Funding for Public sector infrastructure projects

The financial provision of infrastructure projects in the public sector is a tool to ensure their efficiency and quality.

The nature of the project and the particular environment determine the choice of financial instruments as well as the sources of funding. Usually, the state provides public funds from the national and local budgets, with budget funding based on many principles.

In different countries, various instruments for external financing of infrastructure projects are being implemented. The most commonly used sources are bank loans and loans from international financial institutions, syndicated loans, bonds, hybrid securities, and more. The sources of funding are diverse, and they are very different - banks, institutional investors, international financial institutions, and more. A significant source of long-term financing for infrastructure projects is also the grant schemes provided by European funds and international programs.

Funding sources for public sector infrastructure projects

The financing of infrastructure projects in the public sector is based on the following principles:

Principle of a division of competences

Within certain limits, funding from centralized and decentralized sources of public financial resources is subject to specific goals, priorities, criteria, and requirements for determining the scope of funded projects and activities.

Funding from extrabudgetary funds is governed by laws and regulations that set out eligible directions and types of costs borne by these sources.

Unlike extra-budgetary sources of funding, funding from the state budget is more flexible in that it provides funds for a wide range of projects, without imperative bans that exclude funding for certain groups of projects and activities.

Equality principle

The grant is made on a competitive basis, based on a system of criteria, formal requirements, and restrictions that are the same for all applicants.

For financing from extrabudgetary funds, the competitive start applies to projects of a specific type and activity. When financed from the state budget, the competitive start is implemented in a batch, i.e., the targeted grants are provided for a package of investment projects in different infrastructure sectors.

Complementarity principle

The provision of financial resources in practice respects the requirement for the complementarity of funding to support project implementation. Most often, this principle is implemented concerning the funds provided by the republican budget, and in recent years - in the case of financing with funds from the structural and investment funds of the European Union.

Principle of reasonable concentration

An investment project rated as acceptable in terms of funding sources shall be provided with priority over other projects to accelerate completion and entry into service.

The nature of the project and the specific environment determine the sources of funding. There are different classifications of sources for financing public projects. Depending on their origin, the funds are domestic (national and local) and external (from sources outside the country).

Based on the organizational structures that dispose of the funds, the sources of funding can be distinguished from centralized and decentralized. Depending on the level of fundraising and spending, they are defined as public and private. Finally, from ownership of the funds used, the sources of financing are their own and attracted (debt instruments and grants). In most cases, infrastructure projects are funded on a mixed basis - from different sources, through the appropriate forms and methods of financing.

Own sources of financing (funding) for infrastructure projects

Public sources of budget financing for infrastructure projects in the public sector are public funds provided by the state and municipal budgets. Funding shall be following the level of decision making. Budgeting is often done in two ways: centralized and decentralized.

The centralized financing of infrastructure projects

The centralized financing of infrastructure projects is implemented through the bodies of the central executive power - ministries, agencies, and other structures with competence at the national level. Funding is primarily for projects of socio-economic importance that go beyond local interests; for example, projects benefiting several municipalities or districts.

A considerable part of the regional projects are financed by the Ministry of Regional Development and Public Works (in the field of road infrastructure, drinking water supply, cross-border cooperation, etc.), the Ministry of the Environment and Water (in the field of wastewater treatment and waste management) ) and others.

The state budget finances municipal projects and programs through state transfers, including targeted subsidies for capital expenditures and other targeted expenditures set annually in the State Budget Act and following the provisions of the Public Finance Act. The targeted subsidies are used to carry out the state policy for the development of the municipalities and to implement local investment programs and projects.

Targeted subsidies to finance capital expenditures

Targeted subsidies are provided with a clearly defined purpose - to finance capital expenditures for construction and overhaul, for the acquisition of fixed assets, and research and design work and under certain conditions prescribed by law. These are, above all, requirements for sectoral priority and continuity over time - priority provision for sites in specific infrastructure sectors (eg, drinking water, health and social activities, education, and environmental protection), as well as the highest construction sites. 

In many countries, there is greater diversity in the forms of republican subsidies provided. Their nature and type are determined according to various criteria, such as restrictions on their use, methods for determining their size, method of municipal financing expenditures, the number of subsidies, and how they are spent. In addition to the targeted grants, these countries provide: 

  • Grants for specific projects (to finance certain municipal activities);
  • Subsidies according to an agreed formula (the amount of the subsidy is determined by given parameters and quantities, for example for urban transport in large cities); 
  • Supplementary subsidies (to offset the external effects of economic and social activities in the municipality or to promote the consumption of certain public services in the municipality); 
  • Limited grants (provided as an absolute amount for the implementation of a program or the implementation of a project); 
  • Unlimited subsidies (provided for the implementation of a local project of national importance).

