Credit Enhanced Infrastructure Bonds in Emerging Markets Book by Venu Prasath

Credit
Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath
Credit Enhanced
Infrastructure Bonds
In Emerging Markets
By
Venu Prasath.T
M.Sc International Construction Management
University Of Leeds
United Kingdom
Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath
Dedication
I dedicate this work to my Family, Teachers, Friends and God for their dedicated
participation for success in my life.
ACKNOWLEDGEMENT
I would like to thank my supervisor, Prof. Nigel Smith, for the patient guidance,
encouragement and advice he has provided throughout this book. I have been
extremely lucky to have a guide who cared so much about my work, and who
responded to my questions and queries so promptly.
I would also like to thank my family and friends for their moral support throughout
the year during my MSc studies.
ABSTRACT
In this research the author recommends increased use of bonds as a financing
instrument in emerging markets. It is common in the current market condition where a
borrower from emerging markets had to go into complex process for gaining
infrastructure investments compared to a borrower from a developed country all due
to credit risk involved. In this research, the author developed an improved credit
enhancement process that might help borrowers in emerging markets increase
investments in a less complex way than the previous condition. The potential of bonds
as infrastructure financing upgrading it with credit enhancement feature to fit in and
reduce the funding gap and increase the infrastructure investments in emerging
markets. Making it a significant tool for mitigating the credit risk involved in
emerging markets.
Table of Contents
Dedication ............................................................................................................................ 2
ACKNOWLEDGEMENT ...................................................................................................... 3
ABSTRACT ............................................................................................................................ 4
List of Figures: .................................................................................................................... 8
List of Tables: ...................................................................................................................... 8
Chapter 1: Introduction ..................................................................................................... 9
1.1 Introduction: ........................................................................................................................... 9
1.2 Research: ............................................................................................................................... 11
1.3 Literature Review: ............................................................................................................... 12
1.4 Research Methodology: ...................................................................................................... 12
1.5 Limitation and exclusion: .................................................................................................. 12
1.6 Dissertation outline: ............................................................................................................ 13
1.7 Chapters: ............................................................................................................................... 13
Chapter 2: Existing Use of Bonds ................................................................................. 15
2.1 Introduction: ......................................................................................................................... 15
2.2 Bonds: ..................................................................................................................................... 15
2.3 Types of Bonds: .................................................................................................................... 16
2.3.1 Conventional Bonds: ................................................................................................................... 16
2.3.2 Indexed Bonds: ............................................................................................................................. 17
2.3.3 Asset Backed and securitized bonds: ..................................................................................... 17
2.4 Bonds by Issue: ..................................................................................................................... 18
2.4.1 Government Bonds: ..................................................................................................................... 18
2.4.2 Sub Sovereign Bonds: ................................................................................................................ 18
2.4.3 Corporate Bonds: .......................................................................................................................... 19
2.5 Bond Markets: ...................................................................................................................... 19
2.6 Domestic Bond Markets: .................................................................................................... 20
2.7 International Bond Markets: ............................................................................................ 21
2.8 Foreign Bonds: ..................................................................................................................... 22
2.8.1 Eurobonds: ...................................................................................................................................... 22
2.9 Infrastructure finance through bonds: ........................................................................... 23
2.9.1 Traditional Infrastructure financing: ...................................................................................... 24
2.9.2 PPP infrastructure bonds: .......................................................................................................... 24
2.10 Summary: ............................................................................................................................ 25
Chapter 3: Challenges in infrastructure funding in emerging markets ............... 26
3.0 Introduction: ......................................................................................................................... 26
3.1 Infrastructure in Emerging Markets: ............................................................................. 26
3.1.1 Bank Loan Funding: .................................................................................................................... 28
3.1.2 Equity Financing: ......................................................................................................................... 28
3.2 Domestic Funding: ............................................................................................................... 29
3.2.1 Domestic Risk: .............................................................................................................................. 29
3.3 International Funding: ....................................................................................................... 30
3.3.1 International Risk: ........................................................................................................................ 30
3.4 Credit rating: ........................................................................................................................ 30
3.4.1 Effects of Credit Ratings: .......................................................................................................... 31
3.5 Sovereign Rating: ................................................................................................................ 32
3.6 Infrastructure Deficit In Emerging Markets: ............................................................... 32
3.7 Summary: .............................................................................................................................. 33
Chapter 4: Credit Enhancement option & Existing Credit Enhanced schemes . 35

4.0 Introduction: ......................................................................................................................... 35
4.1 Credit Enhancement: .......................................................................................................... 35
4.1.1 Senior/subordinated: ................................................................................................................... 36
4.1.2 Overcollateralization: .................................................................................................................. 36
4.1.3 Reserve funds: ............................................................................................................................... 37
4.1.4 Spread Accounts: .......................................................................................................................... 37
4.1.5 Letter of Credit: ............................................................................................................................ 37
4.2 International Agencies guarantee: ................................................................................... 37
4.3 Pilot Program Projects: ...................................................................................................... 40
4.4 Europe 2020 Project Bond Initiative: .............................................................................. 40
4.4.1 Implementation: ............................................................................................................................ 42
4.5 UK Guarantees Scheme 2012: .......................................................................................... 43
4.5.1 Implementation: ............................................................................................................................ 44
4.6 Hadrians Wall Capital 2009: ........................................................................................... 44
4.6.1 Implementation: ............................................................................................................................ 45
HWC debt initiative (Murphy, 2011) .................................................................................. 46
4.7 IIFCL Credit Enhanced bond: ......................................................................................... 46
4.7.1 Implementation: ............................................................................................................................ 47
4.8 Summary: .............................................................................................................................. 48
Chapter 5 Research Methodology ................................................................................. 50
5.1 Introduction: ......................................................................................................................... 50
5.2 Research Methodology: ...................................................................................................... 50
5.3 Characteristic of Research: ............................................................................................... 51
5.4 Research Methods: .............................................................................................................. 52
5.4.1 Basic Research: ............................................................................................................................. 53
5.4.2 Applied Research: ........................................................................................................................ 53
5.4.3 Quantitative and Qualitative Research: ................................................................................ 54
5.4.4 Descriptive Research: ................................................................................................................. 54
5.4.5 Predictive Research: .................................................................................................................... 55
5.4.6 Explanatory Research: ................................................................................................................ 55
5.4.7 Exploratory Research: ................................................................................................................ 55
5.5 Research Strategy & Approach: ...................................................................................... 56
5.6 Research Sample Selection: ............................................................................................... 57
5.7 Research Data Sources: ...................................................................................................... 60
5.7.1 Credit rating: .................................................................................................................................. 60
5.7.2 Infra Investment and funding gap: ......................................................................................... 61
5.8 Research Method Selection: .............................................................................................. 62
5.8.1 Literature Search: ......................................................................................................................... 62
5.8.2 Applied Research: ........................................................................................................................ 63
5.8.3 Quantitative Approach: .............................................................................................................. 63
5.9 Selecting Data Collection Approach: .............................................................................. 64
5.9.1 Secondary Data: ............................................................................................................................ 64
5.10 Summary: ............................................................................................................................ 65
Chapter 6:Development of Credit enhancement ....................................................... 67
6.0 Introduction: ......................................................................................................................... 67
6.1 Infrastructure funding by emerging countries: ............................................................ 67
6.1.1 Brazil: ............................................................................................................................................... 68
6.1.2 India: ................................................................................................................................................. 68
6.1.3 Nigeria: ............................................................................................................................................ 69
6.1.4 Indonesia: ........................................................................................................................................ 69
6.1.5 Attracting Institutional Investors: ........................................................................................... 70
6.2 Credit Rating: ....................................................................................................................... 70

6.2.1 Bond Yield: .................................................................................................................................... 72
6.2.2 Relation between Yield rate and Credit Rating: ................................................................ 73
6.3 Credit Enhancement: .......................................................................................................... 75
6.3.1 Working of Credit Enhancement for Emerging Countries: ........................................... 76
6.3.2 Credit Tranching Mechanism: ................................................................................................. 77
6.3.4 Eligibility Criteria: ....................................................................................................................... 78
6.4 Implementation: ................................................................................................................... 79
6.4.1 Creating Special Purpose Vehicle (SPV): ............................................................................ 80
6.4.2 Providing Guarantee: .................................................................................................................. 80
6.4.3 Improving Credit Quality: ......................................................................................................... 81
6.4.4 Claims and Repayment: ............................................................................................................. 83
6.5 Alternative Option ............................................................................................................... 84
6.5.1 Stand-alone Government Guarantee: ..................................................................................... 84
6.5.2 Bond Insurance: ............................................................................................................................ 85
6.5.3 Letter of credit: ............................................................................................................................. 86
6.6 Summary: .............................................................................................................................. 86
Chapter 7: Conclusion ..................................................................................................... 88

7.1 Introduction: ......................................................................................................................... 88
7.2 Existing Use of Bonds: ........................................................................................................ 88
7.3 Infrastructure funding challenges in emerging markets: ........................................... 90
7.4 Existing Credit Enhancement option: ............................................................................. 91
7.5 Development of credit enhancement for emerging markets: ..................................... 92
7.6 Recommendation: ................................................................................................................ 93
7.7 Limitation: ............................................................................................................................. 93

List of Figures:

Figure 1: EIB project financing model __________________________________________________________________ 42

Figure 2: HWC Debt Initiative ___________________________________________________________________________ 46
Figure 3: Infrastructure Spending Data as of 2012 ____________________________________________________ 70
Figure 4: Government 10Y Bond Market Trend _______________________________________________________ 74
Figure 6: Credit enhancement co-operation triangle __________________________________________________ 79
Figure 7: Bond issue credit support structure __________________________________________________________ 83
List of Tables:

Table 1: Sovereign Credit rating by S&P _______________________________________________________________ 71

Table 2: Moody's Sovereign Rating _____________________________________________________________________ 71
Table 3: Fitch Sovereign Rating _________________________________________________________________________ 71
Table 4: Credit Rating Arrangement ___________________________________________________________________ 72
Table 5: Sovereign Rating by S&P as of Aug 2013 _____________________________________________________ 74
Table 6: Example Bond class ____________________________________________________________________________ 82
Chapter 1: Introduction
1.1 Introduction:
Developing infrastructure is one of the top priorities for any government of emerging
markets. Infrastructure projects require a long-term finance in which it has to depend
on capital market. There are various problems that most of the emerging economies
face for gaining domestic and foreign investments. Especially in the infrastructure
sector, Many Public and private projects are stopped due to the insufficient funding
for infrastructure. Every government invests certain amount of its GDP for
developing the in house infrastructure, so that it would able to contribute to the
economy of that nation but development of governments ambitious projects face
difficulties to implement from design stage. It results in increased infrastructure
deficit that affects the economy. Over the years banks have been playing major role in
financing infrastructure in majority of the countries and after the financial crisis in
2008 there has been a significant decline in banks providing long-term finance for
infrastructure projects and monoline insurance companies. Governments and private
companies also depend upon the equity market and bond markets and it has been
growing at large. Bonds are seen as efficient way of financing since bonds are major
part of the capital market that are mostly from 10 years to 30 years for maturity.
Infrastructure projects are also long term since project proposal to completion of the
construction might take years and gaining return on investments from tolls might take
another few years. The author has discussed about bonds and its different types in the
following chapter. Public and private companies issue bonds to gain investment for
these long-term investments projects and governments needs to take all possible steps
to encourage private investments and a well-established capital market. If the country
does not have a well developed capital market or the size of the domestic capital
market is small then it increases the dependency for investments from abroad. So its
necessary to have a well-established capital market that are huge source for funding
long term projects.
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Gaining investment is a significant task for any entity whether it may be a

