Small and beautiful?

There’s a bit of a paradox in emerging markets. Observers largely agree that a boost in infrastructure investment, as a precondition to a competitive economy and a thriving business ecosystem, should be one of the first policies pursued by their governments. And there is a recognition that, across many developing nations, constrained public resources mean that private capital should be called in early to help.

Yet it’s also the case that specialist funds are still playing only a small part in the financing of emerging markets’ infrastructure programmes – while their private equity buyout counterparts have been active in many of them for more than a decade.

The picture is not so clear-cut in the largest developing nations, where frameworks have been created to foster a greater involvement of institutional financiers; insiders cite markets like the Philippines or Mexico that have taken visible steps to entice private investors. But that leaves a whole raft of smaller nations where infrastructure needs are great and political progress is encouraging – and yet where institutional money is nearly completely absent.

Take Serbia, for example. The 7.2 million-strong nation elected a new government last March on a mandate of sweeping reforms including privatisations, changes to labour legislation and an ambitious infrastructure upgrade. Yet the latter will most likely require the private sector – alongside Development Finance Institutions (DFIs) – to do much of the heavy lifting. Still reeling from disastrous floods that hit its energy sector hard, Serbia’s economy is expected to contract by 0.5 percent this year – putting even more pressure on the government to rein in spending.

Local investors think the country understands this. Siniša Mali, Mayor of Belgrade, last October unveiled a rather impressive range of projects: a €1.2 billion metro system; a €250 million waste-to-energy plant; 16 underground garages; a new main bus terminal; a €25 million new main train station; the expansion of the Suburban-Urban rail; a €182 million waste water treatment project; and the expansion of the city’s international airport, budgeted at more than €1 billion. He was eager to underline that the government would be seeking external sources of funding, largely through public-private partnerships (PPPs).

A number of local experts we spoke to are optimistic that a good portion of these will go through – notably because some of them have already attracted funding from private financiers. But they also provide good reason to think that not many of these investors will come from the institutional world – at least for now.

The country has relatively advanced PPP laws, insiders say, but rather weak enforcement mechanisms; it also remains to be seen how the various projects will be integrated in practice. Yet more of an issue is the fact that most of the projects being touted are in the greenfield space, while observers say most institutional investors are keener to invest in operating, cash-yielding assets.

Still, a number of blue-chip funds regularly invest in greenfield, and some of them have been known to target emerging markets. The main reason why institutional capital is not yet eyeing opportunities in Serbia, others note, is probably more straightforward: the country still doesn’t offer a pipeline sufficiently developed for investors to spend the time and resources needed to understand its political, legal and regulatory frameworks.

A second, related point lies in unrealistic return expectations. One banker operating in the region says that resilient political and regulatory risks in Serbia mean private players wouldn’t consider investing there unless they can generate internal rates of return (IRRs) of nearly 25 percent, an ambitious target to say the least for core infrastructure assets.

As was noted during Infrastructure Investor’s first Emerging Markets Forum in October, investor appetite for developing nations is growing. But market feedback suggests smaller countries will only receive their slice of the institutional pie once their frameworks, sufficiently tested, are able to deliver both solid guarantees and sufficient scale.