Municipalities are the subject of decentralized financing of infrastructure projects. The own budget funds are allocated and allocated for the implementation of investment programs and projects by the decision of the municipal councils. It is their competence to determine the investment priorities and the sectoral affiliation of the funded projects.

Budgeting at a central and local level

Budgeting at central and local level is carried out following many principles: maximizing efficiency with minimum cost (budgets should only be made available if projects deliver the most significant impact); targeted use of budgetary resources (project financing takes place after the adoption of the annual budget and thus provides control over resource expenditure in the priority areas identified previously), provision of budgets according to the degree of implementation of the plans ensuring the implementation of already started projects).

An important source of capital financing for infrastructure projects is central public off-budget funds. Unlike state / local budgets, extra-budgetary funds have organizational autonomy and continuity over time. They are formed by various sources of public finances and invest in local and national projects. Usually, the provision of funds from these sources is made on an individual basis, on a competitive basis, after defending a set of requirements, criteria, and indicators. 

Funds raised for financing infrastructure projects

External financing

External financing instruments for infrastructure projects are widely used in different countries. The most commonly used financial instruments are loans from banks/consortium of banks, loans from international financial institutions; bond loans; hybrid securities; leasing; grant schemes, private equity.

Debt financing

Debt financing is a flexible and attractive method of providing part of the necessary financial resources for the implementation of projects. Debt financing is provided at the expense of funds attracted to the financial markets, such as bank loans, loans from financial institutions, syndicated loans, and bond loans.

Lending

Lending is carried out based on several principles: repayment, maturity, solvency, security, and target nature of the loan. Credit documentation is a contract that establishes the underlying conditions (loan value, loan term, method of utilization, repayment, guarantees, measures in case of the bad performance of obligations, etc.).

There is diversity in credit, and their application varies on a case-by-case basis. Depending on the scale of the infrastructure projects, we distinguish between short-term and long-term loans. Short-term loans are used to cover the costs at the time of project approval and to find funding for its overall financing (usually up to the design phase) or to complete the project stage (s). Typical of long-term loans provided by international financial institutions is that they lend most often to governments or less often to government guarantees.

Other borrowings may be used in parallel with the primary loan repaid as a principal obligation. Bank lending is practiced because of the high value of the project.

Depending on the nature of the project, loans are granted without guarantees or with a limited guarantee. Typically, bonding depends on the stage of the project being funded. At the construction stage, when costs are highest, and there is no revenue, the risk to creditors is highest, and the demand for guarantees is common. In some cases, at the operating stage, when income is generated, and receipts are guaranteed, warranties can be removed.

A typical debt instrument for financing infrastructure projects is bonding

A typical debt instrument for financing infrastructure projects is bonding. Bonds are a type of long-term interest-bearing securities issued by the government, local governments, banks, financial institutions, and companies. Bonds are a form of long-term loans used by the issuer. They may be of fixed or floating interest, which is charged on the face value of the bond. With each bond issue, there is a risk of non-payment associated with the inability to collect the interest and principal amounts.

The main parameters that determine the suitability of bonded loan financing are the scale and useful life of the project, the cost of financing, and the payout profile. These parameters need to be compared with those of bank lending to determine which financing is more appropriate for the project concerned.

Bonds are an alternative source of financing for infrastructure projects

Bonds are an alternative source of financing for infrastructure projects, especially if the project is of such size that the banking sector does not offer enough liquidity to provide attractive margins. Many projects are financed by bond loans, with timely interest and principal repayments guaranteed by insurance institutions whose primary business is providing credit guarantees to bondholders. As a result of the guarantee, the bonds themselves receive a high credit rating, which lowers the cost of the loan.

The main attractive feature of the bond market is the availability of financing with a long-term financial interest, which makes it not only cheaper than bank financing but also offers the possibility of extending the payback period of project debt, which in turn significantly improves the economic performance of the project.

On the other hand, bond financing also has some disadvantages. The trustees of the bonds have some authority. Still, they may not cover issues such as material changes to the project schedule, documentation, or situations that cause the creditors to intervene. The loan amount is provided to the investor after the project contract and the supporting documentation. In some cases, this does not satisfy the recipient, as it utilizes the loan of periodic parts against certificates from the engineer or architect confirming the completion of the respective design stages.

Debt financing has many advantages 

Regardless of the instruments used, debt financing has many advantages - it creates the opportunity to start infrastructure projects with financial plans provided to implement them according to the activity plans, allowing future users of infrastructure services to bear some of the burdens of debt.

Debt deficiencies also need to be taken into account. One of them is the commitment of a portion of revenue over a long period due to the long-term nature of these financial instruments. The possibility of a flexible response to changing economic conditions, political priorities, and the amount of revenue from consumer fees are also limited.