government, a private company or individual. Its an important part of any sector and
its subjected to various risks that possibly might occur. And all investments vary
according to the risk involved. As (Mayo, 2013) investments needs decision on
choices to own assets such as stock, bond with the risk owning them. Risk plays a
major role in investors decision in making their investments. This is the same with
bond financing with emerging economies risk.
The financial risk that emerging countries carry is huge from inflation, currency
depreciation, budget deficit etc. The economy of a country not only affects the
government issues but private issues also since the private companies are also
affected by inflation, currency value. So there must be some organization to value and
calculate the risk involved in each projects whether it may be government or private.
For this purpose there are many credit rating agencies that assign rating to each and
every company that issues bonds. Each credit rating agency does not need to be same
since each rating agencies have different formula for calculating the risk involved.
The author would discuss about credit rating agencies in following chapters of the
research. So investors use credit rating as a reference for making their investments on
safe assets. And credit rating has influence through out the global economy since its
being used as guide to invest. And since most emerging countries face financial
difficulties they are awarded with a poor credit quality rating. It affects the
investments to the economy from the capital market. The government can obtain
investments in domestic market but it cannot obtain investments from foreign markets
without risk and it also affects the entities located in the country.
When there is a credit risk in any issue and the borrower is rated with a poor credit
rating it affects funding for a particular project. The investor does not invest in
infrastructure projects that could possibly face financial difficulties or default risk. So
in this case the borrower is forced to pay a high interest rate for the bonds and it also
increase the cost of borrowing funds. The borrower with these difficulties still is not
able to attract credible lenders. So the author finds this as unfair solution. The
emerging countries that are already in many financial difficulties need a reduced cost
of borrowing and more reliable. Because increasing the bond yield its not a permanent
solution. Since countries facing financial difficulties are subjected to serious
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fluctuations and altering the bond yield may be a temporary move and if the country
gets into more complicated status then the borrower cannot keep raising the yield.
Apart from these issues one of the major investors and suitable investors for the long
term financing are the institutional investors that are the pension and insurance
companies. Pension and insurance companies have minimum investment criteria for
the credit quality of the bonds they invest. And they remain untapped funding source
for companies in emerging countries. So the author finds that the borrower need a
more reliable means of gaining investments.
So from the above statement it is clear that infrastructure in emerging countries are
very much influenced by the credit rating so it becomes a need to find an alternative
way to mobilize the funding for infrastructure projects in emerging markets. An
improved credit quality might help gaining more investments and it is not possible
until an external agency supports the bond issue. If the third party supports the issue it
would benefit the developers in emerging economies. The developers would be able
to gain investment in reduced cost and they would be able get access to the new
market that can only be accessed by high quality issues and the bond yield will be
reduced while the price of the bond might increase. On the whole it would contribute
to the capital market attracting private investors. There do exist credit-supporting
methods in developed countries offered by various institutions but that might not be
suitable or fit in for the requirements and risk carried by emerging economies. Its
important to select and develop a credit enhancement option for mitigating the risk
and improve the credit quality of the issues.
1.2 Research:
Aim:
To develop a credit enhancement process for infrastructure bonds mitigating the credit
risk and improving the credit quality of the bonds in emerging economies.
Objectives:
To study the existing use of bonds in infrastructure
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To investigate the challenges in developing infrastructure in emerging

economies
To study the existing credit enhancement options
Development of a credit enhancement option for bonds suitable for emerging

economies infrastructure.
1.3 Literature Review:

The literature review, which is a systematic, explicit and reproducible method for
identifying and evaluating existing works completed and submitted by various other
authors (Fink, 2010). The author carried out the literature review by accessing and
gathering information from various sources such as books, journals, documents and
websites. The author also created a list of key words that might give related results
while web search. For example, books and journals were searched by relevant key
words like bonds in infrastructure sector, credit enhancing bonds, impact of
credit ratings and information and sources were noted and included in the research.
1.4 Research Methodology:

(Kothari, 2004) States research as a scientific and systematic search of information on
a specific topic and research methodology is method under which the research is
carried out. So it is significant part of the research in which the method of carrying
out this research should be identified. There are two major types of research such as
basic and applied (Babikir, Ali, & Mabuo , 2009) and author choose applied research
since the research is based on a existing problem that the emerging economies are
facing for gaining infrastructure investments. The author is recommending a credit
enhancement method that might be applied and contribute towards the solution of
various problems involved in those countries.
1.5 Limitation and exclusion:

In this research the author has not discovered methods and solutions. The author had
discussed option and had given an improved version of a particular solution suitable
and fit in for the emerging economies. The author has not taken effort in creating a
simulation or practically implemented the developed option since the scenario is
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completely different from regions and multilateral agencies involved and it is not
possible to recommend one standard method for all scenarios but can be modified
according to the needs.
1.6 Dissertation outline:

This dissertation work has been separated into various chapters and each chapter is
divided by headings and sub headings whenever necessary. The chapters begin with
an introduction followed by the main body and ends with a summary. This structure is
same for all chapters in the dissertation.
1.7 Chapters:
Chapter 2: Is discussing the existing use of bonds since the main objective of
the research is very much related to bonds so its important to find the existing
use of bond and different markets that are functioning.
Chapter 3: Is about the challenges the emerging economies are facing for
developing infrastructure in the country. The author has discussed about
various problems that emerging countries face in gaining infrastructure
investments and how credit risk affects the infrastructure investments.
Chapter 4: Is about the credit enhancement options that are available for the
bonds that could increase the credit quality of the borrower. The author also
discusses various credit enhancement option and also included the existing
credit enhancement schemes and initiative and discuss how it works.
Chapter 5: Is about the research methodology in which the author has included
the method in which the author would be carrying out the research. The author
has discussed various research methods and data collection methods that are
commonly used and has selected one of the methods and has given reason
behind it.
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Chapter 6: In chapter 6 the author carries out the development of the credit
enhancement option for emerging economies. The author would recommend a
credit enhancement structure that might improve the credit quality of the
issues. The author has discussed how risk can be mitigated and how the
government and third part agency can contribute in improving quality of the
infrastructure bonds.
Chapter 7: Its the conclusion where the author had discussed about the
objectives of the research and has also discussed about the various risks and
benefits of the credit enhancement. And the author discussed about the future
of the credit enhanced options.
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Chapter 2: Existing Use of Bonds

2.1 Introduction:
This literature review explores some important aspects that will give an understanding
of the current bond market. This chapter will provide an overview of basic of bonds
and its existing use in infrastructure financing. This chapter will give main attention
to
The bonds and its types
Various bond markets and its significance
Overview of Infrastructure bonds
Traditional and PPP infrastructure Financing
The main purpose of the work is to understand the previous work done related to
bonds. In this chapter will look in the perspective of various authors for bonds and its
types and different bonds by issue, which is being carried out for project financing
and will also discuss about the bond markets globally and its significance.
2.2 Bonds:
Bonds are similar to a promise that is made by a borrower to a lender to repay a
certain amount of borrowed money within a given time and paying a certain amount
of interest during the span and use of the borrowed money. And its also called as
IOU (Fulton, 2005). Fulton gave his meaning of bonds in a very simple manner and
gives an understanding of what bonds are about. (O'Sullivan, 2003) Offers a more
specific and technical explanation of what bonds are about he explains that bonds are
a debt instrument under which the issuer owes the lender a debt and depending on the
agreed terms of the bond the obliged pays a interest that are also called as coupons or
repay the principal amount at a later date which is called the maturity date. (Mobius,
2012) The borrowers are the issuers of the bonds. And bonds can be issued to raise
finance by various entities such as the governments, corporations, banks, multilateral
agencies, individuals and others. And time span of bonds can be lasting from around
12 months to over 30 years during which interest or coupons are paid to the lenders
periodically (Mobius, 2012).
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When an investor obtains bonds in exchange for lending money to the company that
is the issuer this action is called buying a bond and it can also be called as making a
loan. Bond is an asset held by the lender, which the lender can sell at stock exchange
at any time since bonds are also assets similar to equity. Its like shares traded in the
market the bonds can also be traded in the market. So any transaction in which bonds
are exchanged from borrower to the lender is referred as buying bonds and selling
bonds (Simanovsky, 2009).
Bonds are generally contrasted with stocks, which are also a method for raising funds
by the selling the equity share of the entity. But in stock market the stockholders are
subjected to ups and downs of a company. And bonds are loans that are considered to
be a more secure form of investments than stocks since the borrower by selling bonds
does not sell the equity ownership of the company to the investors but in the case of a
stock market the issuer has to sell the ownership of the company to obtain investment
(Elmer, 2005). So this is one of the reasons why governments and sub national
governments find bonds more suitable way of arranging funds than the stocks. When
governments, corporate companies, private institutions and other entities want to raise
long term finance, but do not want to dilute their ownership in the company can turn
to bond markets where they can borrow money without having to repay possible for
decades (Veys, 2010).
2.3 Types of Bonds:

2.3.1 Conventional Bonds:
A conventional bond is the one that has a fixed maturity date and a fixed coupon that
has few bells and whistles like a complicated formula for the interest rate of payments
that are linked to maturity dates that could be changed. In simple terms, it can also be
defined as a bond that pays interest rate over predetermined time and the return of the
original or par value of the investment at the maturity date. These are very plain
bonds and are also called as vanilla bonds (Veys, 2010). A plain vanilla bond make
regular interest payments to investors and pay the capital to buy back the bond on the
redemption date at the time of maturity (ACCA, 2011).
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2.3.2 Indexed Bonds:

Indexed bonds are unlike conventional bonds does not have coupons or principal
fixed, but it can change with reference to some of the index. A suitable example of
index-linked bonds is the linkers. The linkers have the coupon and principle
fluctuating in line with inflation offering protection against inflation. In the case of
conventional bonds although offering a high initial interest rate it is seen that their
real value whittled away in a high inflation atmosphere. So it seem to be a major
factor where pension and insurance companies with long term inflation linked
liabilities like the linkers but however it is worth making a note that the linkers
sufferer significantly wider bid/offer spreads than the conventional bonds due to their
lower liquidity (Veys, 2010). In 1981, the index linked bonds for institutional
investors where first issued by the UK being among the earliest developed economies.
The index-linked bonds reflect the borrowing rates available are the first time of the
issue in the case of conventional bonds. The index linked bonds reflect the rate much
of the government than the nominal borrowing rate in which there is much smaller
difference in the yield rate over time (DMO, 2013). The UK government being one of
the earliest to issue in 1980s followed by the US governments suit by issuing
treasury inflation protected securities (TIPS) in 1997. The indexed government bonds
are widespread and now available in countries like Canada, France, Japan and being
widely accepted financial instrument (Campbell, Shiller, & Viceira, 2009).
2.3.3 Asset Backed and securitized bonds:
The asset backed and securitized bonds are similar to ordinary bonds but have assets
whose revenues pay the interest and principal. The company that issues guarantees
ordinary bond payments in general. A set of revenue generating assets is included to a
SPV and these assets pay the lender their interest and principal (Veys, 2010). These
are debt instruments that have been created from a package of the loan assets on
which the interest is payable generally on a floating basis. The asset-backed market
was developed by US and is largely diverse market containing wide range of
instruments. Examples of asset-backed securities are mortgage-backed securities
(MBS's), collateralized mortgage obligations (CMOs) and collateralized debt
obligations (CDOs) (Choudhry, Joannas, Pereira, & Pienaar, 2002). The asset backed
securities market has grown strong over time and the market has been as the emerging

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alternative source of financing for business and is capable of providing attractive

alternative to investors. By using this market a business can separate the functions of
the originator and servicing of loans or receivables from that of the funding them. It is
capable of increasing the liquidity of the balance sheet assets and increase the
revenues without adding additional balance sheet financing, and even a company with
weaker credit quality will be able to access the capital market that usually reserved for
business with higher credit quality (Sabarwal, 2006).
2.4 Bonds by Issue:

