Presented by slEconomics at the Africa Infrastructure Rollout Conference 2013, Sandton South Africa

1. slEconomics
Economics Consulting in Utilities and Infrastructure
Africa Infrastructure Rollout Conference 2013
Sandton, South Africa
19 November 2013
Contact:
Dr Stephen Labson
slabson@sleconomics.com
Contact:
Mtutu Benya
mbenya@sleconomics.com
www.sleconomics.com
www.sleconomics.com

2. 
Role of infrastructure development

Pubic sector infrastructure investment

Funding options

Regulatory and policy challenges
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3. 
The infrastructure challenge has been escalated to a priority agenda due to increased demand for
service delivery and the need to grow the economy in tandem with population growth;

These challenges are not unique to RSA alone but they are a continental problem and as part of the
SADC region together is grappling to achieve economic growth, efficiencies and effectiveness.
Macroeconomic drivers
• The South African economy has averaged about 3
per cent growth a year since 2009.
• GDP growth was roughly 2.5 per cent in 2011/13,
a GDP growth of 5% would meet the current
needs of service delivery.
• There was a modest recovery in job creation
during 2011/12 but the unemployment rate
remains high at 23.9 per cent.
• The national government’s budget deficit for
2011/12 was 5,2 per cent of GDP and public
sector borrowing requirements at 7.1% GDP.
• Total (gross) loan debt was R1.1 trillion as at 31
December 2011, equivalent to 38.6% of GDP.
Infrastructure developments
• Budgeted public sector infrastructure spending of
roughly R845 billion is planned for from 2012/13 to
2014/15 of which R300 billion is targeted to the
energy sector and R262 billion in transport.
• To 2020 R3.2 trillion is expected to be invested in
43 large scale projects in areas such as:
• Adding 11,719 MW of power generation capacity
and 6596 km of high voltage transmission lines.
• Replacing 6405 km of rail freight, coal and ore
lines increasing rail network capacity by 149.7
million tons, and procuring 1317 new locomotives
and 25,000 new wagons.
• A R100 billion port expansion at Durban.
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4. 
Energy and Transport represent the bulk of South Africa’s investment in infrastructure, which is now a
significant proportion of total Government borrowings.
Government
borrowings
(R billion)
2013/14
2014/15
213,9
235,1
225,3
200,8
General
government
borrowing
145,7
158,2
147,8
126,7
Non-financial
public
enterprises
slEconomics Pty Ltd
2012/13
Public sector
borrowing
requirement
Source: South African Reserve Bank, Quarterly Bulletin March 2012
2011/12
68,2
75,9
77,6
74,1
(NB 1 Rand = AUD$ 8.41 as of 19/06/12)
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5. 
South Africa’s public sector infrastructure programme is expected to be funded from a range
of sources
Funding options
Source of funds utilised
• A combination of internally generated surpluses
and borrowings from capital markets by public
enterprises .
• Enterprises such as Eskom, Transnet, SANRAL,
and ACSA have made use of corporate bond
markets and short term commercial paper
facilities.
• Direct private sector investment such as the
Department of Energy’s 3,625MW renewables
Independent Power Producer Procurement
Programme currently underway.
• Mixed shareholding, such as that for Telkom
South Africa (Government retaining 38%
shareholding) and Airports Company South
Africa (Government retaining roughly 75% of
shareholding).
• Direct government contributions for entities
such as Passenger Rail Agency South Africa
(PRASA) and Eskom
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• Multi-lateral institutions such as the African
Development Bank; Development Bank of
Southern Africa; the World Bank; and the
French Development Agency
• Local institutions such as the Industrial
Development
Corporation
and
Public
Investment Corporation
• Sovereign funds (e.g. China and the Middle
East)
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6. 
Four broad components for funding public sector infrastructure projects

Debt financing - which can be sourced directly by the public enterprise where a stand
alone corporate entity has been established and/or by government through loans or loan
guarantees.

Equity injection - in which government as shareholder can provide cash injections to the
sector.

