entirely or cut the likelihood of completion on existing projects. Even when a government guarantees to cover various project risks, the guarantees are only as good as the guarantor.

6The link between weak governance and lack of economic progress is clear. Each year, Transparency International surveys more than 175 countries and ranks them in its Corruption Perceptions Index. A poor score reflects widespread bribery, a lack of prosecution or punishment for official corruption, and public institutions that fail to respond to citizens’ needs. Unsurprisingly, failing states such as North Korea and Somalia rank at the bottom of this index, but so do Burma (Myanmar), Haiti, Iraq, and Afghanistan — all places where developed-country policymakers are working to support economic growth and promote greater stability and progress by developing infrastructure.

7A disproportionately large number of the most corrupt states are in Africa, including key regional players such as Nigeria which ranked 136 of the 167 countries in the 2015 Corruption Perceptions Index. The World Bank’s repeated efforts to encourage governance reforms in countries where it engages in projects show how important and difficult governance reforms are to achieve. Despite attempts to cut the “leakage” of its financings into bribery, corruption, and offshore accounts, projects are still left to support debt service that produced no value.

8Another key indicator of sustainability is the rule of law. In recent years, the American Bar Association helped to launch the World Justice Project, which now publishes an annual Rule of Law Index. Still in its early iterations and with insufficient data to analyze many countries, the 2015 index covers 102 nations. It analyzes factors such as the presence of independent courts and administrative agencies, a clear and transparent lawmaking process, and access to legal remedies within each society.

9Unsurprisingly, countries such as Venezuela and Iran rate very low, but so do several key US and European allies such as Nigeria (96), Kenya (84), and Egypt (86). A significant number of African states that fared poorly in Transparency International’s corruption index do not publish enough data for inclusion in the Rule of Law Index, but it is safe to assume they also would score very poorly.

10The effect of poor governance on economic development is striking. In 2014, the World Bank ranked 185 countries according to various development indicators, including per capita income. At the bottom were countries such as the Central African Republic and the Democratic Republic of the Congo. The 20 poorest countries on the World Bank’s list are all in sub-Saharan Africa. Even key regional players with significant natural and human resources, such as Kenya (150) and Nigeria (123), were far down on the list.2

11These rankings correspond with the aforementioned indexes rating elements of political sustainability such as corruption and the rule of law. They also underscore the enormity of the challenge in building successful sustainable economic models — including financing models for infrastructure development — absent fundamental political reforms.

12Mindful of the risks in undertaking infrastructure project financing in such difficult places, the investment community has begun initiatives to develop and track social and environmental standards.

13One prominent private-sector example is the Equator Principles (EPs), now in its third iteration. The EPs state that a financial institution engaged in project finance cannot provide loans or advisory services unless the sponsors can prove that they will meet minimum standards for determining, assessing, and managing environmental and social risks associated with the project.3 Any risky projects must first complete an Environmental and Social Management Plan that includes mitigation, plans of action, monitoring, and management of any potential issues, as well as establishing grievance mechanisms if needed.4 In addition, an independent expert must conduct an environmental and social impact review.5 TAs of 2016, 78 financial institutions from 35 countries have adopted the EPs, representing 80% of total involvement in global project finance.6

14Although the EPs are the best-known, other standards are also common in project financing. The EPs are based on International Finance Corporation (IFC) performance standards, which are also applied when IFC financing is secured for a project. Certain country-based initiatives may also apply. The Japan Bank for International Cooperation (JBIC), the Export-Import Bank of the US (Eximbank), and other export credit agencies have implemented their own guidelines.7

15A criticism of these standards is that they lack independent oversight and risk becoming a routine reporting exercise without much substance. Some non-governmental organizations are critical of the EPs’ oversight and implementation. The question of how to handle noncompliance with the EPs by participating financial institutions remains unresolved. Many of these standards are far more robust with respect to environmental guidelines than they are to human rights.

  • 8 Nixon, Ron. “Obama’s ‘Power Africa’ Project Is Off to a Sputtering Start”. New York Times, 21 July, (...)

16On a specific policy level, President Obama made infrastructure development in Africa a high priority for his administration. In a 2013 speech in Cape Town, he announced “Power Africa”, a program that in his words would provide “a light where currently there is darkness, the energy need to lift people out of poverty”. Power Africa was the Obama administration’s signature infrastructure initiative in Africa, a $7 billion commitment coordinated by the Agency for International Development.8

  • 9 Ibid.

17The program’s launch was hampered by difficulties in consummating power generation deals among African governments and private companies. Power Africa was intended to promote private investment rather than to provide direct government financial assistance. The US Eximbank was supposed to provide $5 billion in financing in the form of loans, loan guarantees, and insurance to help pay for American exports incorporated into the projects. Congressional debate in 2016 on whether to renew Eximbank’s charter stalled US government funding for Power Africa.9

18The problem in getting Power Africa off the ground, however, started at the local level. Consider the case of Nigeria, the continent’s most populous country with more than 170 million people. Nigeria’s vast oil reserves yield about 80% of government revenues. The combination of falling oil prices along with longstanding corruption and efficiency problems, however, severely hampered development. On a visit to Washington, the Nigerian head of state sought US assistance in helping recover stolen funds, and in an op-ed piece in the Washington Post, he said, “The fact that I now seek Obama’s assistance in locating and returning $150 billion in funds stolen in the past decade and held in foreign bank accounts on behalf of former corrupt officials is testament to how badly Nigeria has been run”.

19In a July 2015 visit to Kenya and Ethiopia, President Obama admitted that Power Africa had fallen far short of its objectives. He laid much of the blame on debilitating governance failures in the countries concerned.