2.4.1 Government Bonds:
Government bonds are a bond issued by the central government of a country borrows
funds to fill the gap between the income from tax and the amount that they spend.
Governments issue bonds to re finance debt and raise capital and they are usually
considered to be a top-level quality bonds in domestic level since they are backed by
the central government unless they belong to emerging market bonds and the default
risk is high. But most individual investors focus their investments trading on
government bonds (AFME, 2013). Government bonds are the backbone of the fixed
income securities markets in both emerging and developed countries. Government
bonds are reinforced with the faith and trust of the government not by physical or
financial assets (Worldbank, 2001). It is common that many institutional investors
such as the pension and insurance companies prefer government bonds due to their
risk free bond issues in the domestic market and a long term investment with expected
future income stream adding to that the government bond yields have been
benchmark for setting up or comparing the other rate in the financial market such as
rate on corporate borrowing. The government bond yield rates are referred before
fixing the interest by other issues (Coyle, 2002).
2.4.2 Sub Sovereign Bonds:
The sub sovereign bonds are issues by any level of government below the national or
central governments, including regions, provinces, states, municipalities that issues
bonds. In Europe the sub sovereign market are primarily dominated by agencies and
supranational institutions such as the World Bank, KFW and the European Investment
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bank (EIB). As the European countries have increasing joining each other and
increasingly become a single market the growth of the sub sovereign bond market are
significant (AFME, 2013). The bonds at sub sovereign level target investors from the
domestic capital market that mostly the local people. The local people are more
familiar with local government issues and its plans than overseas investors. And most
often these issues are issued in local currency and by issuing in local currency it has
an potential advantages to raise finance without exposure to an volatile international
capital market and currency movements (Platz, 2009).
2.4.3 Corporate Bonds:
Corporate bonds are debt obligation or IOU issued by public or private companies for
gaining investments. There are many types of bonds in which companies issues bonds
to gain funding for the company and use in various purpose from building new
facilities or procuring new equipment to expand the business by financing
acquisitions. Corporations also issues bonds to substitute for bank financing due to
their inability to get or finding it not financially viable (AFME, 2013). In the
corporate bond market the primary and secondary markets provide linkage for
corporate issuers and investors efficiently around the world. The domestic and
international corporate bond markets provide for diverse needs. Domestic markets are
significant for small scale growing companies and for domestic investors. While the
international markets accommodate large companies and conglomerates to gain the
global pool of capital including the pension and insurance companies funding and
help the institutional investors obtain a diversified and consistent returns. The
corporate bond markets are also significant for governments to meet the urgent global
public policy challenges presented by ageing populations and the necessity to
maintain growth reducing imbalances. It also helps governments indebtedness
offering investors an alternative to government bonds (ICME, 2013).
2.5 Bond Markets:

Both institutional and individual investors have access to bond markets, but the
institutional investors have more occupancy in the bond market than other investors.
In the European market, the individual investors represent less than 5% of direct
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investments in bond markets. In European bond markets the majority of the bond
market participants are the pension, insurance companies and banks (AFME, 2013).
Financial instruments less than one year for maturity and above one year are two
kinds of markets. The short-term instruments that less than 12 months make up the
money market and the long-term instruments which is above 12 months make the
capital market. There is a difference between the primary and secondary markets. A
new issue of the bonds by the underwriter or the institutional banks on behalf the
client is made in the primary market. Such an issue can be made public. If the bonds
are requested to by or a private offered there the customers of the institutional banks
offered stock. The secondary market is the market in which existing bonds and shares
subsequently traded (Choudhry, 2001) and another major factor is the size of the bond
markets and the trading derivatives based on bonds in between the financial
institution is many times larger than the equity market. The size of the world wide
bond market is in trillions of US dollar (Patrick, 2006).
The Value of the entire global bond market is over US$10 trillion that includes the
Eurobonds and all other types of bonds. There are various types of bonds that are
issued internationally. Foreign bonds are issued by foreign companies or governments
and denominated in the currency of the issuing domestic market. Dragon bonds that
being issued in Asia but the issues are denominated into US dollar. In recent times,
the worlds largest issuer of bond is United States having a market share of about 35
percent and followed by Europe occupying about 28 percent and japan having 13
percent making these the major players in the bond market (Mobius, 2012).
2.6 Domestic Bond Markets:

The global bond markets are categorized as domestic or national that includes
government and sovereigns and international bonds. The domestic bond markets that
include bonds that are being issued by the home government, sub sovereign, agency,
and corporations that is located in the country where the bonds are being traded
(AFME, 2013).
Bond markets are split in to two markets from the primary market those issues new
bonds to the secondary market trading existing bonds (Benhamou, 2012). In domestic
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bond markets all types of debt are traded from government securities to corporate
issues issued in their own domestic currency. And bonds are subjected to the tax laws
and regulation of the home country (Mobius, 2012). One of the main feature of any
domestic markets are they are subjected to the local government rules and regulations.
The are regulated by one single national government. For example the London sock
exchange for example is domestic market under the regulation UK law. And it
governed by the UK national government. Members of the exchange are sunhected to
the regulation of the government agency the financial service authority (FSA) and
exchange can only function after approved recognition as investment exchange by
FSA (Coyle2, 2002).
2.7 International Bond Markets:

The international bond market is the issue that is not issued in the home currency in
market where it is located. The foreign bond market comprises bonds issued by the
issuers who are not located or reside in the country of issuing. There are drafted
regulation between the residents and non-resident issuers and may have different
requirements for issuance, selling, restrictions, taxing and disclosure (AFME, 2013).
The international bond market also refers the counter debt capital markets, the broker
dealers trading the bonds issued by governments, sub national governments,
municipalities and corporate organizations and there are increasing trading in new
growing bond trading platforms (Benhamou, 2012). Entities from both developed and
developing countries have increasingly used the debt markets to raise capital outside
their existing domestic markets and list their securities in major financial centers. And
there has been significant growth in amount raised in foreign markets grew more than
four times between 1991 and 2008 reaching about one trillion US dollars nearly
accounting for 40 percent of the total amount raised in capital markets (Gozzi, Levine,
Peria , & Schmukler, 2012). The international capital market has origins from the
offshore funds traded in popularly used currencies particularly dollars. Since dollars
had been used as trading currencies. Offshore funds are funds that are held in another
country. For example funds that held in a bank in Switzerland by a US company.
Many offshore funds are Eurocurrencies particularly Eurodollars. And the
international markets are also referred to as Euromarkets although it is being mainly
operated in Europe it is not restricted or limited to European countries (Coyle2, 2002).
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(Benzie, 1992) Although the use of international markets are encouraged for various
reasons the pattern of issuance activity is strongly affected by the regulatory
constrains and central banks have often placed restrictions on the issuance of
international bonds denominated in currency for which they are responsible.
2.8 Foreign Bonds:

Foreign bonds are the bonds where the foreign entity issues bonds that are
denominated in the currency of another country. For example, a US company issues
bonds, and raise capital in China denominated in Yuan. In the Chinese investors are
not subjected to foreign exchange risk for investing in a foreign issue. At the same
time it is also important to understand that a Chinese company Chinese company can
also issue bonds and raise capital in china denominated in Chinese Yuan but the
bonds issued by the Chinese companies are domestic bonds since its located in china.
In the case of foreign bond the issuing company is located in foreign country. And it
can also explained as Indian company issuing USD bonds in UAE is also can be
called as foreign bonds (Rajib, 2012). (AFME, 2013) Also states that the foreign
bonds are issued in the currency of the country that the non-resident or a foreign
issuer actually issues the bond. These bonds are also traded in domestic market like
any other bonds in the same market. For example the bulldog bonds that are
denominated in sterling for its issue in UK by a non UK issuer and Yankee bonds that
denominated in dollars for its issue in US by a non us issuer. Similarly Rembrandt
bonds issued in Netherlands and matador bonds in Spain etc.
2.8.1 Eurobonds:
In Eurobond, a foreign company issues bonds denominated in a currency that is not
the home currency for the investors. For example, a US company issues bonds and
raises capital in South Korea denominated in US dollar and not in South Korean won
it can called as Eurobonds and at same time US company issues pound sterling in
south Korea can also be considered as Euro bond. As the there are two cases above
the first one can be called as euro dollar bond and the second one can be called as
Euro sterling bond. The history for the development of the Eurobond market is due to
the unfavorable tax regime in US during 1960s that forced companies to issue USD
denominated bonds outside US and first issue being issued in 1963 (Rajib, 2012). The
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multilateral agencies and corporations are major issuers in the Eurobond market. The
multilateral agencies such as the World Bank, European bank for reconstruction and
development use such bonds for financing developments of infrastructure in countries
where the support is needed. Governments, corporations, banks issue Eurobonds for
various reasons including financing raising capital for the projects. The Eurobonds are
also called as bearer bonds that are not located or registered anywhere centrally it
belongs and considered as owner to whom ever hold or bear the bond. And the bearer
status also allows Eurobonds to be held anonymously (AFME, 2013).
2.9 Infrastructure finance through bonds:

Project bond financing that has been over the years considered as a viable and
profitable method for raising finance for projects in Asia since the 1990s after the
financial crisis that affected the countries in the region after which the bond market
started significant growth as financing and alternative option for the lack of liquidity
in the equity market and banking sectors after the financial crisis (JBIC, 2007). As the
above point mentions the bond has been an alternative to equity and bank financing.
Bonds can be one of the sources where a entity can rely on. Growing countries face
raising demand and need to build roads, railways, ports, power and water
infrastructure and in many countries the private investment has contributed
significantly to the infrastructure rollout. Government should improve the funding for
infrastructure projects through bonds in local capital markets. This included risk
mitigation through minimum revenue and other guarantees, or participation in
concession companies (Mezui & Hundal, 2013).
Most of the infrastructure financing in recent years have used the form of bonds due
to the nature of raising funds in which they are project based that is they are built on
purpose for specific activity or an objective with a limited project life span. Financing
through bonds is one of the most reliable sources as discussed in earlier sections of
the research that bonds being trillion-dollar market it is necessary for the project
developers to use this opportunity. Its suitable move for any entity if there is a need
for large funding and it does not want to sell its ownership then bond becomes the
most suitable choice for the company. The author would discuss the significance of
infrastructure financing through bonds in the later section of the research.
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2.9.1 Traditional Infrastructure financing:

Traditional bonds are generally issued in public service sectors to finance
infrastructure for projects such as renewable wastewater treatment or transportation
sectors such as bridges, roads and airports (NB, 2012). The traditional infrastructure
procurement of construction by the government for infrastructure, such as the hospital
building and school buildings in which the government usually specifies the quantity
and quality specification. Private companies winning the bid and awarded the project
takes the requirements note and implements during construction. Here the government
becomes like a client and awards construction works through a typical tender system
and after completion transferred to and operated by the government (Burger &
Hawkesworth, 2011).
2.9.2 PPP infrastructure bonds:
Governments have been increasingly using the PPP to finance, structure and operate
public service infrastructure projects. The government selects a combination of the
builders, operators and financiers to carry out the project after calling formal call for
tenders. So the governments will be able to transfer the risk of construction, operation
and financing to firm that are specialized in these activities. The government then
takes charge of the asset after the debt maturity. To finance a PPP project the
consortium members of the project usually allocate equity for 10 to 20 percent of the
project. The remaining are gained from the markets by issuing long term
infrastructure bonds that have 10 to 30 years to maturity. There is various credit risk
that may possible affect the credit quality of the project. The credit risk generally
concentrate during the construction period where the cost overrun might possible
occurs and risk is carried by the companies. Four to five years after the construction
period the projects funds are obtained after that the government contractually secures
the interest and principal. There is also some risk related to the operation cost of the
project after the post construction period, and depends on the consortium competency
to properly evaluate the long term operating costs (NB, 2012).
Most investors in PPP bonds have been institutional Investors with their long-term
liabilities against their need to produce long term cash flows. The major investors
have been the pension funds, insurance companies that invest directly and these
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investments from institutions are credible investments that ideal for infrastructure
finance (EPEC, 2010).
The main risk of PPP bonds is the credit risk and the complexity of the structures;
contracts and guarantees require specialized expertise in infrastructure project
analysis to mitigate the risk and it important to consider the liquidity risk also since its
more of a complex structure that might have reduced trading of the bonds in the
secondary market. Increasing the number of investors and standardization of bond
structures are factors that improve liquidity conditions (NB, 2012). PPP infrastructure
bonds play a significant role improving the infrastructure condition of many
developing nation and finding a way to mitigate the possible risk might help increase
the number of PPP projects.
2.10 Summary:
The critical review of this chapter will indicate the significance of bonds and its use as
an important method in existing project financing and as an alternative to bank loans
and equity markets.
Key points:
Bonds are debt instruments, loans lasting from 12 months to 30 years.
Governments, corporations, banks, international organizations, and individuals

issue bonds.
Government bonds are risk free in domestic issue.
Bonds are open to Individual and Institutional investors but Institutional

investors occupy 90% of the market.
Government and corporate bonds are subjected to risk in International market

issue.
Bonds seen as suitable method to Long term funding.
Bonds are great for infrastructure since it takes long time for returns.
Bonds play major role in governments initiative to PPP projects.
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Chapter 3: Challenges in infrastructure funding in emerging markets
3.0 Introduction:
This chapter involves in discussing the challenges for infrastructure funding in the
emerging markets. The chapter first discusses the existing and need in infrastructure
in emerging economies and it takes the opinion of various authors. It involves various
funding which was available previously and discusses the various risk present right
now with those methods and issues involved domestic and international investments.
The author will try to find the importance of
credit rating in existing financing options and its impact on funding in developing
countries. The author will also include the impact of credit quality for a sovereign,
which resulted in infrastructure deficit. The reason behind infrastructure deficit and
the role of credit rating in causing problems in funding infrastructure in developed
countries.
3.1 Infrastructure in Emerging Markets:

