March 23, 2016

Using Debt Finance to Grow Rapid Transit Infrastructure

Rio de Janeiro_Transoeste BRT

Rapid transit infrastructure is one of the most beneficial – and costly – investments that a city can make. Governments must often invest hundreds of millions or even billions of dollars into the design, construction, and procurement of infrastructure for rapid transit projects. Meanwhile, the economic benefits, though significant, only accrue over the course of several decades. Debt finance is widely considered the optimal financing strategy for such large investments, as it allows authorities to implement projects with much less initial capital investment, then pay off the investment using returns generated from the project itself, in the long term. Debt finance is a critical tool for cities with limited budgets and many demands for capital.Picture1

An additional benefit of debt finance is that it ensures that the population benefiting from the project will be the population paying off the project over time. Projects paid for in cash use money accumulated through taxes in the past to pay for the infrastructure of the future. Additionally, many debt-financed projects often undergo significantly more review because lenders are incentivized to critically evaluate a project’s design to ensure that the investment is a good one and the loan will be repaid.

Governments access debt finance in the form of loans or bonds from five main sources: Bonds, national development banks, multilateral development banks, commercial banks, and bilateral lending (including export credit agencies). The chart below shows the average portion of projects financed by different debt sources in nine countries, based on the financing details of 90 projects sampled.  Ideally, governments should aim to finance up to 70% of a project’s cost using debt. However, the figures show that only Colombia is maxing out its use of debt to finance 70% of project cost on average.  This means that one strategy for governments to increase investment in rapid transit is to increase the use of debt financing.

Check out our full report here.
Check out our full report here.

Further, each source of financing has advantages and disadvantages along the following criteria: Credit rating required, interest rate, repayment period, special loan conditions, and any other transaction costs. Governments should actively pursue the most advantageous debt sources.

Bonds tend to have the advantageous lending terms, but require strong credit ratings, which governments should work to improve. National and multi-lateral development banks are another low-cost source of debt finance, though there is often higher conditionality on the loans. Actively seeking and employing low-cost debt to leverage limited capital for high quality rapid transit is one strong strategy for governments at any level to increase rapid transit investment.

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