20More recently, in a different part of the world, the Investment Fund of Malaysia (1MDB) was created as a sovereign wealth fund in 2009, not long after Najib Razak became Malaysia’s prime minister. The fund aimed to promote economic development and foreign direct investment, as well as transform Kuala Lumpur into a global financial hub. Unlike other sovereign wealth funds, 1MDB was based not on government financial surpluses but rather on raising debt in global financial markets to acquire infrastructure assets.

21Bond issues undertaken by 1MDB — and led by Goldman Sachs against unusually high fees — rose to a peak of $11 billion by March 2014. Some of the proceeds were used to buy infrastructure assets such as power plants. Other funds flowed into joint ventures with international partners, such as Abu Dhabi and Saudi Arabia. Allegedly a significant share of the funds raised were diverted to various insiders — with several hundred million dollars going to Malaysian prime minister Najib’s personal offshore bank accounts via various channels, including a small Swiss private bank. Mr. Najib denied wrongdoing, stating that some of the money was a personal gift from an unnamed Saudi donor, and that in any event most of the funds had been returned.

  • 10 Paddock (2016).

22The case was dropped in Malaysia but remained under investigation in Switzerland and the US, where in July 2016 the Department of Justice issued a civil complaint alleging that $3.5 billion was siphoned from 1MDB for the personal benefit of various officials. For its part Goldman Sachs was alleged to have violated the 1970 US Bank Secrecy Act, which required financial intermediaries to do proper due diligence on clients and prevent money laundering.10

23Whatever the 1MDB outcome, the lack of transparency and the level of corruption involved, the incremental risk faced ex post by debtholders, and the exposure of the Malaysian public to debt service that may not come close to being generated by the use of its capital, all highlight the reach of governance issues. Big-ticket infrastructure can be a scammers’ honeypot, undermining the financial economics of otherwise viable projects, creating negative value for those required to meet future debt service obligations, and elevating the risks to which investors are exposed.

24In the face of such challenges, some will argue that the US and other developed country governments’ efforts to finance infrastructure projects should focus closer to home and on more stable democratic states where commercial financing is more available, transparency and legal protections are better and where results will likely be superior and more predictable. The opposing view argues that government-supported infrastructure projects should include a mix of target countries and that overcoming governance obstacles may lead to more general reforms and hence to benefits beyond the project economics themselves.

25It may therefore be appropriate to support a mixed portfolio of infrastructure initiatives in target countries that starts with developed economies and extends to others undergoing political and social transitions. For the US, such a strategy could apply to countries such as Indonesia and Colombia, where a concerted effort to identify funding for infrastructure projects could support both economic and political development.

26The global commitments to a low-carbon economy and the UN SDGs also help prioritize and build political support for financing infrastructure in specific countries. When economic support for infrastructure is framed in a larger context it can encourage continued political reform and democratization.

27A second category of countries consists of key regional leaders, such as Kenya and Nigeria in Africa, although often these countries pose greater investment risks than more developed nations. In a country such as Nigeria, where weak government and widespread corruption have impeded economic progress for decades, the merging of political reform and economic support agendas is practical could prove to be wise.

28A third and still more challenging category consists of countries with extremely weak governance that are at critical junctures of their transitions (e.g., Myanmar). Often the window to effectuate change in such nations is very narrow, and active outside engagement is needed to prevent backsliding. In such countries, government efforts to support infrastructure financing must be accompanied by diplomatic strategies that underscore the critical need for fundamental political reforms. By clearly articulating this strategy and acknowledging the inevitable risks, governments such as the US, can fulfill salutatory commitments to improve infrastructure in less developed countries whilst working to promote democratic governance models rooted in human rights, transparency, and the rule of law.

29To appreciate the importance of the interaction between politics and economics in determining infrastructure outcomes, consider the case of electric power generation, the infrastructure subsector that arguably caused the most recent FDI bubble to turn out badly.

30After a wave of privatization and (partial) deregulation around the world, more than $400 billion in FDI in power generation took place between 1992 and 2002 and allegedly led to more than $100 billion in value destruction.

  • 11 Hill and Thomas (2005).

31From the US alone, 24 established utilities invested abroad during this period and, apart from two that exited at the crest of the investment wave, the remainder suffered an estimated–11% internal rate of return in the aggregate. Even worse, analysis of individual foreign investment projects undertaken by US utilities indicates that “high-status” firms (i.e., those with current or former directors or top managers of Fortune 500 firms on their boards) were particularly prone to large-scale FDI, and that neither equity analysts nor stock markets seemed to have much foresight about the viability of these projects.11

  • 12 Hausman, Hertner, and Wilkins (2008).

32None of this should be particularly surprising. According to the international business historian Mira Wilkins, the electric power sector was one of the first to be subject to counterstrikes by national governments via nationalization of FDI in early 20th century Venezuela and in Russia after the Bolshevik Revolution.12 Power generation is a prime example of a sector prone to governmental intervention and associated problems because of the business’s relatively large size, large sunk costs, environmental externalities, public perceptions of entitlement and systemic effects on the rest of the economy. Even without nationalization or expropriation, losses can be visited on foreign infrastructure investors through price controls and other regulatory measures.

33Of course, many of the same points about business characteristics apply to other infrastructure verticals. For these reasons, infrastructure finance involves — or should involve — astute consideration of political economy alongside project economics.


1 See Kahale (2011).

2 World Economic Outlook Database, April 2015, International Monetary Fund at

3 Equator Principles,

4 Ibid.

5 Ibid.


7 See, e.g.,,

8 Nixon, Ron. “Obama’s ‘Power Africa’ Project Is Off to a Sputtering Start”. New York Times, 21 July, 2015.

9 Ibid.

10 Paddock (2016).

11 Hill and Thomas (2005).

12 Hausman, Hertner, and Wilkins (2008).


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