Infrastructure is the driver as well as the outcome of economic growth and its very
vital for emerging economies. Quality infrastructure is required for various industries,
services and trades and plays an important role in reducing poverty and income
inequality. The rapid growing populations and rising urbanization rates in emerging
economies have led to a global shortage of infrastructure services such as roads, rails,
housing, communication, etc. why infrastructure is so important? Infrastructure acts
as a lifeline for an economy and countries that invest in infrastructure benefit from
faster and safer standards of living such as increased access to the part of the country
with improved transportation and communication, Increasing the production
manufacturing sectors, improving business centers and above that improving the
living standards of the people. All leading to enhanced productivity and
competitiveness that ultimately ends in higher consumption and economic growth
(Ash, Ahmad, & Petitcolin, 2011). The term infrastructure covers from public utilities
such as power, piped water supply, telecommunication, piped gas and public works
such as roads, dams and canals, and other transport sectors like urban, and interurban
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railways, urban transport, ports and waterways and airports. Many western managers
assume that the emerging economies have little or no infrastructure and it as a
worthless to spending time and money exploring markets in those countries. And
many developing countries have not yet established basic infrastructure outside of the
capital city of the country (Cavusgil, Ghauri, & Agarwal, 2002). Infrastructure
investments are crucial in emerging economies and there is increasing need for funds
that is required for investing in the infrastructure sector globally. The growing
demand for infrastructure in emerging economies is due to the growing population
and economic development. There has been considerable growth in infrastructure in
emerging economies, but it is still far behind that of the developed countries standard
and it remains far behind and insufficient with rapid increase in demand. This issue is
gaining importance on the worldwide political and economic arena. The World Bank
estimates that India loses 1% in economic growth every year due to supply
bottlenecks, and Russia is said to have had several high-profile transportation system
failures in recent years. Therefore, countries with emerging economies should pay
specific attention to their infrastructure development in the years to come to prevent it
from constraining future growth and investment in infrastructure has been falling.
Since the onset of the financial crisis, a lack of liquidity has made banks reluctant to
take on extra long-term debt. The introduction of the Basel III framework has
reinforced this hesitancy by increasing regulatory pressure on banks to hold extra
capital against long-term projects (Manev, Doychinova, Todorova, & Vassilev, 2011).
In emerging markets various factors play a major role in their economy such as
inflation, currency fluctuation etc. Bonds yields increase to high interest rate when the
home currency falls down. So the yields need some kind of backup. Monoline played
a significant role; monoline insurance companies insure bonds for a price according
the risk they carry. Insured bond are more attractive to the investors. But after
financial crisis the monoline insurance companies were not able to insure bonds that
resulted decrease in credit quality of the bonds. This is due to the high uncertainty and
unpredictable risk in market. It affected monoline insurance and it reduced the
insurance of bond that had effects on credit quality of bonds. A low credit quality is
less attractive to investors and the projects where not gaining many investments and it
cannot attract the pension and institutional investors. And the banks were also
affected and were not able issue long-term debt to infrastructure projects. The author
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thought that bonds are best suitable enhancement method but with credit
enhancement. Bonds with improved credit quality will be able to meet the challenges.
70% of European companies are funded by banks comparing to 30% of US
companies rests are being funded by bonds (Edmond de Rothschild, 2013). European
banks have reduced directly lending to companies instead supports them to issue debt.
As for infrastructure sector its the same the European investment bank as discussed
already in literature review helps funding the companies by debt issue. So its
important that developing countries to learn from the above and instead of preferring
the bank lending it can move on to bond market and the government should also
encourage private investment to bond market that puts the capital market in a
progressive way. The emerging economies should seek help from the multilateral
agencies like the European companies for their funding to obtain a good credit quality
to their bonds. Having a well-developed capital market with considerable private
investments it would be able to reduce the infrastructure deficit in its country
3.1.1 Bank Loan Funding:
Banks are increasingly facing non-performing loans and deleveraging globally since
the long term financing has been constrained after the financial crisis. And a
dysfunctional money markets and risk mispricing add further pressure to the banks
and the shift from credit to equity culture and an originator and hold to an originator
and distribute approach have endangered banks business models (World Bank, 2013).
Richard threlfall of KPMG UK says its not surprising to see the decline in private
finance for infrastructure and also mentions that the collapse of long term bank
financing for infrastructure was expected, and no clear solution has been emerged.
Banks are subjected to immense commercial and regulatory pressure to recycle their
capital. As a result, the long term bank financing for infrastructure projects are
efficiently dead (Threlfall, 2012).
3.1.2 Equity Financing:
Due to the financial crisis there is an uncertainty in the future economic prospects and
the low interest rate environment may have affected firms in need for a long-term
equity capital. A number of long-term structural changes may also be impacting the
role of stock markets, including regulatory changes in response to corporate scandals
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29
that have made equity financing more costly (World Bank, 2013). (Johnson, 2011)
Says that Bonds are better investment than equity, since return from stock markets in
Italy, Germany and Japan have lost to the respective bond market that showed better
and positive result by a report released by Duetsche bank.
3.2 Domestic Funding:

Governments play a significant role in encouraging the use of infrastructure project
bonds in local capital markets. This includes risk mitigation through minimum
revenue and other guarantee or participation in concession companies. Domestic
funding is the funds raised from the domestic market from local entities and
individuals. In essence, infrastructure projects need longer dated financing which is
most suitable for institutional investors; but in many countries that part of the market
is very much in its infancy. There are some notable emerging markets that has over
the decade transferred form foreign investors dependency to domestic funding that are
in large from the institutional investors. Russia and China have successfully
completed this transition. Other notable examples are Latin American countries such
as Chile or some of the Asian countries including Malaysia (Mezui & Hundal, 2013).
So far, banks have been the main source of funding these projects, but they are unable
to provide long-term funding given that their funds are short term in nature with even
most long term funds are with a maturity of one to three years (TET, 2013).
3.2.1 Domestic Risk:
Governments are among the largest borrowers in the capital market for funding the
budget deficit and to manage the economy (Coyle, 2002). Government bonds are risk
free in the domestic market and the payment of interest and principle are made as per
schedule. A government issuing in its own currency in the domestic market does not
get into risk since governments bonds are risk free in case of problem it can simply
print more money to repay its debt (Coyle, 2002) but the Government bonds are
vulnerable to political risk. The government does not necessarily go out of business
since instability in the economy only results in regime change. The other bonds issued
by non-government entities are subjected to various risk such as credit risk and
political risk.
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3.3 International Funding:

The international market plays a major role in funding the growth of emerging
economies. And it mainly depends on the liquidity of the capital markets to
accommodate global investments (COL, 2010). There has been difficulties in
mobilizing funds for the developing countries since the level of income generate is
not enough to meet the level of sufficient domestic savings and domestic financial
system often does a poor job or directing the funds back in domestic capital
formation. This makes access to international capital market, which is an important
source of funding, and raises the level and boost the rate of investments and growth
(Setty & Dodd, 2003).
3.3.1 International Risk:
An Important difference between the international and domestic bonds is the impact
of foreign currency movements. When the investors invest in the bonds of another
country, the investor should first convert the US dollar into home currency. As a
result, the value of fund is affected not just by the performance of the bonds in the
portfolio but the currencies that the bonds are denominated (Kenny, 2013). The value
of the government bonds can be affected by the currency risk since the investor
keeping funds in dollars the strength or weakness related to the currency in which the
bond is denominated can affect income and price appreciation on the total return.
Using hedging to mitigate the currency risk may negatively impact on returns. The
bonds are subjected to the interest rate risk. The interest rate and the price of the bond
are inversely related, if the interest rate goes up the price of the bond goes down and
when the price of the bond goes up the interest rate goes down. It is not a problem if
the investors buy and keeps it up to maturity and in this case it would collect
scheduled coupon payments and receive face value when the bond is repaid (Ross,
2012).
3.4 Credit rating:

Credit rating is the opinion of the credit rating agencies on the capability and
willingness of the issuer of a debt instruments to meet the debt service obligations
when it is required. The ratings are assigned and are in alphabetical or alphanumerical
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symbols that represent the various level of quality. As symbols are simple and easily
understood tool that helps the investor to differentiate between debt instrument
according to the credit quality. The rating agencies also offer explanations for each of
their rating to give a better understanding. The credit rating establishes a link between
the risk and return on investments thus act as a measuring stick against the risk
involved in any instruments. An investor refers the credit rating to assess the risk level
and compares that with the offered interest rate that gives the expected return on
investment (PSNA, 2012). The credit rating agencies are specialized in analyzing and
evaluating the credit worthiness of any corporate or sovereign issuers of debt
securities. In the new financial structure the credit rating agencies are significant in
the management of both corporate and sovereign credit risk (Elkhoury, 2008). The
credit rating agencies in the process of collecting data and processing reduces a firms
capital cost by certifying its value in market thus resulting in a solution or reducing
the informative asymmetries between borrowers and issuers (Ramakrishnan &
Thakor, 1984). The idea of the risk involved in an issue for an investor without a
credit rating system that mainly depends on the familiarity of the investor about the
issuer and it is not possible that every investor taking a detail risk analysis on the debt
instrument issuer and its not feasible for the issuer to offer those. So the need of credit
enhancement cant be overemphasized and it is of great assistance to the investors
while taking investment decisions (PSNA, 2012).
3.4.1 Effects of Credit Ratings:
The first and crucial step to gain investments for developing economies is to gain a
favorable credit rating. In the current economic condition of the globe a strong credit
rating plays a major role in determining the credit worthiness in cost and availability
of credit flows. But if the credit rating is not favorable it might result in a reversal of
capital flows, a disruption in the financial system and an overall economic downturn
(Setty & Dodd, 2003). If market participants rely on the credit rating for their decision
on making a particular investment then the credit rating influence the investment
decision of the investor and affects the borrower with a low credit quality in emerging
markets. Assigning of a low quality rating may lead to a higher cost of borrowing
because it makes an assumption for the investor about the creditworthiness of the
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borrowing company as poor and because of the regulations that restrict investors
holding of a low rated bond (Manso, 2013).
3.5 Sovereign Rating:

The credit rating of countries or sovereign rating has assumed great importance.
While rating agencies, such as Standard and Poor, Japan Centre for International
Finance and London based Economist carry out periodical studies of the
creditworthiness of various countries, lenders and exporters use such reports to finetune the rates at which funds are made available to borrowing countries and to add
clauses -of varying stringency in the export sales agreements. The higher the risk
associated with a country, the higher the margin charged above the benchmark rates
(PSNA, 2012). Governments generally seek credit ratings not only to ease their access
to international capital markets, but also because these assessments affect the ratings
of other borrowers of the same nationality. Institutional investors prefer credit rated
securities to unrated securities of apparently similar credit risk (Cantor & Packer,
1996). The sovereign ratings are being increasingly important since governments
around the world try to tap the global bond market. The sovereign ratings might have
effects of inflation, currency and high cost for borrowing (Kuepper, 2012). The major
issuers in the global capital markets are the national governments and the ratings
affect a large number of other issuers originating from the same country. The agencies
does not rate public or private sector issuers that are higher than their origin country
rating and therefore sovereign ratings influence the ratings given local municipalities,
provincial governments and private companies located in the same country (Packer &
Cantor, 1995).
3.6 Infrastructure Deficit In Emerging Markets:

