Subsidies

While infrastructure finance focuses on the initial sources of investment financing, the ultimate sources of project revenues can only be generated from user fees or taxes.  Some infrastructure sectors (power supply, ports, airports, telecommunications) depend for full cost recovery on direct user fees, while others (water supply, urban transport, roads) often require subsidization through taxes in addition to the user fees.  Subsidies are thus an instrument to ensure full cost recovery where user fees are kept low for reasons of affordability or externalities.  However, subsidies can also be a key factor in mobilizing financing for private infrastructure projects.

To raise private financing, government subsidies can be broadly structured in the following two different ways:

• A subsidy as an integral element in the initial government capital contribution, which reduces the up-front private financing requirements, and thus subsequently reduces the level of user fees for full cost recovery.
• After financing the initial capital investments entirely though private sources, a subsidy as a subsequent on-going payment by the government, to keep user fees at affordable levels during the operating phase.  This structure aims at ensuring sufficient utility cash flow to cover all financial obligations, including the debt service and the return on shareholders’ equity.

The recent focus has increasingly turned towards subsidies that can be targeted and can be linked to the delivery of specific outputs, such as electricity delivered or connections provided. Structured as Output-Based-Aid (OBA), these subsidies can improve effectiveness of service delivery by delegating it to private entities and tying subsidy payments to outputs. Financially, OBA subsidies form part of a project’s cash flows and thus provide the basis, along with user fees, for mobilizing private financing of the up-front capital investments.

The World Bank manages the Global Partnership on Output Based Aid (GPOBA), a multi-donor trust fund established to design pilot projects for OBA approaches and demonstrate aid effectiveness via application of efficient service delivery to the poor.  GPOBA offers support in the design and development of OBA projects and provides financing for the output-based subsidies to catalyze public-private partnerships.