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South Africa’s road to recovery: The risks of a private sector-led infrastructure build plan

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Sonia Phalatse is a feminist economist and researcher at the Institute for Economic Justice (IEJ).

Infrastructure development should entail a shift from the economy’s reliance on fossil fuels and industries such as mining and commodities, towards greater diversification, especially in industries that are low-carbon and employment-creating. However, this may not correspond with the interests of private capital.

The Reconstruction and Recovery Plan, formally announced by President Cyril Ramaphosa in October 2020, centres on infrastructure as the key driving force to job creation and economic growth over the next five years.

Despite the government’s insistence on increasing and improving infrastructure development, public infrastructure spend has steadily declined over the past three decades, with public investment being half of what it was in much of the 1960s, 1970s and 1980s. 

In 2019, Gross Fixed Capital Formation (GFCF) — a measure of total capital investments in the economy — stood at just over 18% of GDP. This compares poorly with average GFCF for middle-income countries, which was 35% in 2019. The private sector’s contribution to this has been disappointingly low, hovering between 10 to 16% since the beginning of the 1980s.

While using infrastructure as a “flywheel to save the economy” is not a novel plan, what is novel is the focus on private capital to augment, if not replace, government spending. 

It is planned that for total GFCF to reach 30% of GDP by 2030, at least 20% of this should come from the private sector. To achieve this, the government proposes to “de-risk” infrastructure investments to attract private investment.

De-risking infrastructure

De-risking infrastructure entails shifting the bulk of infrastructure risks to the public sector in the form of various financing mechanisms — such as “blended finance” and “public-private partnerships” (PPPs) — in order to make infrastructure investment attractive to, and lucrative for, the private sector. 

It is argued that private investors would substantially increase their investments in infrastructure if the government absorbed greater risks associated with these.

Blended finance is the use of public finance — which includes funds from development finance institutions — to lower the risks involved for private investors. This includes guaranteeing revenue from the project, whether it generates them or not, and offering subsidies to lower the costs for private participants and investment grants, such as equity financing.

Much of the promise of blended finance is in its potential to “catalyse” (or attract) a substantial amount of private financing. For example, the South African Treasury claims that a public investment of R10-billion over the next 10 years will leverage R1-trillion in private investments in infrastructure over the same period. The prioritisation of blended finance forms part of a global push for private capital to partner in meeting the Sustainable Development Goals by 2030.

While expecting the private sector to play its part in achieving developmental outcomes sounds like a laudable objective, these initiatives have become increasingly controversial.

As we show in our recent Working Paper, “Private Sector Finance for Infrastructure Development in South Africa”, the available evidence suggests that such de-risking has failed to attract the envisaged private capital at a meaningful scale. 

Even The Economist has cautioned against the international hype for blended finance, calling it a “honey trap”. It notes that “blended finance has struggled to take off. Since 2014 the flow of public and private capital into blended projects and funds has stayed flat at about $20bn a year… far off the goal of $100bn set by the UN in 2015 for climate investments by 2020”.

Potential risks

The working paper by the Institute for Economic Justice, in partnership with the Friedrich-Ebert-Stiftung, outlines key risks that face South Africa in betting on de-risked infrastructure.

First, it is unclear how much risk the government is willing to absorb on behalf of the private sector, and the contagion effect this will have on the economy. The renewed focus on PPPs does not bode well. PPPs are said to be beneficial in the short term because they are considered off-book transactions (called contingent liabilities). These are usually large transactions that are not accounted for in the budget because they are liabilities that are incurred in the event of an uncertain future event. 

Furthermore, contingent liabilities have the potential to undermine national macroeconomic policy and cause significant economic harm when (and if) they become due — as we’ve seen with Eskom’s debt guaranteed by the state.

The promise to pay the private party is often of a greater amount than what it would cost to just invest through public means. 

PPPs in the UK, for example, were officially phased out from economic policy because of their high fiscal risks and resultant costs to the fiscus. An official audit of the Private Finance Initiative, conducted in 2018, found that the cost of PPPs has been at least 40% higher than relying on public funding.

Second, and arguably the most important factor, is the lack of evidence showing that de-risked infrastructure can narrow the infrastructure gap, particularly for the least developed areas in the country. 

The recently established Infrastructure Fund, expected to house new de-risked infrastructure investments, is said to be set up specifically to transform rural areas and townships through infrastructure investments. At the same time, the Fund prioritises investments in large-scale, “bankable projects” — projects which can generate a viable return for private investors.

As highlighted in the 2019 United Nations Conference on Trade and Development report, such “bankable” projects often yield high profits for private actors — or these profits are guaranteed by the state — at the expense of smaller-scale investments that may have greater developmental impacts. 

In addition, commercially viable investments usually serve areas and communities that are more likely to be able to pay for those services. User affordability is essential in the assessment of development impacts. 

However, getting the price right for users, particularly for low-income households, is not an incentive for the private participant. This fundamentally goes against the UN’s commitment to “leaving no one behind” by 2030.

Public investments must take priority

The government and its partners must maintain developmental goals as the first and foremost purpose of infrastructure investment, and not set out to primarily establish a business-friendly environment. 

The current narrative surrounding the Infrastructure Fund overlooks key historical failures in “megaprojects” (such as the infamous Medupi and Kusile power stations) that have been socially and environmentally damaging.

Infrastructure development should seek to close critical gaps in both social and economic infrastructure provision. This would entail a shift away from the economy’s reliance on fossil fuels and industries such as mining and commodities, towards greater diversification, especially in industries that are low-carbon and employment-creating. However, this may not correspond with the interests of private capital.

For these reasons, the government cannot afford to focus its energies on creating lucrative investment opportunities for the private sector. This will likely create further financial crises for the government, something that it currently cannot afford. 

More importantly, a private sector-led infrastructure drive will continue to undermine the needs of millions of people in this country, for whom accessible, safe and affordable infrastructure remains undelivered. DM

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Comments - Please in order to comment.

  • Kerry Barton-Hobbs says:

    Thanks for sharing, Sonia. Let’s hope the ANC is listening.

  • Louis Potgieter says:

    Auditor General reports show abysmal internal controls, and the trend is worsening. Internal controls are required to address risks and meet objectives. How can government now de-risk projects by accepting more risk onto itself?

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