The case for privately funding solutions to SA’s infrastructure crisis

It is evident to South Africans that the nation’s infrastructure is starting to limit individual freedoms as well as economic growth and employment.

According to the National Development Plan, SA should be spending at least 30% of GDP by 2030 on infrastructure to promote inclusive economic growth. Unfortunately, spend has tracked well below this target since the early 1980s, and the country lags behind other, faster-growing economies in this metric.

Inadequate investment in critical infrastructure such as energy, rail, road, ports and housing has been a contributing factor to SA’s poor economic performance. Better infrastructure brings with it more inclusive growth and prosperity, as well as global competitiveness. SA sorely needs the latter.

Internationally SA is in the bottom quartile when it comes to gross fixed capital formation as a percentage of GDP, with the World Bank estimating it at 14% in 2020. This is just more than half the world average of 26%. The SA Institution of Civil Engineering has rated 17 out of 32 infrastructure segments as “at risk of failing” or “unfit for purpose”, indicating that the situation needs urgent and sustained attention for the benefit of the whole of society.

As upgrading our infrastructure takes on added urgency and environmental, social & governance considerations become important and prevalent, we are witnessing the convergence of developmental credit and commercial credit. Commercial credit investors have been waking up to the infrastructure opportunity and the asset class is becoming even more relevant.

However, SA is still some way behind other emerging markets, where there has been a clear shift towards providing debt to noncyclical businesses. The Organisation for Economic Co-operation & Development survey of large pension funds has estimated that the Government Employees Pension Fund has total exposure to infrastructure of just 1.2%, compared to Brazil’s Previ, which allocates 5.1%.

According to Willis Towers Watson, the seven largest markets for pension assets (Australia, Canada, Japan the Netherlands, Switzerland, the UK and the US) had an average allocation to private markets and other alternatives of just 7% in 2000, but this had risen to 26% of assets by 2020.

Now, however, the landscape for infrastructure investment in SA is improving and showing large-scale opportunity. Numerous government reforms are reshaping the investment landscape, including accelerated adoption of policy positions on renewable energy and independent power producers and a temporary ban on the scrap metal trade — one of the biggest drivers of localised blackouts and the effective collapse of SA’s rail networks.

This has coincided with the development of teams of infrastructure specialists with a wealth of private and public sector expertise, which combined with institutional-grade risk processes can cater to a deep savings pool eager to invest in infrastructure.

Catalytic energy

Equity provides the catalytic energy to get projects off the ground and is key to the transition. Infrastructure debt is becoming interesting for large allocators for a few reasons. Debt provides a large and attractive investment opportunity to deploy in size, typically accounting for 70%-90% of the funding required for projects.

As a debt investor the equity upside is forgone, but in its place the investment becomes more defensive and provides greater certainty, thanks to preferred rights to the underlying assets and cash flows.

Debt providers are able to exploit their position in the funding structure to encourage, influence and incentivise borrowers to design and operate their projects in an impactful and sustainable way.

Finally, the speed at which investment can take place is also fast-tracked given the protections afforded to debt holders, standardised terms and the growing opportunity set in both private and public markets.

SA has a clear and critical need to invest in infrastructure, both as a primary boost to activity and as a facilitator of growth for the wider economy. The government’s infrastructure investment plan provides ample opportunity for private investment, representing an investment value of more than R2.3-trillion in more than 200 projects in sectors from transport to water, energy, human settlements and digital communications.

Allocations to alternative investment in SA, including infrastructure, are up 21% in 25 years, and asset owners are starting to recognise the benefits offered by investment in infrastructure, such as predictable, steady cash flow with low volatility. The actual defaults and losses experienced in infrastructure debt are lower than the perceived risk, behaving more like a portfolio of investment-grade corporate bonds.

There is an enormous infrastructure funding need, which will require the involvement of commercial and developmental lenders. On the commercial side, banks alone will not be able to provide enough support and are looking for partners through asset owners and fund managers.

The convergence of commercial and developmental objectives comes at the perfect time: SA has a deep savings pool which, if channelled effectively and conservatively, would not only be able to achieve commercial returns but also curb unemployment and meaningfully tackle inequality and poverty.

Delivering on this substantial project of national importance will require a collective effort from the government, asset owners, asset consultants and the investment management industry.

• Micklem is co-head of SA & Africa fixed income, and Zulu investment specialist, at Ninety One