WORKING PAPER

Rapidly developing nations face particular challenges in meeting their infrastructure investment needs. They are big and fast growing, with substantial infrastructure needs, but immature financial systems and a scarcity of domestic long term investors. Add to this the challenge of climate change that can add substantial infrastructure investment needs to these countries.

In this project, which supports the upcoming report by the New Climate Economy, the Brookings Institution, and the London School of Economics, “Delivering on Sustainable Infrastructure for Better Development and Better Climate,” we explore the infrastructure investment models that India and Brazil have used to address this challenge.

• Brazil has used a highly centralized model with a strong national development bank (BNDES) to provide stable and relatively low cost finance to infrastructure projects.
• India has used a more decentralized approach with a diverse set of public and private financial institutions delivering finance on more or less commercial terms.

We explore both models, using two climate change relevant wind energy projects, to evaluate how the different models influenced the cost and effectiveness of finance for infrastructure.

In theory, the more centralized system should benefit from efficiencies, driven by economies of scale, and enable better control and coordination of development efforts. On the other hand, a more disaggregated system could encourage more innovation and encourage private sector participation to grow more rapidly.

But theory does not take into account differences in economies, institutions, resources and cultures that can waylay even the best laid system. Looking into these real projects and their interaction with the financial model yields several important insights:

1. The differences between infrastructure finance in the two countries are smaller than a superficial glance at the two models would suggest. Despite the difference in models, both countries ended up with public financing dominating these infrastructure projects. Leverage, that is the amount of debt in the project relative to equity, was similar in both and there was little financial innovation in infrastructure finance. The two models also suffered many of the same problems, including a failure to adopt many of the project finance models, risk assessment, insurance, debt segmentation, and construction finance models that are more commonly found in developed economies.
2.  Differences between the two countries have as much to do with differences in policy than with the financing models. In fact, the finance models may be more reflective of the general policy environment rather than a driver of the policy and finance landscape. In Brazil, a national development bank plays a role alongside a well-developed national regulatory, auction and pricing system. Development bank finance enables this mechanism to achieve attractive pricing as bidders can secure attractive financing. In many ways the regulatory and development banking systems have been developed together, each taking advantage of the capabilities and impact on the market. In contrast, there are wide variations in regulation and policy in India, with risks, financial stability, targets and regulation varying from state to state. National level policy does have an impact, but this impact can often be overwhelmed by state level issues in many states around India.
3. Centralized development banking models do, in practice, show clear benefits. The centralized development banking did foster greater scale than in India. This scale helped achieve financial objectives, ease control to reach government policy targets, and other benefits suggested in the table above.
4. Development bank models could do more than was observed in Brazil. However, the Brazilian model did not achieve some of the potential benefits, including risk transfer and enhanced liquidity in the market.
5. But centralized models can also learn from the checks, practices and safeguards inherent in the decentralized model. These include an ability to foster investment from commercial and international development sources, as well as safeguards.
6. Both of the models reviewed potentially face governance issues. The centralized model can better support national policy than a decentralized model, an advantage for policy but potentially leading to concerns about financial inefficiency and higher infrastructure costs, as well as governance concerns. The decentralized model, on the other hand, while reducing the potential for governmental interference, can still prompt suboptimal investments for many reasons: if power off-takers are in poor financial health, or the system facilitates relationship-investment practices, or decision making is still centralized under a small set of actors, for example.