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February 25, 2019

Building Bridges: Borrowing for Public Investment

Bridge
Posted by Taz Chaponda[1]

Building megaprojects often requires such a vast capital investment that the country may have to borrow from development finance institutions, export credit agencies or other sources. For large countries like China and the USA, there are likely to be adequate sources of domestic financing. But for low-income and emerging market economies, foreign sources of financing will be required. If so, should countries incur further debt for new infrastructure? And how should they weigh up competing calls to finance it. Cheap loans from large Chinese banks have so far attracted many countries.

China is one of the biggest developers of large infrastructure within its own borders, and beyond. The engineering feats of the Great Wall are now being challenged by new mega projects. Last year, one such project was opened: The Hong Kong-Zhuhai-Macau bridge. This 55km bridge was built over ten years at the cost of almost $20billion (0.2 per cent of GDP). China’s “Belt and Road initiative” (BRI) is expected to rollout similar projects across Asia, Europe, and parts of Africa.

The Silk Road

In 2013, China introduced the BRI, an ambitious economic and geopolitical plan to recreate the ancient Silk Road trading routes by connecting more than 60 countries via a network of road, rail, and maritime network infrastructure. It is hardly surprising that such an undertaking is facing problems. In 2018, some of the landmark projects in Asia began to face delays, largely due to financing shortfalls and questions about the relative costs and benefits for the individual countries.

A report published in August 2018 by Nikkei Asian Review and The Banker magazine reviewed the status of the BRI projects in seven countries - Indonesia, Sri Lanka, Kazakhstan, Bangladesh, Poland, Laos and Pakistan.  Concerns raised include the lack of adequate local participation in the projects, and the mounting debt burden for participating countries. In Indonesia, construction of a $6 billion railway line is running behind schedule, coupled with rising costs. In Sri Lanka, the government found itself unable to repay the $8 billion foreign debt associated with the Hambantota Port, and had to effectively hand over the assets to China.

Reflecting the growing concerns about the BRI projects and their exposure to debt financing risks, the IMF’s Managing Director Christine Lagarde warned that "in countries where public debt is already high, careful management of financing terms is critical". She noted that such “ventures can also lead to a problematic increase in debt, potentially limiting other spending as debt service rises, and creating balance of payments challenges”[2].

Bridges in Africa

While the Hong Kong-Zhuhai-Macau bridge was being opened, several new bridges were coming on stream in sub-Saharan Africa (SSA), including one built in Mozambique by a Chinese firm (see table). Yet, at a cost of about 6 per cent of GDP, the Maputo Bay Bridge added to the country’s rising debt burden which had reached 103 per cent of GDP in 2017 and is now on an unsustainable path[3].

 

Name

Features

Maputo Bay Bridge (Mozambique)

 

Completed in November 2018, it was built and financed by the Chinese. At 3kms long, it is the longest suspension bridge in SSA connecting Maputo to the South African border. It cost $750m or (6 per cent of GDP).

 

The Kazungula bridge

(Zambia-Botswana)

 

 

Opening in March 2019, it is 923m long and cost $260m (0.6 per cent GDP); financed by African Development Bank (AfDB), the Japan International Cooperation Agency (JICA) and an EU grant. It was built by Daewoo Engineering and Construction and will facilitate trade between Zambia and Botswana.

 

Source of the Nile

(Uganda)

 

 

Completed in October 2018, it cost $112m (0.4 per cent of GDP) with 80 percent financing from JICA at an annual interest rate of 0.01%, payable in 10 years. It was built by a Japanese contractor in partnership with Hyundai Engineering and Construction.

 

Trans-Gambia Bridge

(Senegal-Gambia)

 

 

 

Completed in January 2019, this bridge is 1.8km long, and was financed by the AfDB at a cost $65m (3.8 percent GDP). The bridge opens up trade between Gambia and Senegal.

 

Billion dollar bridge

There are of course good economic development reasons for building bridges. But sometimes, the trade-offs can be quite stark as in Sierra Leone. For many years, there was a proposal to build a new airport which would avoid the bumpy boat ride from Lungi to Freetown. The new airport had been approved, with financing from China. Then, in 2018 a new administration canceled the airport project and instead proposed the construction of a bridge linking Lungi to Freetown, again with backing from China. The cancelled airport project was estimated to cost $400 million, while the new bridge, at 13km, may cost an alarming $1billion (25 per cent of GDP). The Lungi bridge should be seen in the context of the country’s public debt that has doubled (from 35 to 68 percent of GDP) over the past five years.

Whether a country should undertake a major public investment is a complex question with both political and public finance implications. To assess the relative merits of such a project requires weighing the costs against the benefits. At a minimum, three tests should be carried out: First, demonstrate there is adequate (verifiable) traffic flows to justify the new project. Second, conduct a rigorous independent assessment of its technical, economic and financial viability. Third, compare the financing arrangements against alternative sources. If there is significant uncertainty about future costs, revenues or related issues, it is far better to delay the project, or scale back the design to avoid unsustainable debt levels.

 

[1] Senior Economist, Fiscal Affairs Department, IMF

[2] Remarks made at a conference in Beijing, in April 2018.

[3] Mozambique: Staff Report for the 2017 Article IV Consultation – Debt Sustainability Analysis. Feb 2018

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.

Comments

Taz, this a very interesting article.
I also share your sentiments on whether developing countries should borrow for such risky investments assuming rigorous assessments were not carried out. Cost recovery will be a major concern if Sierra Leone is embarking on such a project.

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