Infrastructure is for key development but most emerging economies face a high
deficit. Over USD800 billion is invested in infrastructure in developing countries
every year but the actual need of investments in emerging economies are more twice
the amount that is being currently invested. A funding gap estimation of about USD57
trillion is required to meet the deficit in developing economies (Bilal, 2013). The
investments needed on infrastructure in developing countries is far more higher than
the current investments that are being invested in these countries by the governments,
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private sector and other stakeholders. Hence causing a funding gap in emerging
economies (UN, 2008). There is an increased need of private sector infrastructure
investment which vary from country to country, but it can categorized in two ways
insufficient infrastructure funding and a huge increase in demand for a quality
infrastructure (Lord, 2011). The developing world will have to spend an annual
expenditures of $1.1 trillion which is 6.6 percent GDP of developing world through
2015 to satisfy consumer and producer demand for infrastructure services assuming
current GDP growth and demographic trends (Yepes, 2008).
3.7 Summary:
Due to the increase in shortage of infrastructure funding there is an essential need to
access a new source or find a solution to increase the infrastructure funding in
meeting the deficit in emerging economies. Its become important for the emerging
markets to tap the institutional investors become more attractive to them by
improving the credit quality of project bonds. This chapter has discussed the various
issues that emerging markets face in raising funds to finance their projects.
Key points
Rising population and urbanization has increased infrastructure needs in

emerging economies
High shortage of infrastructure funding in developing countries
Banks inability in sanctioning long term loans for infrastructure due to

financial crisis
Higher cost of equity financing in recent times
Infrastructure requires affordable access to long term debt
Small domestic capital market results less liquidity
Lack of private sector investment
Less attractive towards pension funds and insurance companies due to risk
involved
Impact of Low credit quality affects emerging economies
Increase in cost of borrowing which also increase the cost of infrastructure

projects
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Governments inability to meet up the infrastructure deficit
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Chapter 4: Credit Enhancement option & Existing Credit Enhanced

schemes
4.0 Introduction:
In the previous literature review chapter, the author discussed about how credit
quality affects and causes infrastructure deficit in emerging economies. This chapter
will discuss about meeting those challenges with credit enhancement option. This
chapter will discuss the various types of credit enhancement in use and its importance
in funding. This will also discuss about the credit enhancement initiative and this
chapter will cover the existing active credit enhancement scheme in various countries.
4.1 Credit Enhancement:

Credit enhancement encompasses a variety of provisions that may be used to reduce
the credit risk of an obligation. Credit enhancements are often incorporated into
derivatives, corporate debt, securitized debt and other instruments. Techniques of
credit enhancement vary depending how much secondary market is developed,
economic situation and level of credit volume in a country (Saleem, 2008). The
Private sector debt participants, home government support, and donor support (world
bank, Asian development bank, European investment bank, IFC etc.) are the three
pillars of credit enhancement to improve projects bankability by enhancing its
creditworthiness (McLindon & Labadan, 1998). Majority of project bonds with no
credit enhancement will get BBB rating. And in case the project gets a public or
private support the credit quality of the bond increases to A. The credit level increases
only when a high credit quality guarantor backs the project when the entity which is
offering support is also having poor rating, then it wont help the credit rating of the
project bond in any ways (Thompson, 2012). A special purpose vehicle is created for
the bond issuance and which the guarantor backs. A Credit enhancing arrangement
from bilateral and multilateral organizations and regional banks, where those
organizations provide a guarantee to the lender. If the SPV cannot make payments on
its debt, then the guarantor will make payments to the lender on behalf of the SPV
(Slivker, 2011).
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Credit enhancement may be offered by third parties with the objective of mitigating
specified risk, rather than comprehensive risk, of the project. Specific risks that
traditionally have been addressed by credit enhancement include credit risk, currency
risk and sovereign risk (Thompson, 2012). Many projects financed with tax-exempt
bonds are required to have credit enhancement, which is a guarantee from a financial
institution or government agency that improves credit status, and mark ability of
bonds (Eastman, 2013). The bond issuance for long term infrastructure funding needs
an investment grade credit rating. The less the level of credit rating more is the cost of
borrowing for the emerging economies. A credit enhancement from international
finance institution such as World Bank or IFC will improve the credit rating, which
will reduce the cost of financing the infrastructure projects at home (Wong, Almeida,
& Kanza, 2013).
4.1.1 Senior/subordinated:
This is one of the common types of internal credit enhancement method encountered
in the market. It involves a bond ranking below CMO that absorbs all the losses
arising from default or the cause leaving the main issue unaffected. The subordinated
bond clearly has the higher risk attached to it, so it trades at a higher yield. Most
senior /sub ordinated arrangements also incorporate a shifting interest structure. This
arranges for prepayments to be redirected from the subordinated class to the senior
class. Hence it alters the cash flow characteristics of the senior notes (Choudhry2,
2003). Generally senior subordinated credit structures are created with single or
multiple subordinated credit classes depending on the sub ordination levels required
by the rating agencies. The pay classes are designed in the credit structure
sequentially in, which the losses are allocated first to the junior classes (Fabozzi,
2001).
4.1.2 Overcollateralization:
Overcollateralization is a payment structure, which is also called as turbo structure. It
is a method of using the excess spread, which is the cash that is left over after paying
all fees and bond coupon expenses using this excess amount to pay down the principle
amount of the structure bond (Fabozzi, 2001). (Strumeye, 2012) Says that it is created
when there are more collateral in issuing than the debt issued to investors. Many
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issuers along with monoline insurance for internal credit enhancement use
overcollateralization. It is used to improve a BBB-/Baa3 rating to an eligible level and
to obtain an AAA/Aaa rating (Bhattacharya & Fabozzi, 1996).
4.1.3 Reserve funds:
It is a portion of funds that has been generated from an issue of bonds, The reserve
funds are the profits generated when the bonds were initially issued and it is placed
separately. The reserve funds are used in the event of crisis it is used to compensate
the investors suffering from capital cost (Choudhry, 2003).
4.1.4 Spread Accounts:
It is generally seen as a alternative to overcollateralization as credit enhancement
(Fabozzi, 2001) and says that spread accounts are built up to some predetermined
levels which is specified by the credit rating agencies. But unlike overcollateralization
it is accumulated in an account as cash and reinvested as some short-term eligible
investments.
4.1.5 Letter of Credit:
The originator arranges for a letter of credit from a third party usually from an
acceptable bank. Credit insurance is a little more advanced form of credit guarantees
where the issuer may share risk such as interest rate risk covering (Kothari V. , 2006).
(Davis,, Choudhry, & Fabozzi, 2007) describes the letter of credit option is one of the
oldest forms of credit enhancement but the author also says that its not been used very
often in recent times. It is financial assurance given by a bank to cover the credit
losses up to a predetermined amount. This type of enhancement has been less popular
since some issuers were themselves downgraded which lead to a downgrading of
assets due to providing letters of credit.
4.2 International Agencies guarantee:

The international agencies play a significant role in helping the development of
infrastructure in emerging market. Various agencies have a long history of providing
aid in improving the infrastructure standard and living standards of people in
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emerging economies. In this the author has mentioned the name of many agencies that
might possibly sanction credit enhancement for infrastructure projects in the research
sample countries. And discuss their probability of offering credit enhancement and
their previous experience in doing so.
World Bank: The World Bank has been well known international financial
institution that has a history of providing aid for infrastructure in developing
countries. (World Bank, 2013) The World Bank provides various guarantee
instruments for borrowers like sovereign governments, sub national
governments (state owned enterprises, municipalities), private projects (BOT,
PPP projects). Which is intended to cover the credit risk of sovereign
governments or sub sovereign entities that also require a counter government
guarantee to the bank.
International
Financial
Corporations:
The
international
financial
corporation that is also part of World Bank group offers full and partial credit
guarantee to private sector entities. It offers guarantee on failure to cover the
risk of paying scheduled payments and unlike the World Bank requirement it
does not require a counter guarantee (World Bank, 2013).
African Development bank: The African development bank plays a
significant role in development of infrastructure in location where the poverty
level and living standards of people needs significant improvement. (AFDB,
2003) The African development bank offer partial guarantee for bonds that in
failure to repay carries credit risk. The initiative is introduced to improve the
credit rating of the borrower and investors as well that also helps gain
investments in reduced cost.
Asian Development Bank: ADB being a major bank in Asia and Pacific
region provides funding to governments, private companies and finance,
guarantees projects. ADB offers partial guarantee for infrastructure projects in
the region helping to improve the credit quality of the bonds (ADB, 2012).
ADB can guarantee funding and guaranteeing infrastructure projects in India
and Indonesia.

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BRICS Development Bank: BRICS is a association of five major emerging

economies such as brazil, Russia, India, china, south Africa. The BRICS fifth
summit in South Africa proposed a new development bank. (ALJAZEERA,
2013) The new bank will be alternative to World Bank since many multilateral
agencies dont change quickly to reflect their new found clout. Brazil and
India being a part of BRICS is a great advantage and its bank initiative will
benefit.
There are many other multinational and regional institutions but the author to be
specific only mentioned agencies that play major role and related to the research
sample countries that would be discussed in following chapter. The World Bank
group has a long history of lending finance to developing countries. The regional
banks are committed to the welfare of the region and its essential to change the policy
and introduce schemes according to the demand. New institutions like BRICS
development bank with combination of power emerging economies play a significant
role in the world economy. Since as BRICS nation alone account for 43% of the
world population its major move to have proposed a development bank which would
be benefit for brazil and India in obtaining investments. It is not new for developing
countries to seek help from multinational agencies but the way each country drafts it
policy and strategy of implementing plans to improve basic infrastructure in the
country is important. The author finds there is no single way that a institution can
support a nations infrastructure. (Slivker, Project Finance, 2011) There are a variety
of support that a financial institution like the above mentioned can offer a entity such
as guarantees, political insurance, interest free loans, low interest loans, market
interest loans, technical support etc. Each government has different scenario and it is
not possible to recommend one agencies and a one method of supporting the nation
infrastructure. The home government has figure out what kind of support it requires
from the multilateral agencies or fit into a scheme that may be favorable for the
nations infrastructure development.
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4.3 Pilot Program Projects:

The governments can help improving the domestic capital market for infrastructure
financing by in the first instance, a limited number of eligible pilot projects, which
can issue securities for raising investment finance. Government can help by
developing the preconditions required for successful issues of corporate securities,
through: (i) creating technical prerequisites and minimum criteria for the issuing
companies, related to its capital structure, financial situation, corporate governance
and management teams; (ii) requiring mandatory ratings of debt issues by reputable
and reliable credit rating agencies; (iii) Encouraging institutional investors, by passing
the laws and regulations required, especially for pension funds and mutual funds (iv)
Further strengthening the domestic government bond market, by approaching full
tradability of all issues, dematerializing new issues (Kumar, Gray, Hoskot, Klaudy, &
Ruster, 1997). Governments or financial institutions can back the infrastructure
projects under pilot phase so that they can share the risk involved in the project and
attract private investors raising finance for the project. Governments can upgrade their
credit as borrower or as the guarantor for public and private projects using risk
mitigation instruments of more creditworthy institutions, which in turn can lower their
cost for infrastructure development (Matsukawa & Habeck, 2007). A pilot phase
project initiative is proposed by European investment bank in 2012 to stimulate
investment in key strategic EU infrastructure in transport, energy and broadband and
to establish debt capital markets as an additional source of financing for infrastructure
projects. The aim is to attract institutional investors to the capital market financing of
projects with stable and predictable cash flow generation potential by enhancing the
credit quality of project bonds issued by private companies (EIB, 2012). The Indian
IIFC has proposed plans for developing the bond market and funding US$1 trillion for
infrastructure projects by facilitating channelization of long term funds towards
infrastructure sector from fairly untapped sources like insurance companies, pension
funds and FIIs (IIFC, 2013).
4.4 Europe 2020 Project Bond Initiative:

