Infrastructure development has been considered as a major driver of growth and prosperity in any socioeconomic context. The growth in infrastructure developments has a direct relationship with the growth in GDP, employment generation and poverty reduction. Infra-structures development helps ensure economic development of the country and improve living standard of the people through sustainable and environment-friendly investments. Good infrastructure not only increases productivity but also reduces the cost of production. The creation and expansion of good infrastructure stimulate investment in real sector. The role of infrastructure in development remains undisputable. Energy, Water, Irrigation, Sanitation and Transport are important to reach a minimum standard of living. Infrastructure touches every aspect of growth and shows the future of the country.
Infrastructure Gap – Nepalese Context
Many studies and reports have shown huge gap in infrastructure developments of Nepal. According to World Bank report, the country requires to invest around 10-12% of GDP in infrastructure development to meet double digit growth in GDP and SDG goals by 2030 BS. At present, in total, around 5% of GDP is mobilized through government expenditure and financial institutions in infrastructure development resulting in still above 50% gap (around 5-7%) annually. The nominal GDP of Nepal is around 32 billion USD, it means investment in infrastructure gap seems around 3.2 billion USD to 3.8 billion USD per annum.
For many years, Nepal has set aside less than 3% of its GDP for Infrastructure. For Nepal to achieve double digit growth, the investment in Infrastructure needs to be increased sharply by 8-12% of GDP or as much as 3.5 Billion USD annually. This gap can be fulfilled either by increasing the investment by the Government of Nepal or attracting FDI and private capital for investment in infrastructure. Recently, governments have taken many initiatives to encourage private investments in infrastructure to bridge the infrastructure gap. Private sector participation can bring not only additional capital but also end-user benefits from a more competitive environment in the form of lower costs along with the use of the private sector’s technological and managerial competences in the public interest.
We have experienced that government alone cannot build infrastructure due to constraints in funding, technology, capacity and bureaucratic hurdles. Past experiences also show that government funded large projects have suffered from cost overrun, time overrun in implementation and often have been a political dilemma effecting the infrastructure development decisions. This suggests that involvement of private sector either by innovations in PPP model (VGF/ HAM) or BOOT or any other form of association, as has been the case in the global market, would pave a way out for strengthening the infra space development. Hence the investing in infrastructure has become a major challenge in Nepal due to lack of long-term capital.
Unlocking the Gap – Role of Institutional Investors (Pension Fund and Life Insurances)
The role of long-term fund holders like; pension fund and life insurance fund are very important for unlocking infrastructure investment gap in any country. Normally this type of fund holders have long term liabilities around 15 to 20 years and their funds are being invested in short term assets, say for 2-5 years fixed income placement. A huge Assets and Liabilities mismatch is the critical factor for them if we analyze their balance sheet deeply. In the context of Nepal, Employee Provident Fund (EPF), Citizen Investment Trust (CIT), Social Security Fund (SSF), Life Insurance Companies, Re-insurance company, Army Welfare Fund, Policy Welfare Fund and many other institutional investors having billions of rupees, which are the major sources for long term investment especially in infrastructure development due to their liabilities, are of long-term nature.
Those types of fund can meet the infrastructure investment gap to some extent. However, to fulfill the infra gap as we mentioned above in real term, we have to bring foreign investment anyhow. Institutional investors have traditionally invested in infrastructure through listed companies and fixed income instruments. Only in the last two decades have investors started to recognize infrastructure as a distinct asset class. Since listed infrastructure tends to move in line with broader market trends, it is a commonly held view that investing in unlisted infrastructure, although illiquid, can be beneficial to ensure proper diversification. In principle, the long-term investment horizon of pension funds, life insurance companies and other institutional investors should make them natural investors in less liquid, long-term assets such as infrastructure, often included in the alternative investments part of the portfolios.
Infrastructure investments are attractive to institutional investors such as pension funds as they can assist with liability driven investments and provide duration hedging. Investing in infrastructure shall enable these types of entities to match their asset and liability with less pricing risk as the fixed pricing is generally preferred in infrastructure financing. These investments are expected to generate attractive yields in excess of those obtained in the fixedincome market (like investment in fixed deposits and other debt instruments) but with potentially higher volatility. Presently, the pension funds and insurance companies are mostly investing in fixed deposits of the banks with lesser maturity period which is naturally exposing them to re-pricing risks and requirement of the active portfolio management which is not the core competencies of these types of institutions.
The accepted practice has to be locking the asset tenure with liability in long-terms. Infrastructure projects are long-term investments that could match the long duration of pension/insurance liabilities. In addition, infrastructure assets linked to inflation could hedge pension/insurance funds’ liability sensibility to increasing inflation. Despite increased interest from investors in infrastructure, there is little evidence on the actual investment ultimately flowing to the sector. National statistical agencies do not currently collect separate data on these investments which has resulted in narrowed information view to policy makers’ attention on Institutional investors (such as pension funds, insurance companies and sovereign wealth funds) investment in infrastructure.
Way forward
Although it is growing gradually, institutional investment (especially from pension funds and insurance companies) in infrastructure is still limited. Clearly, different countries are having different experiences/ policies/ practices of on-boarding institutional investors (especially pension funds and insurance companies) in infrastructure. Learning from best practices, following can be considered as way forward to crowding-in investment in infrastructure from these sectors:
– The broad range of indirect instruments (Equity Funds, Sectoral Bonds, Debt Funds, Municipal Bonds) can be issued by PPP projects / BFIs to route the capital from pension funds and insurance companies.
– The country has now specialized institutions like: Investment Board, Hydroelectricity Investment and Development Company Ltd. (HIDCL), Infrastructure Developments Banks. Leveraging the policy to mandate pension funds, insurance companies to investment in deposit and debt instruments issued by these institutions and counting those investment as investment in priority sector shall create big head room to route large quantum of capital in infrastructure.
– The more and more government bonds have to be earmarked to infrastructure where insurance companies and pension fund have to invest in given percentage.
– Incentive to commercial funds (mainly in the form of private equity funds, Debt fund, mutual funds or listed investment trusts) shall help funds to provide sweeteners to pension funds/insurance companies over the traditional investment instruments.
– Some funds are sponsored by governments, national agencies, or MDBs, and often, there is a combined public and private involvement.
– The main focus of infrastructure investing has been on the equity side although the interest in debt is growing. The co-investing from government, pension fund, insurance companies to supply both equity and debt in regulated greenfield and brownfield PPP projects like energy will largely unlock the supply of capital. Monetizing and refinancing operating assets in regulated sectors can be stepping stone to re-supply the existing locked capital from BFIs into greenfield projects.
At last we can say that infrastructure investment is long term investment that seems to be a natural fit with the long-term liabilities of many pension and life insurance funds. Hence pension fund and life insurance companies must invest their funds in Infra basket to match their assets and liabilities and for development of infrastructure projects in the country for their own benefits as well as the country’s economic growth and more employment generation.
(DCEO, Nepal Infrastructure Bank)
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