Government grants - whereby government as a policy decision allocates its resources in
the development of public works.

Regulated revenue and tariffs - which (outside of government grants) are ultimately
relied on to repay capital investment over the longer term.
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7. 
Debt financing in its various forms represents a significant component of infrastructure funding
due to the large capital requirements associated with capacity augmentation, the long term
nature of the physical assets, and the (often) stable source of regulated revenue

The availability and cost of funds is of course currently a critical issue with global capital markets
under strain limiting the availability of funds and making borrowings relatively more expensive
than compared to recent history.

World Bank Group reported that the debt/equity ratios in infrastructure projects reaching closure
changed from around 85/15 in 2005–07 to 73/27 in 2008. 14 Projects reaching financial closure in
early 2009 had debt/equity ratios of around 70/30.

Both availability and cost of borrowings is directly dependent on the credit worthiness of the
entity acquiring financing.
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8. Theory
And practice

Government guarantees can support the
amount of borrowings a state owned
corporation is able to source and the yield
required by debt providers.

However, a government’s cost of capital is
not independent on the level of support
provided to state owned enterprises in the
form of direct guarantees and/or associated
contingent liabilities.

For example, where government is
either legally obligated to service the
debt of a wholly-owned entity in the
case of default – or there is a strong
expectation of the same by debt
providers – the availability of funds is
reduced and the cost is greater than it
otherwise would have been
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•
The relevance of contingent liabilities is illustrated by
recent actions pertaining to SANRAL, whereby in an
affidavit to the Constitutional Court of South Africa
(21 May 2012) the Minister for Finance stated that if
SANRAL was to default on its outstanding loans
there would be:
•
“considerable risk of negative consequences for
the South African Government's capacity to raise
funds from capital markets. The credit rating of
SANRAL in the money markets will in the first
instance be severely affected , since it raises
money by issuing bonds. The credit rating of
South Africa would also be impacted on
negatively, since SANRAL is a wholly
government-owned. entity and its standing
affects the Government’s standing.” (emphasis
added)
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9. 
Direct equity injections (as opposed to pure government grants), sovereign funds and similar investment
vehicles have been used in a number of counties in providing equity capital to infrastructure projects.

Generally speaking, the provision of equity capital implies a future stream of dividends to shareholder,
and is best suited to sectors/projects where there is the expectation of commercial return on investment.
Return on investment for public enterprises

The cost of capital is broadly defined* as “the expected rate of return on alternative investments of
equivalent risk. It is the rate of return that investors require based on the risk-return alternatives
available in competitive capital markets” and there is strong argument to be made that this
fundamental relationship is equally well applied to competitive capital markets and public
enterprises. i.e.



In both market and regulatory environments scarce capital must be allocated to various
investment options.
The underlying opportunity cost of capital employed to each investment option (or business)
is dependent on the risk characteristics of that investment (business).
This is the case for privately held businesses and public enterprises. For this reason, the
commercial rate of return provided for in the capital markets may be seen as the appropriate
conceptual starting point in which to assess the appropriate rate of return on investment in
public infrastructure.
* Brattle Group, “The Cost Of Capital For The Dampier To Bunbury Natural Gas Pipeline” October 1999
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10. 
While government grants often play an important role in infrastructure development, scarce resources
must be allocated to meet a range of social objectives.

This can constrain a government’s ability to build major infrastructure projects by way of grants from the
fiscus. In this sense government grants may not provide a sustainable way in which to fund public
infrastructure.

Broadly speaking, government grants as related to public infrastructure projects are often funded is by
way of:
 General taxation — the general tax base which revenue is sourced and the expenditure of the
revenue raised.
 General purpose public borrowing — funds raised by issuing debt securities (e.g. government
bonds) on domestic or international markets.
 Hypothecated taxes — taxation revenue (usually from specific taxes or levies) directly assigned or
‘earmarked’ to fund designated expenditures.
 Intergovernmental transfers - the transfer of finances between different levels of government (e.g.
from national to state or municipal governments).
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11. 
Public Private Partnerships (PPP) as developed in the UK in the early 1990s under its Private
Finance Initiative (PFI) are employed extensively in the delivery of public services and
building of infrastructure.

