GCC countries advised to weather the financial storm and prepare for the future

Given the GCC's rapid growth, countries need to prioritize investment in their infrastructure. Governments, banks, and other stakeholders must collaborate to prioritize sector investment and provide or attract financing to enable infrastructure development to continue, finds a new report by Booz & Company.

Governments should prioritize projects that focus on long-term strategic objectives and establish the right legal and regulatory framework to attract and foster private-sector investment; and market its attractive growth prospects to global investors and developers.

"Governments can also support the creation of dedicated infrastructure investment vehicles within the region and structure deals that facilitate easier debt and private financing,"

commented Fadi Majdalani, a partner at Booz & Company.

Banks, lending institutions, and private-sector investors should avail of the significant growth opportunities in GCC infrastructure project financing. An array of investment vehicles are available to facilitate this.

The immediate future of GCC infrastructure
Infrastructure projects in GCC countries have increased at unprecedented rates. From 2002 to 2008, GCC governments awarded approximately $720bn worth of projects.

Yet spending has not always kept pace with economic and population growth: Kuwait still lacks capacity for peak load electricity production, Saudi Arabia and other GCC countries face water shortages, and the UAE is experiencing overloaded sewage plants and congested highways.

"GCC countries have not been spared from the global financial crisis and economic recession, with sharply reduced oil prices, decreased liquidity, and falling share prices on regional stock markets, which have impacted infrastructure developments in two ways," explained Walid Fayad, a principal at Booz & Company.

Lower oil prices threaten the fiscal health of GCC governments, potentially impairing their ability to spend on infrastructure; and the tight credit markets and disruptions in the loan syndication market limit the availability of long-term financing for it.

The impact of sharply reduced oil prices on governments' infrastructure spending

GCC governments continue to rely on oil exports for the bulk of their revenues despite recent diversification High oil prices allowed GCC governments to fund major development activities, including infrastructure, even while generating comfortable budget surpluses. Spending on infrastructure had risen to as much as 30% of the budget in some countries.

But with recent oil-price falls, governments face the possibility of running fiscal deficits.

Sovereign wealth funds (SWFs) and government-owned investment companies (GOICs) may step in to finance infrastructure projects as other pressing requirements compete with it for funding.

"It's important that SWFs and GOICs take a profit-driven approach when they participate in infrastructure development. They would also benefit from a broad effort to rationalize the current large number of funds and companies," explained Fayad.

The impact of the credit crisis on infrastructure financing

In recent years, loans granted by banks for PPP infrastructure financing rose to unprecedented levels, often fueled by governments' willingness to back them. These totaled more than $48bn in GCC countries in 2007/2008.

High oil prices and increased liquidity drove growth in local bank deposits from governments and wealthy individuals, allowing banks to extend infrastructure loans. Infrastructure funding demand however rapidly outpaced local banks' available funds, requiring participation from foreign banks. In Saudi Arabia, the UAE, and Qatar - European, Asian, and U.S. banks have provided most of the debt financing.

"In this new era, credit and loan syndication markets are disinclined to pursue long-term project finance deals and banks are reluctant to underwrite loans for large infrastructure projects, fearing the syndication overhang in a world of constricted liquidity," stated Majdalani. The cost of debt has also risen, affecting the financial viability of many projects.

Developers are having difficulty securing competitive underwritten loans, and, should the crisis persist, they will be more reluctant to commit to new projects.

"Because of this, a wave of planned infrastructure projects relying on syndicated infrastructure loans will probably be set aside, retendered, or delayed," Majdalani stated.

The way forward

The global downturn may affect the growth and spending priorities in the GCC region. Infrastructure stakeholders need to take immediate measures to support infrastructure development:

Governments

GCC governments cannot afford to overlook the fact that continued infrastructure spending is crucial to long-term economic development in GCC countries.

"GCC governments need to prioritize the infrastructure projects most in line with its strategic objectives. This will provide governments a clear framework for aligning regulations, incentives, and capital toward those deemed most critical," explained Fayad.

Governments also need to make sure that they have the appropriate legal and regulatory framework in place to foster private-sector investment, decrease risks to lenders and developers, and provide required incentives, especially to the emerging class of regional infrastructure and private equity funds. Steps to take include:

- Establishing transparent foreign direct investment and concession laws tailored to attract private sector investments under PPPs and public finance initiative schemes;
- Granting sovereign guarantees to lenders and developers;
- Making favorable, secured off take commitments in concession agreements, and establishing frameworks that minimize the private sector's long-term demand risks, in order to guarantee ade¬quate returns.

The governments also need to support the creation of infrastructure investment vehicles managed for profit. These should facilitate access to infrastructure financing in the region, so necessary projects can move away from reliance on foreign banks for funding.

"These vehicles can be used to attract financing from a variety of sources, including local and global banks and alternatives like private equity funds," commented Fayad.

Finally, GCC governments must structure deals that facilitate easier debt financing and private financing, by breaking projects into smaller pieces to make them more digestible to the credit markets and accessible to single developers. When breaking up these projects, governments need to ensure a continuity mechanism through public-private financial agreements.

They can also facilitate project financing by allowing for incomplete debt syndication, with the remaining debt requirements being covered by sponsor-guaranteed bridge financing, and by avoiding projects that require competing underwriting bids, which limits the pool size of lead arrangers.

Banks and Lending Institutions

Although governments create a framework for infrastructure projects that is favorable to debt financing, banks must also do their part in promoting and facilitating infrastructure financing, especially for their long-term financial health and growth. These projects require large volumes of debt at lower margins, but with government support, they carry the benefit to banks of proportionately lower risk.

To successfully and profitably support infrastructure developments, banks and financial institutions should consider the following:
- Banks should disintermediate themselves and take a more proactive approach to financing infrastructure projects relying more on the capital markets
- Banks should step in to provide short-term financing where necessary, provided they receive government and sponsor guarantees.

Banks should participate in state-sponsored infrastructure investment vehicles to reduce their overall risk while providing good investment return opportunities.

Industry players and other equity investors

In recent years, the average ratio of private to government expenditure in GCC countries has been below the OECD average, suggesting strong potential for more private sector involvement in infrastructure development.

"Governments can boost private sector investment through encouragement and support, but a long term strategy is required, as through recent initiatives such as privatisation of government assets and initial public offerings of public sector infrastructure companies," Majdalani stated.

Industry players and developers willing to demonstrate their commitment to the region by investing time, effort, and capital have the chance to secure a leading position in the GCC infrastructure market. Participation now also means a chance to establish market share, and a chance to benefit from debt recapitalization once the credit markets ease.

"Private-sector companies need to select specific sectors and projects based on their potential for financial performance and competitive advantage," Majdalani explained.

They must construct fact-based industry perspectives to help them anticipate the post-recovery structure of these industries and position themselves for future growth opportunities.

The private-sector should consider tapping into the capital markets to obtain additional and cheaper sources of financing and reduce dependence on syndicated bank loans. One avenue is private finance initiatives (PFIs), which allow the raising of funds in capital markets through the sale of corporate bonds issued by the company running the PFI. PPPs can also go this route, with the project company issuing bonds or sukuks directly.

Where bank lending is unavoidable, developers may need to give extra reassurance to lenders in order to secure credit: "Developers should consider reaching out to secure sovereign guarantees or themselves deviating from non-recourse project finance schemes," Fayad commented.

Finally, debt financing support may be obtained by private entities from foreign funds or export banks. Such arrangements require attracting foreign players into local infrastructure developments through such vehicles as joint venture collaborations.