Project financing is widely used to finance large infrastructure projects

In some countries, project financing is widely used to finance large infrastructure projects. It is a method of financing long-term infrastructure projects as well as public service projects based on a financial structure without or with collateral, debt, and property used to finance the project being paid back from the cash flows generated by the project. Project financing relies primarily on financial markets and markets for the provision of services, as well as their regulation. Project financing offers opportunities and resources to investors, creditors and other participants in it to absorb and share costs, benefits, and risks in an economically viable way, through the selection and implementation of individual financial instruments used for a specific purpose.

The positive features of project financing that differentiate it from traditional project financing can be summarized as follows:

  • Financing an overall project, determining the cash flows from its use, not the products being manufactured or marketed;
  • The lenders finance the project based on its return, not on the solvency of the project company.
  • It is based on a contractual framework involving several interconnected contracts with third parties - suppliers, customers and government bodies, which is of particular importance for securing credit;
  • The repayment of the loan is guaranteed by the proceeds from the operation of the site, following the terms of the signed contracts, and not by the financial resources of the project itself;
  • The applicability of contracts and accountability are more critical to creditors than investor creditworthiness;
  • Investors, for their part, also rely on the perfect contractual framework, which is a sure guarantee to minimize risk and uncertainty.

Project funding also has certain weaknesses related to 

  • Complex and lengthy work on developing the financial package; 
  • A high level of spending on these activities; 
  • The existence of a large number of risks arising from the diversified contractual relationship; 
  • Higher interest rates, fees and commissions for debt service; 
  • Additional regulatory procedures with different effects on the project;
  • The vulnerability of project financing to the instability of financial services markets, etc.

The sources of external financing for public sector infrastructure projects can be different, and the funding sources themselves are very diverse: banks, institutional investors, international financial institutions, etc. These are institutions with experience and experience in project financing.

Commercial banks are the most traditional source of financing

Commercial banks are the most traditional source of financing with attracted capital. Their profit is formed through the mechanism of interest rates, bank commissions, service fees, and other tariff revenues and capital investments. For this reason, the activity of commercial banks focuses on the interest margin gain between lending (purchasing credit obligations) and attracting deposits (borrowing). Emphasis is placed on the creditworthiness of borrowers and the guarantee of their loans.

In this sense, bank loans are mainly short-term and medium-term and less risky. Commercial banks are, therefore, not a particularly suitable source of financing for large infrastructure projects. Moreover, when financing projects, banks usually impose strict restrictions on borrowers regarding the structure of debt financing and the loan guarantee, which provides them with a significant degree of influence on project implementation. The restrictive terms and conditions contained in a project credit agreement allow creditors to exercise control and maintain a substantial degree of involvement at all stages of the project.

A positive feature of commercial banks is their flexibility, expressed in the tendency to assist in the implementation of the project in case of changes in the specific needs of clients in difficult situations in case of default or delayed payments. To avoid these side effects, commercial banks carefully evaluate issues such as sponsor engagement, the reliability of estimates, the experience and skills of the management team, and government support for the project.

National and regional development banks for financing investment projects

National and regional development banks have a role to play in financing investment projects. These institutions are widely involved in the implementation of infrastructure projects with proven economic viability and relevance to public sector development.

In situations where projects are clearly of national interest but are not financially feasible, financial development institutions can provide guarantees for good implementation, secondary loans, low-interest rate loans, and equity. Such interventions attract additional funding from the private sector and increase the return on investment in it. In this way, financial development institutions create an environment that encourages private sector involvement in project implementation.

Such structures are regional development agencies, which are legally independent, non-governmental, and decentralized structures operating at the regional level. Membership of local authorities is allowed. They aim to support the socio-economic development of the regions and increase their investment activity. The formation of trust funds provides opportunities for financing specific investment projects and activities in various infrastructure sectors and regions.

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  1. Summary

    Public sector infrastructure projects require the efficient and quality financial provision, which depends on the project's nature and environment. Funding sources and financial instruments are chosen accordingly, with the state typically providing public funds from national and local budgets based on budget principles.

    External financing instruments

    Different parties use various external financing instruments for infrastructure projects such as bank loans, loans from financial institutions, bonds, and grant schemes from European funds and international programs.

    Public infrastructure projects are financed based on principles of competence division. Funding from centralized and decentralized sources is subject to specific goals, priorities, criteria, and requirements. Extrabudgetary funds have laws and regulations governing eligible directions and costs. State budget funding is more flexible, providing funds for a wide range of projects without prohibitions.

    Grants

    Grants are awarded competitively based on the same criteria and requirements for all applicants. For extrabudgetary funding, competition applies to specific project types, while state budget funding is provided in a batch for various infrastructure projects.

    Financial resources must complement each other to support project implementation. This is usually applied to funds from the national budget and EU structural and investment funds.

