Magazine article International Trade Forum

Overcoming Political Risk for SMEs through Infrastructure Investment

Magazine article International Trade Forum

Overcoming Political Risk for SMEs through Infrastructure Investment

Article excerpt

Infrastructure investment needs are huge and growing. According to the World Bank's current Infrastructure Strategy, an estimated US$1.1 trillion annual expenditure in developing countries--or 6.6% of the developing world's gross domestic product--is needed to satisfy demand for infrastructure services through 2015 alone.

Private international capital has an important role to play in financing

infrastructure investments, given the fiscal constraints facing many developing countries. However, banks which may have been forthcoming in providing financing to the private sector for long-term infrastructure investments may now be facing constraints in their ability to offer financing associated with Basel III regulations. For example, higher minimum capital levels for banks and new rules regarding assets and liabilities management may discourage project finance lending. Private companies may also have concerns about perceptions of political risk in many locations where they might be seeking to invest in infrastructure projects.

To mitigate these risks, institutions such as the World Bank Group's Multilateral Investment Guarantee Agency (MIGA) offer instruments that help investors and lenders feel more confident moving forward in certain contexts. The first is political risk insurance, which allows cross-border investors and lenders to mitigate non-commercial risks arising from adverse government actions. Those may include expropriation; breach of contract; restrictions on the convertibility and transfer of currency; and political violence events including war and civil disturbance. Political risk in general (and breach of contract in particular) consistently leads the list of the most important constraints facing foreign investors in developing countries.

The second instrument is credit enhancement. It protects cross-border lenders against losses resulting from the failure of a sovereign, sub-sovereign, or state-owned enterprise to make a payment under an unconditional financial payment obligation or a guarantee related to an eligible investment. Credit enhancement products allow sovereign and sub-sovereign borrowers access to longer-term financing and lower funding costs. For example, in 2013, the State of Sao Paulo and the World Bank committed US$129 million and US$300 million, respectively, to the rehabilitation and upgrading 750 kilometres of state roads and the reconstruction of two bridges for inland waterway transport on the Tiete River. The project was expanded, leaving a US$300-million financing gap. …

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