It is sometimes seen as an off balance sheet approach to debt funding.

These programs are generally broader than just financing and often aim to gain efficiencies from
project design, construction, operation, and risk transfer.

Ordinarily, private sector financing is often a significant component of PPPs or PFIs, and useful to set
out as one option for financing public infrastructure.

RSA has since developed its PPP unit with National Treasury.
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12. 
Long term sustainable outcomes require internally generated funds supported by
tariffs.

Proper licensing , monitoring , tariff setting, and dispute resolution mechanisms must be in place.

Tariffs and prices must recover all the efficient costs of supply including a return that is perceived by
the investor sufficient to invest his capital in the industry over time.

When the tariff levels are set right, they provide a positive incentive for private investors to invest in
the sector.

Tariffs must be set over a long term to provide for predictability by the investors to plan their
enterprise performance over time.

The regulated decisions must provide an environment that is consistent over time for sound
strategic planning.

The regulated decisions must be flexible to be challenged in court if needs be or be re-opened for
review at appropriate cost effective times.
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13. 
Moody’s provides its approach to rating regulated utilities in which it sets out the following 4 key
rating factors and weighting in its assessment of credit ratings for regulated utilities*
Moody’s Rating Factor Weighting - Regulated
Utilities
Broad Rating Factors
Factors cited by Moody’s
Weighting
40%
Historic and projected financial performance
as assessed by standard credit metrics.
10%
Financial Strength, Liquidity and Key
Financial Metrics
•
25%
Diversification
Supportive regulatory environments and cost
recovery mechanisms.
25%
Ability to Recover Costs and Earn
Returns
Predictability of regulatory decision making;
the level of political intervention in the
regulatory process, and the strength of the
regulator’s authority over regulatory issues.
•
Regulatory Framework
•
* Source: Moody’s Rating Methodology, Regulated Electric and Gas Utilities August 2009
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14. 
Independent regulators that protect the interest both for a sustainable sector over time
and the interests of customers for tariff structures that are affordable and are flexible
around the different needs.

The balance between cost reflectivity and affordability must be established to the
satisfaction of investors and the customers, that is the tariff must be sufficient for investors
to provide new investment in the sector and the same time it must make the consumers of
the service satisfied that it is value for money.

Regulatory decisions on revenues and tariffs should avoid shocks to the industry and
maintain consistency over time.

Regulatory decisions must be exposed to stakeholder consultation before they are
implemented and stakeholders must be afforded time to comment in writing or orally.
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15. 
Fast-tracking policy and regulation reforms for their enhanced implementation - licensing,
monitoring, tariff setting, and management of disputes.

Enhanced monitoring of projects for speedy regulatory approvals.

Finalizing the best solution for each infrastructure deficiency - proper load forecasting,
demand projections, and supply deficiency estimations.

Facilitation of funding for infrastructure projects.

Guidelines for preparing a finalized infrastructure roll-out plan.

Managing risk in infrastructure projects.

The future for infrastructure financing – long range price trajectory by sector to inform
decision making in each sector to ensure sustainability over time.

The importance of proper stakeholder engagement on infrastructure funding.
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16. 
The regulatory environment is still developing:


Appropriate regulatory and governance frameworks need to be applied to enable
sustainable investment in infrastructure.


Tariff levels have not reached cost reflective levels needed to attract private sector
participants
Uncertain implementation of pricing frameworks further impends investment in
major projects (i.e. Sanral) .
As these challenges are addressed, and with a proven track record of
achievement, ongoing investment in South Africa's Infrastructure will provide
the foundation for economic growth and development into the future.
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17. slEconomics is a boutique economics consulting firm providing
specialised advice to governments, regulators and corporate clients in
the area of utilities and infrastructure. We are based in Sydney Australia
and in Pretoria South Africa, backed by an international network of
associates to bring global experience to local initiatives.
www.slEconomics.com
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