How asset recycling helps governments to pay for infrastructure

Many governments are increasing their borrowing to pay for infrastructure and the recent bipartisan US infrastructure bills worth an eye-watering $3.5 trillion are a case in point. Closer to home, media reports in May 2021, indicated that Kenya had borrowed Sh132 billion for infrastructure projects over six months. It’s no secret that taking on additional debt is problematic for us, considering that Kenya’s debt repayment for the financial year 2021/22 is budgeted at Sh1.169 trillion — which is 36.6 percent of the budget and around 65 percent of total tax collection.

Financing government spending on infrastructure will only get more difficult, particularly when coupled with the vehement resistance of taxpayers to any proposed tax hikes, as shown by the recent brouhaha surrounding minimum tax and excise duty inflation adjustments.

It is, therefore, critical that the government looks for innovative ways of financing its infrastructure requirements going forward. One such avenue to explore is asset recycling, which refers to the funding of new infrastructure through proceeds from the leasing of existing public assets to private parties.

The pivotal idea behind asset recycling is that the lease income generated should be applied strictly towards developing other infrastructure. The government would, therefore, need to put in place mechanisms to ring-fence such income and have sound spending plans for new infrastructure.

From an investor perspective, asset recycling is attractive as it is de-risked since the assets are already operational. The high risk associated with the construction phase of infrastructure development is, therefore, taken out of the equation.

In case there is any confusion between asset recycling and the procurement of management services from an experienced and qualified third party, the latter carries a significant affordability risk. This is because high-quality management services are expensive and the current performance of the assets to be managed may be too weak to pay such fees from the outset. In addition, a third-party manager would have less control over the asset than a lessee, which may hamper their bid to make the asset profitable.

Asset recycling is not a new concept. Australia appears to be one of the pioneering forces behind it as it embarked on the asset recycling journey as far back as 2014.

Some of the assets, which have been successfully leased to private parties include the port of Melbourne and 50.4 percent of Ausgrid, the largest distributor of electricity on Australia’s east coast. A private investor has even been granted a 40-year concession over the land titles registry.

The big question is whether asset recycling can work in Kenya.

Unfortunately, there is no quick answer to this question considering the issues to be factored into such an assessment. One of the most challenging aspects is the identification of an asset to be recycled. A qualifying asset needs to have sufficient long-term commercial value to a private investor. Examples may include a port, airport, power or water utility, a rail network, a toll road or public housing.

Others are national game parks and reserves. Some of these assets may, however, be of such public importance that the government cannot cede any control over them due to national security concerns — a case in point would be a national fibre optic network.

Given the sensitivity, therefore, robust contractual arrangements would need to be put in place to ensure the protection of national interests while building in some flexibility. The government’s oversight should not suffocate the private investors who shall, on their part, require sufficient room to generate a return without political interference.

Another bridge to cross in asset recycling is identifying eligible investors with the expertise, track record, financial muscle and responsible business ethic to lease public assets.

In the Australian context, the asset recycling investors included sovereign wealth funds and institutional investors with a reputation for trustworthiness and stability.

Turning then to the enabling legal framework in Kenya, asset recycling through leasing could be structured as a public-private partnership (PPP) under the PPP Act. The upside of this is that it would go through a rigorous procurement process requiring detailed feasibility studies, which should ensure that the asset leasing transaction is thought through and risks are mitigated. An outright sale of a public asset would come under the ambit of the Privatisation Act but the State may prefer to retain ultimate ownership of its strategic assets, hence a long-term lease is more tenable.

Apart from understanding the regulatory regime, an investor would also be keen to understand the level of judicial independence, competence and effectiveness, especially relating to a contract in which the government or a State-owned enterprise is a counterparty. This could mean dispute resolution clauses, which provide for international arbitration.

In terms of the impact of asset recycling, apart from the evident economic benefits to the government, the leasing of public assets to a private investor can have the positive effect of greater efficiency in the delivery of public services.

However, this could come at the cost of staff rationalisation and few elected leaders would have the political appetite for the resulting redundancies. A private investor would also streamline the procurement function for the asset they are leasing, which is good for the bottom line, but which in itself could provoke resistance from anyone who may have been treating the affected asset as a personal cash cow.

Overall, once the initial birth pains of commencing on asset recycling are over, it is hoped that the benefits to the government, public and investor would kick in and be felt over the term of the project. Hopefully, asset recycling, if embraced, can form part of the government’s arsenal towards achieving some of its Big Four agenda items and Vision 2030 goals in a sustainable manner.

Nyabira is a partner and head of the projects, energy & restructuring practice at DLA Piper Africa, IKM Advocates and Judy Muigai is a director within the same team.