Mobilizing domestic financing for infrastructure – recent positive developments

The past few weeks have ushered in a flurry of announcements of various policies/initiatives aimed at improving the infrastructure situation in Nigeria, with electricity power reform always leading the discussions. The reactions trailing the government’s decision to effectively privatize the electricity power sector has largely being met with positive comments by both Nigerian and international analysts. A major concern that has however underlined these positive comments has been the nation’s ability to attract sufficient investor interest in the power sector. An initial estimate of US$10 Billion is currently being bandied around as being required in the power sector.

This will require a massive sales effort by the government, the privatization agencies and the Nigerian finance & investment community. A very common response to the financing question has been: “Foreign investors are interested”. While I believe that the Nigerian power sector – if properly structured – presents a compelling investment proposition, there are also potential limitations that may prevent the expected rush of foreign investors. Firstly, Nigeria is setting on a privatization program for its electric infrastructure at a time that major emerging market economies are launching programs of similar nature. Brazilian President Lula has announced a US$500 Billion infrastructure upgrade plan, an integral portion of which will utilize private funding. The Indian Government is also planning a multi-billion dollar transportation and electric power upgrad that is expected to require huge private investments in the near future. Therefore, a lot of the infrastructure funds and big firms will be concentrating on these markets and we would face an uphill task competing against these destinations. Secondly, Nigeria also has some way to go in proving its stability as an investment destination particularly with the upcoming elections.

Hence, it is clear that while we should work hard at getting foreign investors we should also be doing as much as we can to mobilize funds domestically. That is why I am quite happy at PENCOM’s – the national pensions regulator – proposal to allow Pension Funds in Nigeria to invest up to 20% of their assets into infrastructure projects and funds. Given the current estimate of pension assets size of N1.73 Trillion (US$ 11.5 Billion), this proposal may free up to US$2.3 Billion for investments in infrastructure. I believe the bulk of these infrastructure investments will be in the electricity sector. I think the proposal to allow Pension Fund Administrators to invest in assets such as Private Equity and infrastructure is a good one as I have long believed that the pension guidelines - as they are currently written – suffer from an illusion of safety. I believe a good national pension fund system should serve two goals: mobilize savings for developing the nation and provide good returns on pension contributions to ensure a decent nest egg for retirees. The very restricted nature of the previous guidelines have led – in my opinion – to distortions or overheating of certain market segments in the country. Pension funds’ constant purchases of Federal Government bonds once pushed the yield on the longest dated (i.e. 20 year) bonds to 8%, in a country with double digit short term inflation rates!!! Analysts also believe that pension funds’ purchases of subnational, state government debt may also spark a bubble in the primary markets for such instruments.

This is why the current proposals to enable Pension Funds invest in infrastructure and private equity should be a win-win for both pension fund contributors and the economy as a whole. Infrastructure and Private Equity investing – if properly managed – should lead to greater diversification and mitigate some of the concentration risks in most pension portfolios. It should also be beneficial to the economy as the country will be creating a domestic capital pool for some of the electric power privatizations and investments that should be coming on-stream in the next 1-3 years. In addition, allocations to private equity should also help catalyze the emergence of a domestic private equity and venture capital industry that will provide much needed funding to early stage ventures, Small & Medium Enterprises (SMEs) and larger pre-IPO companies.

However, while the motives seem honorable and the benefits seem clear we must be mindful of potential pitfalls, with a key pitfall being the dearth of project finance structuring competence among Nigerian financiers. PENCOM should work with key DFIs such as the IFC to build pension managers’ capacity to properly evaluate infrastructure projects as well as private equity and infrastructure funds. The regulator has taken a step in the right direction by mandating minimum standards for such funds and projects, but it will need to go further to encourage best practices and ensure that fund managers do not engage in a race to the bottom to see who can throw the most money at the worst deals. These are solid proposals but the regulators, fund managers and the broader financial industry should work together that the pension contributors and the economy reap the most benefit possible.