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Wednesday, 5 February 2020

Why Egypt is looking to infrastructure bonds to fund its project pipeline

Why Egypt is looking to infrastructure bonds to fund its project pipeline: Egypt is today looking at its first issuance of infrastructure bonds in FY2020-2021, after initially being slated to take place in 2H2019-2020, government officials tell Enterprise. The move, now under study, to fund individual infrastructure projects through the issuance of bonds is increasingly being seen by the government as viable as its infrastructure project pipeline grows — this despite lingering worries in the debt market about the outlook for 2020. Infrastructure bonds’ eco-friendly cousin, the green bond, is still slated to make its Egypt debut before the end of June 2020. For today, we’re digging into what infrastructure bonds are, why the government may turn to them, and what makes them more attractive than traditional methods of financing infrastructure projects.

What is an infrastructure bond? Infrastructure bonds are often issued by either government or by private-sector actors with government backing to finance infrastructure projects of public interest. Governments that issue the bonds tend to offer additional incentives to investors in the form of tax incentives and guarantees. And if they’re issued by private builders or concession holders, the bond is typically seen as lower in risk because of the state backing.

They’re popular in emerging markets: There’s more background here from the World Bank and as you can see here and here, they’re popular in other emerging markets including India even with retail investors. Kenya’s government has occasionally issued tax-exempt infrastructure bonds, and they’re also increasingly being talked up in Asia.

Why is Egypt mulling infrastructure bonds rather than traditional funding methods? There is a strong appetite for infrastructure bonds, particularly from global investors, Assistant Finance Minister for debt Khaled Abdel Rahman tells Enterprise. That appeal, in addition to the fact that these bonds would be used to finance specific projects, whose progress can be measured on the ground, underpin their low borrowing costs relative to other international bond issuances by Egypt (including eurobonds), he added. Furthermore, infra bonds tend to be long-term, with average tenors of around 30 years, Abdel Rahman says. This makes it particularly appealing in light of the FInance Ministry’s 2019 debt reduction strategy, which calls for an increased reliance on long-term debt funding.

Where do things stand now? The government has opened initial talks with the Asian Infrastructure Investment Bank (AIIB), which a government source tells us may be interested in financing Egyptian infrastructure projects through these instruments. Preliminary talks are also happening with credit ratings agencies to gauge how the upcoming issuance will be rated, the source added. Meanwhile, a new Finance Ministry committee will study the global debt market to determine the size and timing of the infrastructure bonds the state may issue in FY2020-2021, Finance Minister Mohamed Maait said.

Look for a hint about the size of the initial program in the FY2020-21 budget, a draft of which will be public in the not terribly distant future. It’s not clear today whether the offering would be in local or foreign currency.

What projects can we expect to see being funded? The government is also currently studying which projects could be backed by infrastructure bonds. The head of the FInance Ministry’s public-private partnership unit, Ater Hanoura, has hinted that desalination plants and dry ports are on the list.

Green bond issuance will determine the timeline, pace and extent of infrastructure bond issuances: While the Finance Ministry is looking to champion their use as a form of cheaper, long-term debt, it is still in the experimentation phase as Egypt has yet to make an issuance and their use globally is still relatively scarce. The true litmus test for infrastructure bonds will be at the end of the current fiscal year, when we will see Egypt issue its first green bonds, Abdel Rahman told Enterprise. The success of these first issuances will determine the extent to which the government will rely on them and the timeline for any potential issuances going forward, he said. Egypt’s inaugural green bond issuance will likely be in the tune of USD 500 mn, he added.

There’s already private sector demand for these types of bonds: EFG Hermes is reportedly negotiating to manage an unnamed state company’s green bond offering, sources told the local press last week, without disclosing the value of the issuance. This comes as regulators are currently deciding whether to approve a EGP 500 mn green bond issuance by an unnamed Norwegian renewable energy company, according to a separate report.

The risks involved: Infrastructure bonds carry distinct risks — primarily factors unique to the projects themselves, the literature suggests, among them project delays and cost overruns. The long-term nature of the project also accentuates FX and inflation risks. Political, regulatory and technical risk also play roles.

Infrastructure bonds are picking up in popularity in Asia, and Europe has led the way. Analysts suggest infrastructure bond markets account for just under 12% of GDP in the European Union — and to just under 7% in Asia. China and India are quickly turning to them. The China-led AIIB priced its first global bond issuance to fund infrastructure projects in May 2019, raising USD 2.5 bn in five-year triple A rated bonds, according to Xinhua. At the time, AIIB’s CFO Thierry de Longuemar hailed the demand for the issuance. India’s government, meanwhile, has made infrastructure bonds a crucial element in funding its infrastructure projects in its 2020 budget, suggesting that the government plans to give investors in its infrastructure bonds tax credits, according to India’s Business Today.

Egypt’s international bond issuances have been successful over the past few years, which should bode well for any international infrastructure bond issuance. Egypt successfully issued USD 2 bn-worth of USD-denominated eurobonds in a triple-tranche issuance that went to market in November at “very good yields.” And while the government is looking to press pause on its reliance on USD-denominated eurobond issuances for the remainder of the current fiscal year, its international track track record will serve it well as it rolls out infrastructure and green bonds to the international market.

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