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INFRASTRUCTURAL FINANCING USING PENSION FUNDS OF THE WEST AFRICAN MONETARY ZONE’S MEMBER STATES

Ngozi E. Egbuna (PhD), Abdoulaye Barry, George Okorie (PhD) and Oyebanji Olaoye ()

No 14, Working Papers from West African Monetary Institute

Abstract: This study is pursuant to the directive by the Convergence Council of the West African Monetary Zone (WAMZ) during its Statutory Meetings held from August 1 - 5, 2016 in Conakry, Guinea, to WAMI to carry-out a comprehensive assessment on the feasibility of using pension funds of the Member States of the Zone for infrastructural financing. The overall objective is to accelerate economic growth by leveraging on pension funds to finance infrastructure in the WAMZ. Infrastructure deficit has been a major challenge to growth of WAMZ economies over the years. Apart from telecommunication infrastructure which has recorded considerable improvement in the last decade, huge deficit exists in basic infrastructure such as road networks, railways, airways, waterways and electricity supply. Infrastructure gaps have existed in the Zone dating back to the colonial era and have widened due to political instability, high population growth rate, poor economic development, poor governance and overdependence on external and public sources for infrastructure funding. Weaknesses in public sector salary and wage policies, and unsustainable rate of debt accumulation resulting in huge interest payments, have led to rising recurrent expenditure, which limited available public funding for investments in infrastructure. Volatile commodity prices also adversely affected public funding of infrastructure due to significant reduction in fiscal revenues. Infrastructure development is critical to economic development as it enhances the productive capacity of the economy. As a capital good, it facilitates the delivery of final goods and services to promote economic growth and prosperity. In particular, infrastructure enhances quality of life including social well-being; and health and safety of citizens. The effect of infrastructure on economic development occurs through diffusion of technology, trade facilitation, division of labour, market competition, and efficient allocation of economic resources across countries and regions. Infrastructure also facilitates adoption of new organizational practices and harnessing of latent resources. While the Zone’s total pension fund assets are estimated at US$24.3 billion in 2016 with potential to increase significantly, allocation of pension assets to infrastructure financing is generally low. The low rate of pension fund investment in infrastructure is partly due to insufficient investment vehicles, as well as the inadequacy of financial instruments to support pension fund investment in infrastructure. The capital markets in the WAMZ are not adequately developed to offer long-term capital needed to support the huge financing outlay for infrastructure development. The enormous challenges experienced by governments in bridging infrastructure funding gaps, have compelled WAMZ countries to formulate new policies and programmes to enhance critical infrastructure financing in their economies. Prominent among the policies is the framework that promotes private-sector participation in infrastructure financing. The advocacy for using pension fund to finance infrastructure is hinged on the following rationale: First, shrinking or grossly inadequate traditional funding sources for infrastructure has made pension fund a viable global alternative. Second is the urgent need to bridge the infrastructure funding gap; third is the characteristics of pension fund as a long term instrument which is appropriate for infrastructure financing; fourth, the steady cash flow nature of infrastructure investments makes it ideal for pension fund investment. International experiences suggest that progress towards improving the management of pension funds rely on good governance. Corollary to that is the widely accepted principle that investment using pension fund assets must be done prudently and cost-effectively with quantitative limits. Global infrastructural gap is undoubtedly huge and the pension fund has provided alternative source of funds for infrastructure financing, without any reported case of default wherever it had been experimented. International experience revealed the need for a comprehensive review of strategy for infrastructure financing in the WAMZ countries. This would require issuing infrastructure bonds, with strong ratings premised on strong project analysis and competencies, and good prospects for repayment on Private-Public-Partnership (PPP) models. The population growth and increasing labour force in the WAMZ creates higher potential for increase in the size of pension funds. The large size of the informal sector in the zone, however, constitutes a serious drag on this potential. Currently, pension fund contributors are predominantly from the formal sectors as the informal sector remains informational opaque. The bulk of the contributions to the pension fund are from the public/civil service and the formal private sector as the information available on the informal sector is low. The size of pension funds in the Zone is growing rapidly. However, utilization of these funds to finance infrastructure projects remains low due to some inhibiting factors. These challenges border on the size of pension fund assets relative to the financing need of infrastructure; regulatory and institutional restrictions; weak enforcement of pension laws; underdeveloped financial markets; capacity gap in managing pension funds for investment in infrastructure; unavailability of suitable investment projects; public institutions acting as custodians and managers of pension fund; multiplicity of schemes handled by the pension fund institutions; and lack of regional platform for exchange and collaboration of the pension sector. Given the myriad challenges affecting the flow of pension funds for financing infrastructure in the WAMZ and the need to address the infrastructure deficit, the following policy recommendations are proposed at the country and regional levels to harness the potentials of pension funds. At the national level, the study advocates for the expansion of the size of pension funds and diversification of investment options, through the formalization of the informal sector, enforcement of existing pension regulations, attracting foreign investors and raising awareness. Furthermore, in order to increase access to long term financing, capital markets should be established in those Member States where they are non-existent and further deepened in those countries where they already exist. Pension fund institutions could invest in financial instruments that are linked to particular infrastructure projects. Such instruments should be tradable in the secondary market and granted liquidity status to attract pension fund investors. Other recommendations include: the need for human capital development considering the evolving nature of this initiative; Member States are encouraged to share risk on the basis of Public-Private-Partnership (PPP) models; Authorities should provide guarantees for institutional investors to mitigate anticipated risk; increase transparency in infrastructure financing using pension funds; and sensitize stakeholders, investors and supervisors on the importance of financing infrastructure with pension fund. Further, Member States should reform their legal, institutional and regulatory frameworks to enhance the use of pension funds for the financing of infrastructure; the regulatory framework and guidelines should inter alia set limits or conditionalities for infrastructure financing. Member States should also establish autonomous agencies to regulate and supervise pension funds in countries where none exists.There is need for a platform for regional collaboration, information sharing and harmonization to raise the level of development of the pension sector in the WAMZ. At the WAMZ level, it would be necessary to establish a collaborative platform where pension fund institutions and supervisors in the Zone could meet for cooperation and information sharing on issues regarding pension funds development and infrastructure investments. This synergy would also help members of the association in mitigating inherent risk in investment projects as well as identify project viability gaps in order to achieve sustainability. Finally, the study finds that regardless of the novelty of the concept in the Zone, pension funds have helped to provide alternative sources of funds for financing infrastructure in most jurisdictions. In addition, there has been no report of default that has resulted in erosion or misplacement of pension funds due to its use in financing infrastructure project. Consequently, using the pension funds of WAMZ Member States in financing infrastructure is feasible. However, Member States are strongly encouraged to put measures in place to adequately address the challenges identified in order to unlock the inherent potentials in pension funds with a view to accelerating growth and development of the sub-region.

Keywords: Pension Funds; Infrastructure Financing; Investment (search for similar items in EconPapers)
JEL-codes: D25 G23 H54 (search for similar items in EconPapers)
Pages: 66 pages
Date: 2018-06
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