Financing Infrastructure In Developing Countries



Earlier Approach-

For low-income countries, investment in infrastructure have alluring benefits as well as doubting costs.  Where transportation, communication and power generation are inadequate, increased supply can do much to boast the productivity and growth.  But where income and productivity are depressed by inadequate infrastructure, the financial resources needed to under write investment are difficult to mobilize.

Because the lack of infrastructure limits investment and the low income countries can find them selves in low-level equilibrium trap which it is difficult to escape.

Two potential escape routs – governments subsidies and foreign borrowing – are available in principle.  If infrastructure is critical for raising productivity and profitability elsewhere in the economy but those who finance the project cannot capture sufficient revenue to repay the cost, the classic efficiency argument for subsidies applies: that subsidy closes the gap private an social benefit will prevent the relevant form of infrastructure from been under supplied.  And even when the returns can be appropriated, investment may still not be attractive if high interest rate makes domestic funds costly.  Investors may than seek finance abroad, where it is cheap.  Not surprisingly, government guarantees and foreign borrowing are prominent features of infrastructure finance in many developing countries.

Barry Eichengreen (1995) argued that costly “White elephant “ subsidies by government have underscored doubts about the efficiency of public finance and the debt-servicing difficulties of developing countries have raise question about the efficacy of foreign borrowing.  Both observation encourages an interest in proposal to commercialize an privatize infrastructure projects and to fund them by promoting the development of financial market.



Economic history reveals that it is possible to finance infrastructure through limited partnership of local residents, though the raising of the requisite capital.  Friends and associates vested their confidence in individual finances with reputation for honest dealing who singled their commitment by putting their own funds at risk.  As Johnson and supple (1967), put it “investment tended to be cumulative social process in an environment lacking an impersonal, national money market”.  Local farmers, bankers, merchants landowners, contractors, and manufactures subscribed to the majority of the infrastructure share.

Underdeveloped market could however impede efforts to raise local finance.  Farmers who had no cash paid their subscription in the form of pork and eggs to feed the construction gangs.  Others subscribed through labour and materials.



This model of local finance was difficult to generalize because the capital requirement of early construction were more modest than those of subsequent projects.  Elsewhere it was necessary to seek external finance (foreign finance).  Such funds were not a substitute for local finance, local investors still had to subscribe to indicate their willingness to put their money where their mouth were. If locals put up funds, external investors could be confident that those in the best position to asses the needs of the infrastructure (project) and monitor it progress and the actions its promoters would do so.

Foreign financing entailed the intermediation of specialized institutions that had grown up in the principal oversea financial centers to deal with information problems.  Issue houses, private banks, bills brokers, and financial investment companies.  They specialized in recommending high-quality foreign bonds that were well known and long established or were backed by the credit to a state government.  To show that they had confidence in the project, these firms often bought the some bonds for their own portfolio.  However, the port folio of project to be financed grew riskier as interest rate rose.  Promoter had an incentive to take on excessive debt because they stood to make huge profits if the venture succeeded but could lose no more than their equity state if it failed.

Contemporaries consequently complained that many worth while investment project were unable to raise external funds, and this inability to obtain credit created an obvious argument for government interventions.



”When great schemes of public utility are brought before the country, it is natural that the government should extend its aid to such enterprises (macpherson, 1955).  In the case of investment in infrastructure, government aid came in there forms: interest guarantees on bonded debt, subsidies, and aid in-kind (often financed by a bond issue designated for the purpose or by earmark revenues).

However, the classic efficiency argument for subsidization rests on externalities: that a project’s social returns exceed its private returns.  This is the bases for any government subsidized projects.  Government guarantees were particularly important in attracting foreign information on projects were considered impossible to finance (macpherson, 1955).  Althoudh the guarantees helped project promoters to surmount credit rationing, they also weakened the incentive for investors tohold management accountable.  Invetors no longer stood to loose or to lose as much.  If promotes and their confederates diverted resources from productive suses, because the government promised to bail the amount.  In the extreme, this might encourage the construction where there was no hope of generating sufficient traffic to service the debt that was incurred.  More generally, it gave promoters an incentive to negotiate sweetheart deals, with contractors that made it possible to channel cash into their own accounts.

