Opinion: Smart cities funding and financing in developing economies

As is often cited, by 2030, 60 percent of the world will live in cities. The world’s population is projected at 8.5 billion people by 2030 thus more than 5 billion people will reside in cities. To prepare, governments around the world are exploring ways to sustain the growing demand for infrastructure to accommodate city living.

Governments spend $2.5 trillion on building and repairing infrastructure each year and low- and middle-income countries require an additional $1.3 trillion of public infrastructure investment. Still, this will not meet current demand for transportation, water, power, sanitation, energy, telecommunications, and other infrastructure. Certainly, it’ll not be enough to meet future needs.

So, what is the solution? Public funding combined with private sector participation in projects offers greater capacity to city governments in developing economies to implement their infrastructure projects, as traditional funding approaches will not be sufficient to meet their significant infrastructure needs. You may ask, what does the future hold for low- and middle-income countries?

Evaluating finance options

Infrastructure spending is driven by several global trends such as increasing urbanization, lack of funds, elevated risk, and the availability of financial support from international development organizations, or IDOs.

Although IDOs can help cities with lower-than-market-rate concessional finance, technical assistance, and private financing, city governments should evaluate and understand private financing approaches, identify the financing structure for their high-impact infrastructure projects, and choose the adequate procurement model for implementation.

Deloitte’s three-step approach allows project teams to evaluate infrastructure projects and determine the need for private sector and IDO financing. This approach includes:

• Understanding project and value in terms of business model, generated value, and how it can be captured.

• Considering all funding and finance options.

• Determining relevant procurement and delivery methods.

What financing options are best for my city?

For global cities, the most common sources of finance for infrastructure projects are public funds in the form of own-source revenues and intergovernmental transfers.

Own-source revenues include taxes and fees. Intergovernmental transfers are grants provided by higher levels of governments to cities for a project.

It’s important to evaluate the following private and multilateral financing mechanisms, in addition to exploring options to blend or combine multiple mechanisms:

• Project financing. This is the financial assessment where remuneration is set based on the estimated cash flows and profits generated by that project.

• Traditional loans and leases that allow a government to pay for an infrastructure investment over time.

• Vendor finance. This is when an equipment vendor offers financing for a project.

• Multilateral investment loans, or “concessional finance”: IDOs and multilateral development banks provide five- to 10-year investment loans for financing.

• Multilateral risk guarantees. These cover a specific sovereign or political risks.

• Multilateral credit guarantees. IDOs also use credit guarantees to cover all risks borne by a private lender within a specified financing period.

• Blended finance. This mechanism refers to a combination of IDO concessional finance with commercial finance.

With a range of procurement structures and/or mechanisms to accommodate their business models, value capture, and funding/financing strategies, city governments can choose the structures that best suit their needs. Some options include direct delivery, operating contracts, joint venture, and public-private partnership.

Success stories

Several developing economies have shown exemplary advancements to meet their infrastructure needs. For example, across the Africa region, mobile phone-based technological innovations have allowed countries in the region to surpass or leapfrog challenges in both communication and financial infrastructure. Mobile banking applications have also reduced the need for common financial sector infrastructure, allowing users to transfer value through phones rather than relying on brick-and mortar banks or ATMs.

Another example is the city of Buenos Aires, Argentina. In 2010, Buenos Aires, similar to other cities, implemented a new mobile app that has improved its response to infrastructure issues and helped to head off some problems before they even occurred. Today, citizens can use the app or social media to ask the government to fix potholes, remove graffiti, or respond to other issues. The citizen might tweet a picture of a broken sidewalk with a short description. Using integrated geographic information system technology, the app sends the location of the problem to the relevant government agency and a vendor is dispatched for repairs. Then a city street inspector uses a mobile device to confirm and document the completed work and citizens can submit their feedback.

Utilizing technological advancements thus allows cities to leapfrog certain infrastructure needs and better rationalize public funding for infrastructure and other policy priorities. In addition, as we have seen, public funding combined with private sector participation in projects offers greater opportunities for city governments to develop and implement their infrastructure projects.

Traditional funding approaches will not be sufficient to meet their significant infrastructure needs.