    Priority is given to investment projects with acceptable funding sources to speed up completion and entry into service. Funding sources for public projects can be domestic or external, centralized or decentralized, public or private, and own or attracted. Infrastructure projects are usually funded from multiple sources and financing methods.

    National-level bodies

    Infrastructure projects are financed centrally through national-level bodies such as ministries and agencies. Priority is given to projects that have socio-economic importance beyond local interests. The Ministry of Regional Development and Public Works and the Ministry of the Environment and Water finance many regional projects.

    Municipal projects

    The state funds municipal projects through targeted subsidies set annually in the State Budget Act, following the Public Finance Act. These subsidies support the development of municipalities and local investment programs.

    Targeted subsidies finance construction, acquisition of assets, and research under specific conditions. Priority is given to infrastructure sectors like water, health, education, and the environment.

    Many countries offer a variety of republican subsidies based on different criteria such as restrictions on their use, methods for determining their size, and how they are spent. These subsidies include grants for specific projects, subsidies based on an agreed formula, supplementary subsidies, limited grants, and unlimited subsidies for local projects of national importance.

    Municipalities finance their own infrastructure projects and decide on investment priorities and sectoral affiliation.

    Budgeting principles

    Budgeting principles include maximizing efficiency, targeted use of resources, and provision of budgets based on plan implementation. Central public off-budget funds are a significant source of infrastructure financing, with organizational autonomy and continuity. These funds are sourced from public finances and invested in local and national projects through a competitive process.

    Infrastructure projects

    Infrastructure projects often use external financing instruments such as bank loans, loans from international financial institutions, bond loans, hybrid securities, leasing, grant schemes, and private equity.

    Debt financing is a flexible way to get funds for projects. It comes from financial markets like bank loans, financial institution loans, syndicated loans, and bond loans.

    Lending

    Lending is based on principles such as repayment, maturity, solvency, security, and the target nature of the loan. Credit documentation is a contract that establishes conditions such as loan value, term, utilization method, repayment, guarantees, and measures in case of bad performance. Credit varies depending on the project scale, with short-term loans covering costs at project approval or completion stages, and long-term loans usually provided by international financial institutions to governments or government guarantees.

    Loans

    Loans may be used alongside the main repayment, due to the project's high value. The type of loan and guarantees offered depend on the project stage. During construction, when costs are high and there is no revenue, guarantees are common. However, during the operating stage, when income is generated and receipts are guaranteed, warranties may be removed.

    Bonds

    Bonds are a common debt instrument for infrastructure projects. They are long-term loans issued by various entities and can have fixed or floating interest. However, there is a risk of non-payment. The suitability of bond financing depends on project scale, useful life, cost, and payout profile compared to bank lending.

    Bonds offer cheaper and long-term financing for projects, improving their economic performance. However, trustees have limited authority and may not cover all project changes. Loan disbursement may also require periodic certificate confirmation.

    Debt financing has advantages as it allows for infrastructure projects to be started with financial plans and for future users to share the burden of debt. However, committing revenue over a long period and limited flexibility in response to changing economic conditions are drawbacks.

    What is Project financing?

    Project financing is a popular method in some countries to fund large infrastructure and public service projects. It involves a financial structure without or with collateral, debt, and property, where the project's cash flows pay back the financing. Financial markets and service markets are relied on for project financing, which allows investors, creditors, and other participants to share costs, benefits, and risks. This is achieved through individual financial instruments chosen for a specific purpose.

    Project financing is different from traditional financing because it involves financing the entire project and determining cash flows from its use. Lenders finance the project based on its return, not the solvency of the project company. A contractual framework involving third parties is important for securing credit. Loan repayment is guaranteed by proceeds from site operation, not the project's financial resources. Contracts and accountability are critical to creditors. Investors rely on a perfect contractual framework to minimize risk and uncertainty.

    Weaknesses of Project Funding

    Project funding has weaknesses such as lengthy financial package development, high spending, diverse contractual risks, and vulnerability to financial market instability. Public sector infrastructure projects can be financed by various sources including banks, institutional investors, and international financial institutions with experience in project financing.

    Financing from commercial banks

    Commercial banks provide financing through interest rates, commissions, fees, and investments. They focus on the interest margin between lending and deposits, emphasizing borrower creditworthiness and loan guarantees. Bank loans are typically short to medium-term and less risky, making them unsuitable for large infrastructure projects. Banks impose strict restrictions on borrowers and exercise control over project implementation through project credit agreements.

    Commercial banks are flexible and can help clients with changing needs or difficult situations, but they assess factors like sponsor engagement and management skills to avoid problems like default or delayed payments.

    Funding from development banks

    Development banks finance investment projects, especially infrastructure projects of national interest. Financial development institutions can provide guarantees, loans, and equity to make financially unfeasible projects viable and attract private-sector funding. Regional development agencies aim to support socio-economic development and increase investment activity in their respective regions through trust funds.

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