In speech by the president of European commission An EU initiative to support
project bonds, together with the EIB, would help address the needs for investment in
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large EU infrastructure projects (Barroso, 2010). The EU took an initiative to finance

its EUR 2 trillion infrastructure projects in various sectors such as energy,
information, communication and transport sector. A 2020 objective fixed by the EU
to finance its ambitious infrastructure development projects by credit enhancement
method. The 2020 project initiative is proposed with the help of the European
investment bank (EIB), which involves in attracting the capital market investment.
The mechanism of this initiative is to improve the credit standing depends on the
capacity to separate debt of the project company into senior and subordinated
tranches. The EIB will offer sub ordinated tranche for senior bonds, which will help
increasing the credit rating for the issue. In the past monoline played a role in
improving the credit quality of the issues but after the financial crisis the absence of
monoline affected development of infrastructure projects. This initiative will act as
replacement to monoline but it differs from monoline in many ways such as it does
not offer a complete guarantee that covers the entire amount of the issue. It only sets a
maximum amount of EUR 200 million, which is 20% of the planned infrastructure
funding. And it only helps improve the credit rating and EIB does not share its own
AAA rating (EIB, 2012). (Eurofi, 2011) Also describes, as this initiative would be an
alternative to monoline wrapped infrastructure bond market. The project bond facility
would provide guarantee to the senior debt holders or introduce a junior debt layer
underwritten by EIB. And the author also says that this initiative has a capability of
attracting additional private sector institutional investors and banks towards the
infrastructure projects by improving the rating of the senior debt trance (Eurofi,
2011). The recent sovereign crisis and austerity programs undertaken in many states
of European Union have a significant impact in reducing the public finance
investments in infrastructure and it might complicate governments action to arrange
funds for the infrastructure development. In this case it becomes importantly essential
to find a new financial solution to mobilize private sector investments. And European
Union 2020 project bond initiative has identified the relaunch of the project bonds
market as a possible solution to find the additional capital needed to reach the 2020
goals set by the union (Gatti, 2012) he also states that majority of infrastructure bonds
issued in the period of 2006 to 2011 have been rated as BBB by S&P. Even though
BBB rating is not a speculative grade this rating does not attract major and suitable
investors like pension funds and insurance companies. So this initiative will mitigate
the risk and attract institutional investors for long-term investments. EC says the aim

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of the initiative is to enhance the credit quality of the private entities that need to raise
private funds for infrastructure projects they promote and the author also insists that
its completely different from so called Eurobonds or stability bonds which are joint
issues to provide general funding for member states of government funding needs. In
this neither the commission not the members states will issue bonds under this
initiative (EC, 2012).
Figure 1: EIB project financing model
4.4.1 Implementation:
Credit enhancement is providing to the companies raising senior debt in the form of
bonds to fund the infrastructure projects. The increased credit quality of the bonds
will support their standings with institutional investors. The issues will be carried out
by project companies and not by European Investment Bank or any of the members of
the states. The EIB will offer credit enhancement in the form of subordinated
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instrument to support the senior debt (EIB, 2012). The PBI works as a tool of credit
enhancement by splitting the debt of the project into slices by senior and sub
ordinated tranche. The EIB reduces the credit risk by providing the subordinated
trance in the form of a loan or guarantee and also improves the credit quality of the
senior debt making it easy to issue in the capital market. And the author also says that
the sponsors of the project create a company to raise financing for the infrastructure
projects and provide funding in the form of equity. After that the EIB supports by
providing a loan or debt service helping the sponsors to borrow funds at a lower cost.
The company will reimburse the senior tranche first to the market and the
subordinated tranche to the EIB and equity at the last (Monk & Provaggi, 2013). EIB
is very clear that it will provide service to only eligible project companies and key
strategic infrastructure projects in Europe (EIB, 2012). Werner Hoyer, EIBs
President says that this initiative will help reopening the capital market funding
strategic energy, transport and communication projects, which are crucial for Europe
development in future.
4.5 UK Guarantees Scheme 2012:

The UK guarantees HM treasury introduced scheme in July 2012. The scheme was
introduced to reduce the delays due to shortage in financing and other risks in
financing and accelerate the investment in significant infrastructure projects
nationally (White, 2012). The intiaitve was conceived to stimulate investments in
infrastructure projects in UK where the market conditions makes the project sponsors
face difficulty obtaining project finance. The scheme will initiate government support
the funding of significant infrastructure projects by underpinning construction,
operation or revenue risk (Herbert Smith, 2012). John Cridland, CBI Director-General
describes this scheme is a major move that would unlock a 250 billion of investment
which would help renew existing national infrastructure in which two third of the
investment expected to come from private sector (Cridland, 2012). Laudy and Ogden
say that this scheme would reduce the credit risk of infrastructure projects worth 40
billion. And the projects eligible under the scheme would be financially credible and
nationally significant infrastructure projects (Laudy & Ogden, 2012). The scheme will
help work get started on many important infrastructure projects in UK and help
exports and benefit thousand of people and a significant boost to the economy
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(Alexandar, 2012). Aisbett says that this scheme is an extension of various

governments previous initiatives such as National loan guarantee scheme and new
funding for lending scheme which are all introduced as credit easing initiatives for
business (Aisbett, 2012). The scheme would bailout infrastructure developments from
adverse credit condition by proving sovereign backed guarantee to help projects raise
finance (Osborne, 2012).
The government has drafted some eligibility criteria in order to benefit from the
scheme for financial support.
Nationally significant- Identified in National infrastructure plan 2011
Construction ready Ready to commence within 12 months of guarantee
Financially credible Having good financial records
Dependent on guarantee
Good value for taxpayer Acceptable credit quality
If the infrastructure project satisfies the criteria then the project will be guaranteed by
the treasury (Herbert Smith, 2012). The government has discretion over the type of
guarantee it would provide for each project in terms of scale, timing, risk exposure
and relationship to the project. The guarantee provided by the government cover
under many types of project risk including construction, performance or revenue risk
(Laudy & Ogden, 2012). Once the project has been crossed pre qualified stage the
sponsor and IUK will enter into discussion after which the project would be
forwarded to internal HMT risk committee before being submitted toe the chancellor
for approval (Osborne, 2012).
4.6 Hadrians Wall Capital 2009:

The HWC was introduced in 2009 for providing new market bond financing solution
to European infrastructure debt markets. Till 2007 the capital markets played a major
role in financing long-term funds for infrastructure companies but after that due to the
credit crunch and the disappearance of monoline affected the ability to sell long term
debt. Banks also had major impact reducing their loans due to increased capital
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charges and liquidity restrictions. So the week capital market without monoline and
bank funding there was a need of a credit enhancement facility, which was established
in 2009. (HWC, 2009). This initiative aims to provide credit enhancement to
infrastructure projects in Europe while targeting returns in line with markets. This
applies the same credit enhancement method that of the PBI to a broader set of
infrastructure investments on fully commercial basis. And the author also insists that
it is being baked by Aviva investors, the EIB and the Development bank of japan
(DBI). The funds goal is enhance project debt in investment grade level by a 10%
capital injection of the project value in notes, which will be senior to equity sponsors
and junior to institutional investors (Mignucci, Frisari, Micale, & Mazza, 2013).
Integrated debt package to a issuer through a single debt instrument issued are a
spread over government benchmark bond. HWC will slice the debt into two parts one
is a senior debt and another is a subordinated debt, which A and B notes respectively.
The A notes will be issued in the capital markets then b grade will be placed with
fund controlled by Aviva. This initiative will help improve the credit quality of the
bond from BBB- with enhancing to atleast BBB+ and therefor becomes an attractive
in the capital market (Murphy, 2011). The minimum rating eligible in this criteria is
BBB- the HWC does not want include and guarantee speculative bonds or junk bonds
since the structure is not capable of covering those risks. The author understands the
large available capital in EU to finance infrastructure and private sector supply of the
credit enhancement and managing credit services must be achieved in order for
intermediate to long-term problems of EU funding to be addressed (HWC, 2009).
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Figure 2: HWC Debt Initiative
HWC debt initiative (Murphy, 2011)

4.7 IIFCL Credit Enhanced bond:
The Asian development bank (ADB) along with India infrastructure finance company
Ltd (IIFCL) will help infrastructure bond issuers to enhance their credit rating and
attract funding from institutional investors such as pension funds and insurance
companies. IIFCL, ADB and domestic finance companies will provide partial
guarantee on rupee dominated bond issues by infrastructure development companies
located in India (PTI, 2012). Vivek Rao, finance specialist of ADB says that the credit
enhancement will improve the credit rating of infrastructure bonds issued by Indian
developers which will attract investments from insurance and pension funds (Rao,
2012). This initiative will support financing Indias strategic infrastructure projects
addressing nations development challenges namely to meet the investment target of
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about $1 trillion in 12th five year government plan (ADB, 2012). This facility will
bring new lenders to infrastructure project financing there by diversifying funding
options of these projects. The IIFCL, which is a government body, seek $12 billion
credit enhancement facility to boost infrastructure in India. And the Central
government has given an approval to IIFCL to start the pilot scheme for credit
enhancement, which will provide partial guarantee to bonds which from majority
bonds at BBB- will get AA credit rating which will make institutional investors invest
in projects (Ray, 2012). Goel managing director of IIFCL said that it has launched
Infrastructure debt fund (IDF) initially it launched with $1 billion which 50%
domestic and 50% foreign investors. ADB, HSBC and Barclays are few foreign
investors. He also states that it is the initial stage since Indian infrastructure needs cost
$1 trillion for 2012-2017 period (Goel, 2013).
IIFCL will setup a Special purpose vehicle (SPV) to facilitate infrastructure funding
given mismatch between the tenure of normal bank loans and long gestation
infrastructure projects. IIFCL mandate to mobilize resources from various sources
including ECB and also allowed to tap into Indias forex reserves to reduce the cost of
finances (Ray, 2012). IIFCL is very clear in financing only commercially viable
projects and project carried out from Public Sector Company, private sector or private
sector under PPP initiative. The project should be approved by Pubic Private
Partnership Approval Committee Rupee debt is raised from the market through
suitable instruments at maturity of 10 years and beyond. Sub ordinated debt shall not
exceed 10% of the project cost (IIFC, 2013). World Bank and Asian Development
Bank support this scheme, the success probability of this initiative is high. The
scheme is in initial stage and the success of this initiative and its possible contribution
to the infrastructure development is yet to be known.
There is an increase in introduction of credit enhancement scheme for funding
infrastructure projects by multilateral agencies and sovereign governments. This rise
in credit enhancement scheme is due to the slowdown of infrastructure development
after financial crisis and existing European crisis. Financial institutions and sovereign
governments are introducing scheme that support projects. For example In Feb 2011
Europe 2020 project initiative proposed by European investment bank which is

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regional development bank to fund infrastructure projects in Europe. Similarly the

UK government due to increasing slowdown of the infrastructure sector and to bring
it back to track proposed a scheme that could possibly kick start the market. It was a
UK guarantee scheme 2012 introduced to fund key national government infrastructure
plan 2011 projects. And there are other similar schemes like Pan European bank to
bond loan equitation 2012, Hadrian wall capital 2009 etc. Most of the above scheme
is schemes are yet in pilot stage but this initiative has to be implemented in emerging
countries government also. Indian infrastructure company limited signing up with
Asian development bank for a partial guarantee for infrastructure projects in India and
it is still in pilot phase and not yet fully functional. So the author finds that bond being
one of the major sources of funding long term investments for infrastructure. When
regular bonds upgraded to credit enhanced bonds and applied in emerging markets it
might be one of the reliable methods for mobilizing finance for infrastructure even
when other methods fail. So the author expects more credit enhancement initiatives
that in collective contribute to the global infrastructure development.
4.8 Summary:
This chapter discusses the existing credit enhancement techniques for improving the
credit quality of the project and attracting institutional investors, such pension and
insurance companies. The chapter also explains some of the existing credit
enhancement initiative carried out to improve the credit quality of infrastructure
projects in various countries.
Key Points:
Credit enhancement is one of the efficient existing risk mitigation techniques

for credit rating.
Credit enhancement can be offered from third parties with objective mitigating
specified risk.
Some important credit enhancement options are senior/subordinated,

overcollateralization, reserve funds, spread accounts, letter of credit.
Europe 2020 bond initiative planned to fund 2 trillion key infrastructure

projects in Europe.
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PBI will increase infrastructure projects at BBB rating to AA rating to attract

investments.
UK guarantee scheme introduced to delays due to fund shortage, risk and to

accelerate infrastructure nation wide.
UK guarantee scheme will help boost the economy.
Hadrian wall capital introduced to provide new bond market financing

solution to European infrastructure debt market.
This initiative will improve BBB_ rating bond to atleast BBB+ rating.
IIFCL credit enhancement scheme is introduced to meet the Indias

infrastructure need of $1 trillion during 2012-2017 periods.
IIFCL funds with 50% domestic and 50% foreign Investment.
IIFCL established relationship with Asian Development bank, World Bank.
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Chapter 5 Research Methodology