Thus, the potential for looting was created, bondholders whose rate of retun guaranteed by the government, had little incentive to expand resources to determine whether promoters had identified a project capable of generating an adequate note revenue stream or whether contractors were siphoning off the projects resources.

This types of fraud is consistent with the predictions of the Akerlof-Romer Model-that government guarantees extended to relax credit –rationing constraints weaken the effectiveness of corporate control if they are not accompanied by effectiveness public sector oversight and regulation.

Curine (1957) Summarized the situation: “As the government would guarantee were tempted to one-half the costs for the road, to effectively force the government to assume responsibility for more than its proper share of the actual expenditure, and to reduce the real value of the assets against which, under the guarantee act, the government held a first mortgage.  Land grants were attractive on several counts.  First, because the prairies in both countries were unsettle and the land remained in government hands, such grant obviated problems of assembling parcels for right-of ways.  Second, a land grant tended to confront less political resistance that did government financial subsidies and interest guarantees, which implied that imposition of distort nary taxes.  Third, compared with other bonds, those backed by montages on land had minimal bankruptcy costs, the interest and principal due to the primary creditors could be paid off, at east in part, through the sales of the land if the project failed.



Severe under-investment is plainly visible in Nigeria’s road, water systems, drains, and other infrastructure.  Because of fragmented accounting and paucity of record/ data, it is difficult to know much is being spent by the federal, state and local governments on urban infrastructure.  Large amounts of urban infrastructure and services are provided under self-help approach.

Nigeria’s future investment requirements for urban infrastructure depends on many uncertain assumptions about economic trends, population growth, price and design standards, undoubtedly, through the amount of investment needed greatly exceeds what Nigeria, with a GNP per capital of US $ 280 (1994), will be able to afford in the foreseeable future. It was estimated in 1987, by the world bank, that about US $ 800 million would be required only to rehabilitate existing urban and semi urban water supply systems (the world bank, 1997).

A limited amount of funding for urban infrastructure is being provided by multilateral agencies such as the world bank and African development bank.  The total value of world bank loan/credit commitment for urban infrastructure projects (including water supply) between 1987 an d1995 was US $878 million.  Commitments by the African development bank over the same period totaled US $884 million multilateral financing flows have been and probably will remain small relative to the nation’s needs.

Lack of funds is not a root cause of poor infrastructure and services.  It is a symptom of more fundamental problems.  These include instability lack of confidence, distorted economic policies, and difficulties of governance.  The mobilization of public and private funds for urban infrastructure depends in the long run, on the alleviation of these problems.

Everyone in Nigeria feels the effects of inadequate operation and maintenance of urban services road surfaces become covered with potholes.  Water pipes break.  Drains fill with silt and rubbish.  Waste collection trucks cannot run due to lack of lubricants and spare parts.  Buses break down as ply their routes schools collapsed due to dilapidated structures.  Hospital shut down due to “out-of-stock” syndrome and excessive industrial actions embarked by the workers.

More than 70% of all public sector revenues are collected by the federal government.  At the same time state and local governments have the legal responsibility for providing almost all infrastructure and social services (including public health and education).  As the allocation of revenue generating powers in unlikely to change in the medium term, states and local governments will continue functions.

There has been a continuing debate in Nigeria about whether the states and local governments are receiving enough money from the federation account to provide the public services for which they are responsible.  It is argued that the current formula for sharing out the federation account (federal 42.5% states 30% local government 20% and special funds 7.5%) guarantees that state and locally provided services will be inadequate.

This argument ignores the enormous untapped potential of internal revenue mobilization by states and local governments regardless of whether or not it makes sense to change the federation account sharing formula, states and local governments have the obligation to collect more revenues from users fees and their own taxes.

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