Pension Funds as a Source for Infrastructure Finance

20.06.2018 | 11:26 Home / News / Articles /
#Pension fund #Norayr Badasyan
Research Associate at Bauhaus University Weimar, Assistant Professor of Economics Norayr Badasyan has provided his article Pension Funds as a Source for Infrastructure Finance to Banks.am. You can read the full article below.

The existence of high quality infrastructure assets is considered to be the main point of departure for the economic development of countries aiming to deliver relevant level of both life quality and social output. The development of infrastructure and relevant institutional environment has always been one of the main priorities of any Government in order to achieve the needed social and economic outputs. From this perspective the Republic of Armenia is not an exception – many Governments considered the issues regarding the infrastructure development in their programs. The question on whether or not they succeeded in this aspect still remains open – actually it is not worth assessing both the existing quality of infrastructure assets in the country and the ongoing projects from the last few years. There are many examples from North-South Road Corridor to the Armenian Railways project (with regard to the latter it is rather difficult to understand the reason for providing subsidies paid from the public budget, when the project was unable deliver any social output).

The existence of relevant financial resources is considered to be one of the main prerequisites for infrastructure development. This is a problem not only in Armenia, but also for many developed countries. According to the international practice, in order to solve the issues related to the financial gap many countries try to attract private investors to the public provision of infrastructure known as public-private partnerships (PPPs).

Armenia has already gathered some experience in the field of PPPs – among such projects are, for example, the Zvartnots International Airport, Armenian Railways concession agreements, and drinking water sector is worth analyzing as a strong foundation for the future projects. The level of economic and social output of these projects still remains questionable. Even now the country has some project drafts that can be considered within the framework of the PPP models (e.g. the construction of tunnels within the North-South Road Corridor Project). Nevertheless, the attractiveness of the country for private investors in infrastructure still remains at a very low level. Such reasons as legal aspects or low level of PPP experience in the public sector can be considered the main failure factors. At the same time, the issue has to be also considered from the perspective of the private investors, who are interested in achieving a relevant level of income or, in other words, the creation of a PPP environment delivering relevant cash flows is a must.

From this point of view, it is of huge importance to discuss the financial and business models, which Armenia can offer to the private investors. The financial models define the main sources for infrastructure financing. The financing instruments are rather varied in the international practice and the correct choice of them is mainly dependent on the implementation period (brownfield or greenfield), the duration of financing and the essence of the contracts. The financing instruments can be classified into two main groups: equity and debt. Debt financing is regarded as the main instrument for infrastructure finance – approximately 60-90% of debt is generated from syndicated loans, bonds and mezzanine (mix of equity finance and debt).

The existence of business models is the next important indicator that defines the main sources of income (remuneration) and is the main prerequisite for achieving relevant return on investments within the existing frame of costs. Business models have a very broad range, but they are mainly divided into user and budget sources. For example, tolls as a direct user payment model or availability payment models (which are mainly regulated based on criteria agreed in the contracts) are used in the road sector (these are examples only of some models - in general there is a wide range of models existing for selection).

Up to now Armenia has achieved no single result for both the financing and business aspects in delivering a relevant PPP environment. The definition of possible combinations of business models can be achieved due to relevant legal solutions. The Government headed by Karen Karapetyan launched the process of drafting the conceptual and legal aspects of PPPs. Nevertheless, it is worth mentioning that the output of these documents was just a bundle of words reminding an introduction chapter of widely-known literature on PPP. In particular, the definition of PPPs by considering their financing, the project evaluation methodologies and mechanisms, the definition of possible business models according to each sector, as well as public sector comparator are completely missing in these papers.  

This means that these papers not only deliver zero output from the perspective of attracting private investments, but also do not give any clue to the possible social outputs to be delivered for society.

These issues can now be solved in the context of the current political environment. The legal bases which will involve both technical and methodological mechanisms can be provided with the support of international organizations (this support existed also for the Government of Karen Karapetyan, that did not deliver the needed results within the former political institutions).

The problem is more complicated from the perspective of financing models - today the Armenian banking system lacks the needed resources to finance infrastructure projects. Up to now all the PPP projects have been financed either from the international banks (given the high risk premium in Armenia these banks have been offering rather high interest rates) or from the international organizations. In this case, there is a need to model alternative solutions.

The introduction of pension funds has been a highly debated topic in Armenia for the last few days and perhaps this is a nice opportunity to discuss how these funds can serve for the financing of the infrastructure projects. In international practice infrastructure projects are very attractive for institutional investors such as pension funds. The interest of pension funds in these projects is mainly associated with duration hedging and diversification needs of the existing portfolios. Countries like Australia, Canada, Great Britain and Chile widely use pension funds as a source for infrastructure finance. This financing model is mainly used as a bond method, which can be paid during the whole lifecycle of the bonds or takes the mechanism of simple loans.

At the same time, the assessment of PPPs provides a strong ground for positive cash flows, which is another indicator for attracting pension funds, which, in their turn, have long-term responsibilities for pension payers. In this case, the existence and usage of the above-mentioned business models are of huge importance. For example, direct user payment mechanisms can be rather risky not only for private investors, but also for the pension funds (commercial risks related to gathering user fees), but availability payment mechanisms can ensure relevant income from public sources during the whole lifecycle of the projects.

This means that a well-developed PPP environment can be a strong foundation for the current Government not only to attract private investors in infrastructure, but also serve as a point of departure to start using pension funds to finance relevant projects. This can be achieved through the development of the relevant institutional and legal environment resulting in the successful and effective operation of the other adjacent links in the chain of the whole economy.
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