5.1 Introduction:
This chapter will contain explanation in detail about the procedure in which this
research is done. It will also include the process involved in research. It will explain
the research approach taken to answer the aims and objective of the work. The
process involved in discussing the research methodology, data collection method and
sources. Starting with the definition of the research methodology it will discuss
various types of method and its approaches. The selection of the samples to collect the
data and carry out the research will also be done and the author will discuss how and
why a method is chosen and why its not.
5.2 Research Methodology:

Pannerselvam calls as system models and techniques flowing in procedure to find the
results of a research problem (PANNEERSELVAM, 2004). (Bhattacharya D. , 2009)
Says its a scientific and systematic way of solving a problem and on top of deciding
methods and techniques it is important to apply methodology as well. The author
understands that the scope of research methodology is very much wider and it also
differs from problem to problem and its important to adopt a particular methodology
for the researcher scenario for the research. As the term methodology refers to overall
approaches and perspective of the research process (Collis & Hussey, 2003).
According to (Clarke, 2005) the research is undertaken for the following reason
Explore an Idea
Probe an Issue
Solve a Problem
Make an argument
Here the author will remind the basic purpose and objective of the research so that
selecting suitable research method can be done. The problem is developing countries
are not able to tap institutional investors such as pension funds and insurance
companies due to their low credit rating. Since for investments from pension funds

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and insurance companies need a minimum of AA rating bond. So attracting private &
Institutional investors improving the credit quality of the bonds seems to be a
solution. So the author considers a credit enhancement option for infrastructure bonds
to improve credit quality and attract investments. So the author has to select
appropriate methods to carry out research.
The author will be taking four emerging economies for collecting data and analyzing.
The countries would be named in the sampling stage later in this chapter. From these
countries the author would be collecting the sovereign rating of each country and its
difference in infrastructure need and infrastructure spending that will give the author
about the funding gap that is present in these countries. With the funding gap the
author would recommend credit enhancement option to tap institutional investors to
meet the funding gap and will discuss the benefits and liability on both the sides.
5.3 Characteristic of Research:

According to (Pathak, 2008) the various characteristics of research is
Systematic Approach
Objectivity
Reproducible
Relevancy
Control
Systematic Approach:
For a good research a systematic approach is essential. The various steps
involved in the research should be well arranged in hierarchical order and
there should be connectivity between each stages of the research.
Objectivity:
Objectivity plays a significant role, In this approach the researchers personnel
views about answer to a problem does not any play any part or find a place in
the research.
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Reproducible Research:
A reproducible research is which an equally capable researcher could
duplicate the author work and form it obtain similar results or findings. And
this could occur only when the research is not subjective but it is objective and
measurements are definite (Pathak, 2008).
Relevancy:
It involves in two major tasks in a research. It avoids collection of unnecessary
data and it compares data collected with researcher criteria for action (Pathak,
2008).
Control:
It is not possible to have control over all factors that play a significant role in
the research. Hence the possible control involves in two aspects. First the
control that is truly within control must be varied with nature of investigation.
Next variable beyond control must be properly recorded or controlled either
administratively or statistically.
5.4 Research Methods:

Research mean re-search states that a subject which is already known but studied
again for an issue or problem. Basic research results in finding and collecting data for
a broad base of application (Kenneth, 2005). It involves in finding out what has
already been discovered on that subject and contributes by providing the empirical
data (James, 2002). (Bhattacharya D. , 2009) Describes research as documented prose
work. An organized analysis of a subject with a help of other related materials with
suitable acknowledgement. (Khan, 2011) Describes research intended to invent or
discover new knowledge, facts and answers to questions and derive a solution to
issues. (Wayne & Stuart , 2004) Systematic which is planned, organized and has
specific goal is good research. It leads to new findings and discoveries from various
researches, which are carried out as major works and minor works. (Walsh, &
Wigens, 2003) Defines research as a range of practical skills and activities, which can
be implemented to carry out a particular investigation. And (Kumar R. , 1996) says
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that research is about asking questions and examining evidence and using that to
understand the phenomena. (Babikir, Ali, & Mabuo , 2009) Describes types of
research as basic and applied from the perspective of application. Quantitative and
qualitative research from information perspective and descriptive, correlation,
explanatory, exploratory from objective perspective. (Rajasekar, Philominathan, &
Chinnathambi, 2006) Classifies research as basic research and applied research. All
these researches are briefed below
5.4.1 Basic Research:
Gathering knowledge for knowledge sake its termed as basic research (Kothari C. ,
2004). Research, which is conducted on the basic principle and reasons for the
occurrence of a particular event. It is performed without any practical ends and gives
a general knowledge and an understanding the laws of nature. Though the general
knowledge gives means of deriving solutions for a large number of practical problems
but it does not provide an answer to a specific problem. In basic research the
researcher need not worry about the practical application of his work since basic
research only needs to new knowledge and it provides scientific capital (NFS, 2003).
It helps to develop theory, to solve puzzles and to address the curiosity of the
researcher without any immediate implementation, which will not produce any
immediate useful or practical solution (Palys, 2009). Example of this research
includes developing a sampling that can be applied to a particular situation.
Developing a methodology to assess the validity of a procedure developing a
methodology (Kumar, 2005). Hence basic research is a contribution to the
development of a theory by which the findings of research is used to take the
decisions for solving a problem.
5.4.2 Applied Research:
Applied research, unlike basic research, its objective is to find a solution for a
problem that is occurring in the society, industrial/business organization. Its main aim
is to find a solution to a practical problem in which research can be applied to make a
difference (Kothari C. , 2004). It is a method to alter or modify any existing theory
and help to formulate policies by application of scientific methods in research
(Bhattacharya D. , 2009). Applied research involves the immediate potential
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application since it is concerned with the practical life such as increasing efficiency of
a machine, and gain factor of production of a product, controlling pollution, all having
immediate potential usage in implementation of those findings in issues and problems
that exists (Rajasekar, Philominathan, & Chinnathambi, 2006).
5.4.3 Quantitative and Qualitative Research:
Basic and applied research both can be quantitative in nature or qualitative in nature.
Quantitative and qualitative researches both are categorized by its way of collecting
information for research. Quantitative research is based on measurement of quantity
or amount. Quantitative researches generally are the information on numbers it can be
expressed in terms of quantity (Kothari C. , 2004). Qualitative research depends on
the quality or kind. It is suitable for making observations on a particular subject where
the researcher himself gets involved. Quantitative research is a method based on the
study, literature and objective which is to test with relative propositions but
qualitative research is done by study in exploration of the subject and objectives with
prior notice and information (Taylor, Gautam, & Ghoshal, 2006). Qualitative research
demands answer to a question and follows a systematic set of procedure to answer
those questions. The qualitative method collects evidence for the research and
produce finding that were not determined in advance. Above all it understands the
research problem from the user perspective in which it is involved. It is best suitable
for obtaining information which culturally specific such as values, opinion, behavior
for a subject (Neu, 2004). (Creswell, 1994) Has given a concise definition about
quantitative stating that its a type of research, which is explaining the phenomena by
collecting numerical data that are analyzed using mathematical-based methods.
5.4.4 Descriptive Research:
Descriptive research focus on what is happening rather than why it is happening, It is
used to systematically address the problem, situation and is not flexible as exploratory
research (Andrew, Pedersen, & McEvoy, 2011). The major purpose of descriptive
research is to describe the current status of affairs, as it exists at present. It includes
survey and fact finding enquiries of different kinds (Kumar R. , 2008). This research
involves with specific research is studied to see if it gives rise to any general theories
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or to see existing general theories are borne out by the specific situation (Melville &
Goddard, 2004). Descriptive research includes surveys and facts finding
5.4.5 Predictive Research:
This research constructs and uses models to forecast the occurrence of an event or
events. Predictive research uses a similar model used in explanatory research to
forecast an event that might occur (Krishnaswamy, Sivakumar, & Mathirajan, 2009).
Predictive research is researching the likelihood that a particular phenomena
occurring at a given circumstances (Andrew, Pedersen, & McEvoy, 2011).
5.4.6 Explanatory Research:
Explanatory research involves in explaining a particular condition or happening about
why does this occur and assessing the links between the variables. This type of
research to be conducted requires some sort of theoretical framework
So that explanation can be obtained from the data (Gratton & Jones, 2010). So
explanatory research is used to describe the relation between the variables and used to
determine the accuracy of a theory.
5.4.7 Exploratory Research:
Exploratory research is initial research, which explores and analyzes the possibility of
finding many possible links between various variables without a clear end usage
application. This research will commence without any end objective except
establishing links between many variables (PANNEERSELVAM, 2004). Exploratory
researchers hope to produce a hypothesis. Which is a relation between two or more
variables. It is conducted to give a better understanding of the current situation and it
does not work in a way to come up with answers and decisions. Exploratory research
is often used when the research question or problem is not well defined (Andrew,
Pedersen, & McEvoy, 2011). For example, if a sale of a particular type of car falls in
the previous quarter its the researchers job to explain what caused the decrease in
sales. The researcher may use exploratory research to provide insight of what caused
low sales. The researcher may conduct interviews with buyers and find why the buyer
doesnt interested in his companies product and the researcher may find that a
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different brand introduced a product with added features at similar price that might
have affected sales.
5.5 Research Strategy & Approach:

The research strategy is the way by which the objectives in the research are
questioned. There are two types of strategy in general which is quantitative and
qualitative method. (Kumar A. , 2002) Classifies approaches as
Historical Approaches
Case Study Approach
Secondary Data Approach
Experimental Approach
Historical Approach:
The historical approach involves in obtaining historical data for the research in
the project. The historical research can be gathering data from certain events
that have been occurred before. So it is analysis done on past events which
leads to exploring further information of past in present day. It utilizes sources
like documents, records and remains of old data (Kothari C. , 2004).
Psychiatrists, philosophers, scientist and historians mostly use this approach.
Case Study Approach:
The case study method involves in a process to study one or more related
cases due its significance of the variables involved are so numerous and
qualitative different that no single survey or data collection can be used to
obtain data about the variables (Fellows, Liu, 2003). In research methodology
the term case study is use in both research design and data collection method.
(Pawar, 2004) States that case study is a study of single case by employing a
data collecting method or a combination of varied data collecting methods that
may involve individual, family, a group or an organization. The strength of
carrying out a case study research approach lies in depth in understanding the

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complexity of the social phenomena behavior and providing rich data through
thick description (Geertz, 1973).
Secondary Data Approach:
The secondary data approach is method for researchers to collect data from
secondary sources. In most research studies researchers use secondary sources
for collecting data and use that as base to collect data from primary sources
such as interview, questionnaires, observation etc. some researches are mainly
based on secondary sources (Pawar, 2004). (Kamins, 1993) states that
secondary sources consist of information collected by others. And these
sources can be private institutions, census survey, reports, official government
documents, letters, newspaper, emails, journals, and books. Some complex
research involve in collecting wide range of resources and primary data
sources collection is practically impossible so in this case researches use
secondary data approach.
Experimental Approach:
This approach provides method to investigate the basic relationship between
certain phenomena under controlled conditions or more simply to identify the
conditions underlying the occurrence of the phenomenon (Pathak, 2008). The
relationships are usually independent, dependent and moderating variables.
Initially dependent variable is about identifying the problem or question. The
independent variables act depending on the hypothesis for tracking the
difference in project (Johnson, 2002).
5.6 Research Sample Selection:

