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Why cash for infrastructure projects should come from pension funds, not global lenders

By Mohamed Wehliye | May 27th 2014

By Mohamed Wehliye

During the opening of the second National Conference on Energy about three years ago, former President Mwai Kibaki directed the ministries of Finance and Energy to explore how pension funds can be used to invest in power and other infrastructure projects. This would help surmount challenges in securing capital from international financiers.

Unfortunately, to date, not much has come out of that directive, despite the fact that there is still a serious funding gap for economic infrastructure such as energy, roads and ports.

The majority of infrastructure construction, maintenance and upgrade work in the country is currently publicly funded. But with the Government fiscally constrained, there are question marks over whether the public sector can be expected to continue dominating infrastructure investment in the coming years.

Investment needs

It is important, therefore, that the Government taps into pensions to offset growing infrastructure investment needs for the country to meet some of its Vision 2030 targets.

Kenya currently invests less than 10 per cent of its gross domestic product in local infrastructure. But the country demands infrastructure investments more than twice the current levels if it is to maintain sustained long-term growth.

The country’s infrastructure spending needs are high in absolute terms — and even more so relative to GDP. Meeting infrastructure targets is estimated to cost more than Sh400 billion per year.

The Government does not have the resources to bridge this gap and would usually have to borrow this money.

But borrowing all this money could endanger the fiscal stability of the country, and thus this gap needs to be funded from elsewhere. But where?

Commercial banks, which are the traditional source of finance in Kenya, face difficulties in lending to infrastructure projects that have long payback periods — they mostly lend short-term funds, which creates an asset liability mismatch.

Most banks are also subject to Central Bank of Kenya sectoral limits. Indeed, there is currently limited capacity for them to lend more to the infrastructure sector.

Furthermore, tighter regulations for banks means they are facing the prospect of needing to increase the amount of capital they set aside to support project finance activities.

For these reasons, the opportunities and need for alternative financing sources have never been stronger. That is where pension funds come in.

The Government should look to attract pension funds as a key funding source for the infrastructure sector. Using this money to fund infrastructure makes a lot of sense for a couple of reasons.

Retirement savings

First, pension funds, with their need for long-term investments to match their long-term liabilities, are an obvious substitute source for such finance. They require longevity of the assets and their returns.

Second, the use of retirement savings to “invest in the future” of the country makes a lot of sense and is a good selling point, especially for public sector pension funds such as the National Social Security Fund (NSSF).

The new NSSF Act is projected to increase pension fund contributions from the current Sh10 billion to as much as Sh100 billion annually in the next few years. This is a lot of money that would need to be invested and can be used to transform this nation economically.

As some of the largest investors in the country, pension funds should be encouraged to allocate cash for investments in infrastructure projects.

Pension funds can, in fact, be the saviours of the economy and stimulate growth through an infrastructure-investing revolution. This has been quite a trend in recent years in many other countries, and there is no reason Kenya should not follow suit.

Over the past decade, pension funds in other countries have moved significantly into infrastructure as part of their “alternative investment” category. Long-lived assets such as toll roads, airports and electric utilities are a good match for the investment needs of such funds — long-term, steady growth in revenues based on providing an essential public service.

One of the key considerations, however, is how the pension funds should invest in infrastructure projects.

There are two options: indirect or direct investments.

Direct ownership

The first includes the purchase of stocks and bonds issued by privatised infrastructure companies, such as electricity, transport and telecommunications firms, and/or purchase of Government bonds that are used to finance infrastructure.

The second is investing directly in infrastructure either through direct ownership of the projects or through the sponsorship of dedicated infrastructure debt funds.

Local pension funds such as NSSF already indirectly finance public sector infrastructure by investing in bonds issued by the Government relating to infrastructure projects or activities. The great majority of pension funds hold Government and infrastructure bonds through their normal portfolios.

In some way, pension funds are, therefore, already financing infrastructure investment in the country, although repayment and risk still rests with the Government.

Pension funds also hold stocks of companies such as KenGen and other utility firms, and thus provide the necessary capital for these companies to invest in infrastructure.

The current indirect investment in infrastructure is, however, not intentional. That is, the investment is not made with infrastructure in mind, but is viewed like any other investment in stocks and bonds.

For pension funds, especially the big ones like NSSF, to have a bigger impact on economic development and also secure better returns that are less volatile for their trustees, they must target and invest directly in infrastructure.

They can make direct controlling investments, in the manner of private equity investments, in companies operating in infrastructure where the fund becomes the main owner, or one of the main owners, of such companies.

This can be done by buying stakes in traditional utility companies or by becoming one of the major shareholders.

They could also invest in infrastructure through debt by sponsoring or co-sponsoring debt funds that will invest only in infrastructure.

The Government, with the help of domestic pension funds, could do what the Indian government did by promoting the setting up of Infrastructure Debt Fund (IDFs) that will raise capital required to finance infrastructure projects.

Pension funds could be asked to sponsor or co-sponsor the IDFs. Such a fund should then be restricted to cover roads, railways, ports, airports and power projects that typically provide for a compulsory buy-out by the government. 

An IDF can be set up either as a trust regulated by the capital market regulator, CMA, or as non-banking financial institutions (NBFI) regulated by the CBK.

Credit risk

While the credit risk associated with the infrastructure project will be borne by the company if the IDF is set up as an NBFC, the risk will have to be borne by the investors if the IDF is set up as a trust.

A trust-based IDF would normally be a mutual fund that would issue units, while a company-based IDF would normally be a form of NBFC that would issue bonds.

The development of proper infrastructure is vital for the economic growth of any country. The Government cannot do it all. To meet the gap in the funding requirement of the sector, it is imperative to promote public private partnerships.

President Uhuru Kenyatta’s administration should follow up on Mr Kibaki’s call for pension funds to finance infrastructure projects as a matter that requires immediate action in terms of Government policy. It should also put in place the necessary regulatory reforms required to achieve the same.

The writer is senior vice president, financial risk management, Riyad Bank, Saudi Arabia.

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