Investors should get good returns from infrastructure projects

Naoyuki Yoshino

Investors have to be given a fair share of the revenue generated in the economy surrounding an infrastructure project to boost public private partnerships, said an expert.

Naoyuki Yoshino, dean of the Asian Development Bank Institute, a global think tank, said PPPs in infrastructure have failed in many countries because the rate of return relies only on user charges, which are nominal.

As a result, the rate of return remains very low. This does not motivate the private sector to come and invest in infrastructure projects, he told The Daily Star in an interview in Dhaka recently. 

The economics professor said it is well known that good infrastructure has a huge spillover effect in the region around a project.

Railways bring manufacturing factories into a region by making the shipping of products faster and safer and connect manufacturers to markets and ports, he added.

New industry creates jobs in the region. Eventually, the service sector businesses, such as restaurants and hotels, are constructed to meet the increased demand, he said.

Farmers and small businesses too can sell their products at train stations, he added.

Studies show that good educational opportunities together with infrastructure investment create qualified workers who enhance regional productivity.

Yoshino said the spillover effects of infrastructure investment will increase revenue from corporate, income, and property taxes. In the past, all these tax revenues were collected by the government and not returned to the investors in infrastructure.

The economics professor has used a method called the difference-in-difference to compute the effect of spill over on tax revenue in places where infrastructure investment occurred compared to ones where no infrastructure investment took place.

It has been estimated that returning a part of the additional tax revenue to the construction companies and investors would raise the rate of return on infrastructure investments by 33 percent to 40 percent in case of Japan and by 14 percent to 16 percent in case of Uzbekistan, according to Yoshino.

He said 50 percent of the tax revenue raised should be shared between the government and the construction companies, which will take the rate of return for the latter to over 60 percent.

“If the businesses do better, the rate of return will be much better. Then it will become attractive for the private sector.”

The model has not been implemented anywhere so far. But the ADBI chief said he wants to start it somewhere.

“If the rate of return on infrastructure is increased by injecting spill over tax revenue generated in the areas surrounding the infrastructure investments, much more long-term private capital could be forthcoming.”

The ADBI chief also said fewer public sector funds would be needed for infrastructure investment. Meaning, the government could increase the total amount of infrastructure investment by attracting private finance when incremental tax revenue from the spillover effects are used to raise their rate of return.

“The higher the expected rate of return, the more private funds would be attracted.”

In Southeast Asia, $8 billion in infrastructure investments are implemented every year against a requirement of $40 billion. But public money is insufficient to satisfy Asia's infrastructure needs, said the economics professor.

He said PPPs have been promoted for infrastructure development in India, Thailand and other parts in Asia. However, most PPP projects were disappointing since the rate of return on infrastructure depends mainly on user charges, such as train fares and highway tolls.

In order to narrow the gap between investment needs and actual government disbursements, the rate of return on infrastructure investment has to be increased.

Also a professor emeritus at Keio University in Japan, Yoshino said utilising private funds to develop infrastructure has the advantage of increasing the pressure to shorten the period of construction, completing it with minimal costs, and operating the project profitably after completion.

He said complex land ownership is a challenge for infrastructure development. In India, Bangladesh and Pakistan, land ownership is stringent, where many people claim their ownership to a single piece of land. As a result, construction cost becomes high.

Leasing is the answer to this problem, according to the economist. The land owners will get user fees every year from construction or road companies and as the change in ownership will not be required, construction will speed up, he added.

Yoshino backed enhanced access to finance for small and medium enterprises as they are the engine of growth.

He talked about a new form of financial intermediation called hometown investment fund that can be used to encourage start-ups and SMEs, as they often have trouble getting bank loans.

The fund has now been adopted as a national strategy in Japan.

The fund is project-driven. Firms and households decide to invest here by getting to know the borrowers and their projects. In this way, the fund distributes the risk but not so that it renders risk intractable, he said.

It contributes to economic recovery by connecting firms and households with SMEs that are worthy of their support. It also creates employment opportunities at the SMEs, as well as for the pool of retirees from financial institutions who can help assess projects.

The fund model has been adopted in Cambodia and Vietnam and is set to start in Mongolia. China, Malaysia and Thailand are also interested, said Yoshino. 

He also called for putting in place a credit guarantee system so SMEs can access loans. If borrowers go bankrupt, the guarantors would pay up to 80 to 90 percent of the loans to the banks. “It is very important for SMEs to work.”

The ADBI chief said a database of SMEs should be prepared, which will classify them as good, medium and risky; this will enable SMEs' credit rating.

Yoshino said post offices can be used to sell private financial products. Post offices are present nationwide, while financial institutions have offices in only large cities.

Post offices become agents where private banks, insurance companies and brokerage houses set up their small offices on the premise of the post offices. Thus, they can be used as a channel to generate revenues.