Infrastructure finance : issues, institutions, and policies

The author analyzes the distinctive features of formal and informal financing of infrastructure and the principal issues policymakers must address in dealing with infrastructure finance: its adequacy in competitive financial systems, its budgetary vulnerability, the rationale for foreign finance, the role of user charges and taxes, the pros and cons of earmarking taxes, the institutional framework for infrastructure finance, the role of municipal finance, different approaches to the private financing of infrastructure (such as franchises, leases, management contracts, and consumer cooperatives), the critical role of contractor finance, and informal financing of infrastructure. The author concludes the following points. Not only the amount of funds but the regularity of their flow is central to maintaining infrastructure. But infrastructure must compete on a level playing field with other sectors. Any essential (but not open-ended) subsidies for maintaining universal minimum standards of service are best carried on the government budget, subject to periodic review. Institutional reform is needed to rationalize the division of resources and responsibilities among all layers of government and to provide mechanisms for insulating infrastructure finance from budgetary and other pressures. Such mechanisms include earmarking, privatization, and objective criteria for sharing value-added tax and other national tax revenue. Most developing countries do not have a national infrastructure agency to fund and coordinate technical assistance for infrastructure projects. The author makes a case for an apex financial entity in charge of municipal financial intermediaries for infrastructure, pointing to the instructive experience of intermediaries in Colombia and Jordan. One responsibility of such an agency would be to determine the necessary import content (for equipment, technical, and managerial expertise) of infrastructure finance, to prevent overborrowing. Privatization of infrastructure should be viewed as implicit earmarking, but official regulation of public utility prices should allow private utilities to generate retained earnings (to encourage self-financing) and should allow adjustments for inflation and exchange rate fluctuations. Infrastructure policy should allow for cost recovery through user charges as well as for tax revenues, especially through municipal taxes, since even the viability of loan finance depends on an efficient tax effort. While infrastructure finance is important, it is not always the decisive constraint, judging from the operating losses of even adequately funded infrastructure projects.