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2008 Sep/01
Public Investment Financing using the Capital Market
Survey Papers 08-01
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- Research Topic Capital Markets
Cho, Sungwon
Park, Chang-Wook
- Summary
- Amid the worsening public finance conditions due to shrinking tax revenues and increases in government spending on social welfare, there is concern over the weakening growth potential caused by the decrease in public expenditures on social overhead capital or infrastructure. In order to enhance the growth potential without undermining fiscal soundness, public authorities will need to improve the efficiency of fiscal spending by relying less on tax revenue and more on utilizing the capital market in financing public investments. In this regard, this paper studies schemes to enhance the utilization of the capital market in financing public investment based on the analysis of the domestic public investment financing and case studies of advanced countries. In Korea, since the enactment of the Private Participation in Infrastructure Act in 1994, the decrease in public expenditures on social infrastructure has been complemented by the private investment through private provision of public infrastructure (PPP). PPP can be an effective means to expand social overhead capital investments given a limited government budget through the leverage effect of government subsidy. Financing of private investment of social overhead capital can be classified mainly into two categories; equity financing and debt financing. Equity financing is led by the construction firms and banks, and investments by financial investors including pension funds are still not very active. Debt financing is mainly conducted through a syndication loan and issue of long-term SOC bond and ABS is still very limited. In many countries, private provision of public infrastructure is actively carried out given the shortage of government funds and the continuous increase in infrastructure demands. The United Kingdom is one of the most advanced countries involved in Public-Private Partnership(PPP) programs. The UK pioneered the so-called Private Finance Initiative which is essentially a PPP model that minimizes government intervention and regulation. In United States, various funding methods are used to finance infrastructure investments. In particular infrastructure project related bonds such as municipal bonds and revenue bonds are widely utilized to fund infrastructure projects. Australia is most renowned for listed infrastructure funds. More than 23 infrastructure funds are currently listed in the Australian Stock Market and actively traded by individuals and financial investors. Based on the analysis of the current state of the domestic public investment financing and the case studies of advanced countries, this paper presents following schemes to improve the utilization of the capital market in financing public investments. First, the introduction of revenue bond structure is recommended to help local governments finance social infrastructure projects and to revitalize the infrastructure project related bond issue. Tax-exempt measures for interest income should be considered to increase demand for these municipal issued bonds. Second, enhancing the usage of Asset Backed Securities(ABS) is recommended. Investing in infrastructure projects inherently entails liquidity risk due to its long term investment horizon, and asset backed securitization of infrastructure related assets will help facilitate the exit of investors. Third, expansion of listed infrastructure funds is recommended. Listing infrastructure funds will enable large scale funding and improve the liquidity of infrastructure investments. In advanced countries, financial investors actively invest in listed infrastructure funds to diversify portfolio risk since infrastructure funds are known to have low correlations with stock and bond investments, and are less volatile than stock investments in general. An infrastructure fund also offers stable, long-term, inflation protected cash flows, particularly important to pension funds in aligning their investment income with pension liability. Lastly, participation of financial investors in the infrastructure investment projects is important. Considering the fact that large scale funding and long-term recovering periods are needed for infrastructure investments, improving the participation of financial investors, especially the pension funds is crucial for sufficient funding of infrastructure investment projects. In order to promote participation of financial investors, financial feasibility studies should be taken more seriously to reduce the operation risk involved in these PPP projects. Also investment related regulations limiting the ability of financial investors to invest in infrastructure assets should be loosened to promote their participation.