Unlocking private sector financing in emerging markets infrastructure

Three levers can help governments and development finance institutions increase private sector financing for infrastructure, narrowing some of the sector’s largest investment gaps.

Developing countries will need to invest more than $2 trillion a year in infrastructure just to keep pace with projected GDP growth over the next 15 years yet many of them face challenges in mobilizing the resources to finance this investment. To close the gap, governments in these countries, together with their partners in development finance institutions (DFIs), will need to unlock private sector infrastructure financing at scale. As we show in this article, solutions are in sight: there are innovative approaches available that could trigger an exponential increase in private financing.

In this article we present three kinds of initiatives and innovations that governments and DFIs can consider to establish infrastructure as an investible asset class. First, they can increase availability of funds (liquidity) from both domestic and international providers of capital. Second, they can increase the scale of investment by bundling together individual projects and providing a portfolio of products in which such providers of capital can invest. Third, they can address the governance and capability gaps that often hinder private-sector investment.

These ideas and insights are based on interviews with leaders across commercial banks, private sector investors, infrastructure developers and operators, and policy makers in emerging markets. This article also builds on previous McKinsey research on approaches to private-sector infrastructure financing, setting out several real world case examples of how those approaches can be tailored and applied to deliver results in emerging markets

The challenge and opportunity of infrastructure development in emerging economies

To put the challenge of infrastructure development in emerging economies into perspective, consider this statistic: in the African nation of Mali, a typical household uses less electricity in a year than a Londoner uses to boil a kettle each day. Across sub-Saharan Africa, nearly 600 million people lack access to electricity altogether with the result that whole communities literally live half their lives in the dark.

McKinsey estimates that, based on benchmark levels of spending, Africa’s annual investment in power infrastructure will need to rise from $33 billion in 2015 to around $55 billion in 2025. Over the same period, annual investment in transport infrastructure will need to increase from $20 billion in 2015 to around $45 billion in 2025. Major additional investment will also be needed in water and telecoms infrastructure.

The requirement for additional, large-scale infrastructure investment is just as acute in other developing regions and will only increase over time. The McKinsey Global Institute (MGI) forecasts that the world will need to invest an average of $3.7 trillion in roads, railways, ports, airports, power, water, and telecoms every year through 2035 to keep pace with projected GDP growth. Emerging economies will account for nearly two-thirds of that investment need and the financing they require could increase even further to meet the United Nations’ sustainable development goals.

Yet many developing countries have significant gaps between their current spending commitments and estimated need. New analysis by MGI shows that some of the biggest spending gaps are in Indonesia and Mexico, while Brazil, India, Saudi Arabia, and South Africa also face significant gaps. On the other hand, China has invested sufficiently to exceed its forecast infrastructure requirement and will arguably need to spend less as a share of GDP than it has in the past.

Although governments in many emerging economies have made considerable progress in recent decades to increase infrastructure investment, they increasingly face budgetary constraints in sustaining that investment from public sources. Overall levels of public-sector debt in emerging economies stand at record levels, and many countries have seen budget deficits increase in recent years. That makes it imperative that governments unlock greater private-sector infrastructure investment and financing, both foreign and domestic. Looking ahead, that imperative will become all the more urgent as governments seek to meet the needs of a growing population in many developing countries and address critical infrastructure gaps to enable broader economic development.

Ensuring scale through a compelling go-to-market and ‘product portfolio’ approach for investors

In addition to the interventions set out above, our analysis of case studies across the world finds that a portfolio approach to offering infrastructure investment “products” that meet the risk return targets of potential investors can be quite successful. Case studies show this works well when governments adopt an active go-to-market strategy to bring those products to the attention of investors. The portfolio approach to infrastructure financing can be adopted at different levels of devolution whether at federal, provincial, state, district, or municipal level.

The portfolio approach represents an important innovation over traditional investment-attraction approaches. The investible financial instruments it creates derive their cash flows from multiple infrastructure projects potentially from several different asset classes rather than a single infrastructure project. Governments taking a portfolio approach create a menu of tradable instruments to attract different sets of investors. For example, they go beyond simply offering units in an infrastructure fund that may be attractive for financial investors. Instead, they offer variant products, such as a controlling equity stake in infrastructure platforms, which may be more attractive to strategic investors.

A portfolio approach offers several benefits to governments. For one thing, it enables investments from a broader group of investors, thereby opening up access to a larger pool of capital. Moreover, it allows financing of commercially unviable infrastructure projects by bundling them with commercially viable projects. This approach also facilitates financing of Greenfield projects by bundling them with brownfield projects. It allows for centralization of infrastructure planning, which in turn leads to optimal prioritization of projects.

For a useful example of a portfolio approach, we return to India. The Securities and Exchange Board of India is promoting the use of Infrastructure Investment Trusts (InvITs), publicly listed infrastructure-investment funds that invest in portfolios of infrastructure projects. There are two public listed InvITs Sterlite Power’s India Grid Trust and IRB Infrastructure Developers’ IRB InvIT fund. The InvITs allow individuals and firms to invest relatively small amounts of capital into infrastructure projects in return for an income proportionate to their investment.

McKinsey