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How guarantors are critical to bridging the infrastructure financing gap
The need for infrastructure financing throughout Africa and Asia is well-documented.
An often-cited statistic from the African Development Bank suggests that each year infrastructure finance in Africa is consistently between USD 68 and USD 108 billion short of the levels required to engender sustainable economic growth on the continent. A similar story is true in Asia, where USD 210 billion is required annually (from 2016 to 2030) for climate change-adjusted infrastructure investments.
Given the scale of the funding gap, it will take a variety of synergistic solutions to sustainably address this funding shortfall. One such solution, that could hasten the closing of this gap quicker than any other, is the increased use of guarantees to support infrastructure project financing. Due to the flexibility of guarantee products, the range of solutions they provide and the long-term benefits that stem from guarantee use, guarantee providers could be in a unique position to unlock much-needed infrastructure project financing.
Since 2005, GuarantCo, part of the Private Infrastructure Development Group (PIDG), has provided blended finance, local currency credit solutions to project finance infrastructure projects in lower income countries across Africa and Asia. In addition to building local capital markets, partnering with a variety of local and international stakeholders, (see Building Partnerships), the infrastructure projects financed have created a significant impact on the lives of local people.
Why guarantors are uniquely placed to accelerate infrastructure funding?
One of the major benefits of guarantees is the ability to unlock local currency (funding. By providing guarantees for the benefit of local banks and bond investors, project sponsors and project companies can attain some or all their debt finance in their local currency. This can have a range of benefits versus hard currency financing, both for borrowers and for local governments. For companies in emerging markets, local currency borrowing (supported by a guarantee) can ensure that debt service payments match their domestic revenues. Governments can also benefit, by structuring infrastructure transactions (where they act as off-taker) to have revenues that are fully or partially denominated in local currencies. This can reduce currency risk for governments and ease concerns for all parties around hard currency availability and convertibility.
In 2019, GuarantCo provided a guarantee to support a 15-year USD 13.5 million dual currency financing solution on behalf of Technaf Solartech Energy Limited (TSEL), the first and currently only operational utility-scale solar project in Bangladesh. Technaf is a project that benefits from a local currency tranche. Although the project’s PPA is linked to the USD: Taka exchange rate, it is not possible for the indexation mechanism to operate in “real time”, potentially causing cash flow issues in the case of currency fluctuations. By having some of its debt service obligations denominated in Taka, the project is better protected against cash flow variances as both revenues and local currency debt tranches are denominated in Taka.
Guarantees can also mitigate certain credit or liquidity issues that might otherwise inhibit financers. One of the most pervasive issues facing projects in emerging markets is that local currency funding providers (whether banks or bond investors) are unable to provide debt solutions of sufficient tenor. This can result in projects seeking hard currency debt, or in certain cases being abandoned if suitable financing cannot be attained.
Guarantee products can help to overcome tenor issues for infrastructure projects. On occasion, it may be enough that a simple partial credit guarantee lowers the risk of a project sufficiently, enabling banks or bond investors to fund the project for a longer tenor than otherwise attainable.
Recently however, guarantors have developed products specifically with the aim of enabling debt terms with longer tenors. In 2019, GuarantCo provided a XOF 14.2 billion (USD 23.8 million) Liquidity Extension Guarantee (LEG) to enable local commercial banks in Togo to provide a 14-year tenor loan to Kekeli Efficient Power to finance the construction of a 65MW power plant and related infrastructure in the port area of Lomé, the capital of Togo. The LEG, alongside Development Finance Institutions (DFI) debt tranches of 15 years, enhanced the longer tenor and made the project viable for the project developer, Eranove. The typical 7-year debt tenors available from local commercial banks in Togo would have been insufficient to adequately support this new infrastructure project.
Perhaps the most transformational impact of guarantors, and arguably the impact that sets guarantors apart from other DFIs, is the demonstration effect that guarantees can have on a country’s infrastructure financing ecosystem. Many DFIs will informally state that one of their objectives is to ‘put themselves out of business’ by helping to develop economies and raise living standards to the extent that external finance is no longer required. Guarantors might potentially bring about this post-DFI reality faster than any other type of institution – due to the demonstration effect that is implicit in guaranteed transactions.
Guarantee transactions enable local beneficiary finance institutions to experience new sectors and new structures with the safety net of an experienced guarantor. This safety net is not just in the form of the credit enhancing guarantee, but also in the form of guidance throughout the due diligence, documentation, and portfolio management stages of the project. GuarantCo has a well-established track record of partnering with key stakeholders in lower income countries to develop capital markets through education on the benefits of developing the local bond markets through guarantees supported by on-shore, and where possible off-shore investors, including through London Stock Exchange listings which GuarantCo has facilitated for a number of its clients including Acorn Holdings in January 2020.
As these local finance parties, whether they be institutional bond investors or banks, gain infrastructure finance experience and become better equipped to assess and manage project risk on their own, the need for guarantors can fall away. When domestic institutions are able to replicate good infrastructure finance practice in their local markets without credit enhancement, then the rate at which infrastructure can be deployed in emerging markets should increase exponentially. GuarantCo have begun to experience this effect, with several customers now being able to access debt from banks or capital markets in a way that was previously unavailable to them – even without guarantor support.
A blended future
Guarantors will never be the panacea for all issues facing infrastructure development in emerging economies, however the flexibility that guarantees provide means that these instruments can unlock new infrastructure projects in these markets. The benefits of a well-structured guarantee are numerous and include reducing foreign exchange mismatches through local currency debt tranches, providing for longer tenors and the “Demonstration Effect” as described above. A well-structured guarantee can complement many of the other methods of financing infrastructure and we fully expect that guarantors will be amongst the key players in accelerating project deployment and closing the infrastructure gap in emerging economies.