Sampling is the process of selecting a number of study units from a study population.
The definition of the research population depends on the problems and goals of the
research. Studies that involve some number of units are taken as whole population for
research but when the research covers a large amount of units then it is not possible
for the researcher to cover the entire units. So the researcher takes samples from the
population for the research (Varkevisser, Pathmanathan, & Brownlee, 2003). So for
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researcher to simplify his work without compremising his data, Selecting samples is
practically viable way of conducting a research. The selection process of the sample is
also important in any research. (Marshall, 1996) says that choosing the study sample
is a crucial stage in any research since its rarely practical, efficient or ethical to study
the whole population. The main goal of selecting quantitative sampling approach is a
representative sample from the whole population. The author made brief study before
starting to choose the sample. For collecting data on sovereign credit rating and
infrastructure investment gap for emerging economies the author needs to collect data
from the emerging countries around the world. The author considered the emerging
countries whose economies are under rapid growth and in need of sufficient
infrastructure to meet the demand. There are many emerging countries and its not
possible to include all countries into the research. So the author made a decision to
depend on the global financial agencies which plays a crucial role in the world
economy. The author studied the list released by various global financial institution.
According to the International Monetary Fund (IMF) labels the following countries as
emerging economies
Argentina
Brazil,
Bulgaria,
Chile,
China,
Estonia,
Hungary,
India,
Indonasia,
latavia,
lithuania
Malaysia
Mexico
Pakistan
Peru
Philipines
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Poland
Romania
Russia
South africa
Thailand
Turkey
Ukraine
Venezuela
59
These countries fall inside the list of countries in the group of emerging economies by
IMF. The rating of these countries varies from investment grade to speculative (IMF,
2012). The columbia university emerging market global players list includes the
above countries and also adds south korea, slovenia to the list. And banco bilbao
vizeaya argentina (BBVA) adds nigeria, egypt, vietnam to the list (BBVA, 2012).
And there are a number of other agencies around the world, such as FTSE(Financial
Times and Stock Exchange) group which is a stock market indices provider, owned
by london stock exchange, MSCI which is a leading investments decision support
organization, Standard and poors (S&P) which is leading credit rating agency, Dow
jones & company which is american financial infromation firm also are providing list
of emerging economies around the world. But the list of countries provided by these
organization already falls in the list named by the author but the point is the author
has considered the list provided by various financial agencies to reduce the
probablility of going wrong or picking up wrong sample and after collecting the list of
countries the author has priortized the significance of each country for being a sample
since many countries does not satisfy the aim and objective of research and would not
be able to obtain results as expected so the author will take sample according to the
need and suitablity according to their rating.
From the countries the author planned to take countries that would be suitable for
analysing and collecting data. The author is aware that even though countries like
China, South Africa, Russia, South Korea come under the category of emerging
countries these have a high investment grade credit rating such as AAA, AA rating
bonds that falls under the category of institutional investors investment grade. These
countries have increased number of per capita earning and are high in infrastructure
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development and have high infrastructure facilities. They have no problem in

obtaining infrastructure investments and pay no higher yield to borrow from foreign
capital market. So the author is aware that taking these countries into the research
would not give any productive finding. Since the main aim of this research is for
countries with poor credit rating under the level of attracting institutional investments
and have large infrastructure investment gap. So the author planned to take countries
with speculative rating and one step above them to the investment grade. In this
research two countries with Speculative rating of BB stable and BB- and two
countries with edge of investment grade such as BBB stable and BBB- ratings.
According standard and poors rating Nigeria has a BB- rating and Indonesia has a
BB+ rating. Countries with non speculative rating which are Brazil has a BBB+ rating
and India has BBB- rating which is one step to speculative or junk bond and Unlike
the developed countries and emerging countries with higher credit quality these four
countries have low credit quality and as discussed in the literature review these
countries have high cost in borrowing funds and pay higher yield to gain investments.
Countries like Nigeria and Indonesia being under the category of a speculative or junk
rating the issues from these countries are not trustworthy by investors in international
capital market so increasing credit quality to attract investments to develop basic
infrastructure in these countries become essentially important. The author considers
these countries as best suitable samples for this research.
In this research the author believes that each and every country credit rating depends
on various reasons and scenario will be different for each and every geographical
locations. The sample covers location of countries representing them such as Brazil
and Nigeria representing the Latin-American nations and African continent. India and
Indonesia representing southern Asia and south East Asian countries respectively. The
author believed that it is essential that these sample countries should also represent the
other similar emerging countries so that it would act as a perfect sample for those.
5.7 Research Data Sources:

5.7.1 Credit rating:
As already above the author mentioned in sampling the various samples that are to be
used to collect data and analyze in this research. Three major worlds leading credit
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rating agencies are Standard & Poors (S&P), Moodys rating, and Fitch rating. These
three organizations assign credit rating for almost all major corporates, governments,
municipalities (Langohr.H & Langohr.P, 2010). The data required from these
agencies are the assigned sovereign rating for each of the sample that is being taken in
this research. The sovereign rating is the credit rating of the sovereign. The level of
sovereign rating indicates the level of investment risk involved in countries
environment (Gaillard, 2011). (Amadou , 2001) Says that the credit rating of a
country reflects its economic and political risk. These factors affect the credit quality
of a country that has effects on investments to that country.
The author would be collecting data from all three agencies for the research samples,
which are S&P, Moodys and Fitch from its official release source. Initially author
had planned to collect ratings only from S&P but later the author thought it would be
better to collect the sample rating from all three to check for differences. Since each
agency has its criteria and formula for calculating the rating for each and every
country so it is not required that all three agencies have to assign the same level of
rating to the countries. Its up to the investor to consider which agency to trust for his
investments. So the individual rating for each of the four samples would be obtained
from the official rating release report of the agencies.
5.7.2 Infra Investment and funding gap:
The information regarding the investment required for each sample governments for
the infrastructure development in its country. All four governments release a yearly
report regarding their budget deficit and its current infrastructure spending and its
shortage of funds. The Indonesian data regarding the investments and infrastructure
needs can be obtained from the governments official annual reports and there are
various other organizations such as Indonesia infrastructure investments (IIF) from
which the data can be obtained from their press release. For India, the data regarding
the infrastructure investments that would be required can be obtained from the
Planning commission of India. In its various publication there is release the data of
the current situation of infrastructure and finance related data that could be obtained
from the official sources. There are various independent financial institution and
finance companies like IDFC in which they release the current report regarding
funding and investments in the infrastructure sector. The Brazil has separate ministry

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for each sectors in infrastructure like ministry of cities, planning, transportation that
make collective decision when it comes to infrastructure spending. The data for
sample Brazil and Nigeria will be obtained from similar sources such as the official
government annual report. Since all governments have a procedure of releasing their
governments financial report to public. The data can be obtained from the official
sources and from individual independent financial institutions that are located locally.
Since institutions that are located local have more understanding of the situation than
from overseas organization and apart from the official government sources the data
can be obtained from the official release of statistics by international credible
institutions such as World Bank, International Monetary Funds, Asian Development
bank, African Investment Bank etc.
5.8 Research Method Selection:

In this section, the author will be explaining employment of the research method. It
starts with describing how literature survey was done, what all factors where
considered while searching for the information and later the type of research, which is
the applied research in quantitative. So the author will discuss why this method was
chosen and reason behind it.
5.8.1 Literature Search:
Literature searching began by listing out various key words related to this research.
(Dochartaig, 2002) Insists that the first step to carry out any type of research is to
frame the questions and interpreting into key words. This benefits the researcher who
can describe their research in terms of key words. So the author listed out a number of
key words and picked significant terms such as bond financing in emerging
markets, credit enhanced bonds, Infrastructure funding gap that might give
results in favor of what the researcher is expecting. The author used the key words in
the library and educational article sites to obtain related materials. The author
preferred new materials than older but the older articles were not omitted. Since the
research involves in an issue that is currently existing and author thought newer
materials would give more updates of current scenario and used the cite links to find
the source and related materials for further referencing. By this author had access to a
wide range of materials through this citation network and articles that were more
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times cited were referenced. The author was aware the increased number of citation
times of an article is more a quality source for referencing. The author targeted very
much narrow articles for the literature review and avoided irrelevant information.
5.8.2 Applied Research:
The author decided to do applied research since the author is aware that the research
is with regard to a problem. The reason behind the authors decision for not choosing
basic research because according to (Gratton & Jones, 2010) basic research itself
involve only in exploring a particular concept or issue without regard for a specific
problem and on the other hand, the applied research is carried out with regard to a
specific problem and tried to provide solution to a practical question. According to
(Gratton & Jones, 2010) perspective above this research involves with a practical
problem that the emerging countries are facing. The problem in meeting the funding
gap of emerging countries due to their poor bond credit rating, it makes them harder
to obtain investment. So the author is recommending a credit enhancement option for
bonds in those countries to attract institutional investors. The author finds a problem
and the recommendation, which is being proposed, can be implemented immediately.
According to Kumar in applied research the recommendations or findings obtained
from the research could be implemented immediately unlike the basic research, which
only contribute to the development of the existing theory or methodology (Kumar,
1996). The author understands the knowledge gap in it and understands the problem.
Even though the author dint discover this method but the author finds this method of
financing suitable for credit rating problem. Hence the author finds the applied
research method more suitable than the basic research since it only contribute to
developing the theory, but in this research the author is recommending a method
which can be implemented by any country immediately if even though the scenario is
differenct for each but the concept is the same. So the author finds applied research as
most suitable for research like this which is dealing with a practical problem and
trying to provide a solution and recommendations.
5.8.3 Quantitative Approach:
Applied research can be quantitative or qualitative or even both (Rajasekar,
Philominathan, & Chinnathambi, 2006) but the author finds quantitative approach
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more suitable for this research. The Quantitative method involves with numbers were
as the qualitative approaches are not numerical (Kothari C. , 2004). The author is
aware that in this research numbers are involved. This research involves in analysing
and finding various amounts and difference between them. The qualitative method
involves researcher personally and observations are made on a subject in which the
data is obtained (Kumar, 1996) but in this research the researcher is not involved
personally, the researcher collects datas from the available data studies. The author
collects data from already available sources and makes no effort in observing or
involving in any subject to obtain data hence the research tends to be in a quantitative
approach. The author finds quantitative approach as best sutitable since its not
possible for the author to collect information individually since the scale of the
research is very high. The research involves in various countries and international
agencies. Datas are confidential and the author cant make effort in obtaining data for
the research personnaly. The datas are from governments and international financial
instituions whos data influences the entire world economy the author can only have
access to those datas when it is made to public domain by respective governments and
agencies. Since the author only has access to already available data which is made
public and qualitative approach is not possible in this case. Hence the author with
consideration of various factors above use quantitative method for this research.
5.9 Selecting Data Collection Approach:

5.9.1 Secondary Data:
Secondary data can embrace a whole spectrum of empirical forms they consists of
data and information that are generated through various documentary analysis,
systematic reviews and findings from large-scale datasets. The secondary data can be
numeric or non-numeric (Smith, 2008). So a secondary data is set of initial existing
information about a topic, which can also be analyzed and carried out in a research to
explain certain events or to prove a point. The data like census reports of
governments, surveys by international agencies and organizations. In this research the
data are obtained from various international financial organization and governments
of the emerging economies. So the scale of the data and its significance is higher
since data from these organizations influence the entire world economy from London
stock exchange, NASDAQ, Sensex etc. So the data from these institutions are very
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confidential and it can be only acquired when its made public and collecting sample
data from each of the organization is practically impossible. When considering the
secondary data it is a efficient method of collecting data. Since it does not involve the
researcher into the data collection process, it saves time and cost of the researcher and
becomes preferred and comfortable method. But at the same time the researcher
should make sure that whether the data is of high quality since many poor sources are
available nowadays. For this reason the author made sure to collect data from highly
cited source than the lower cited sources and in this research most data are planned to
collect from the official sources of the governments and international credible agency
there was less probability of collecting low quality data. There is another problem
with secondary data collection method according to (Rew, Sullivan, Lewis, & Miles,
2000) mentions that one of the main limitations of a secondary data is that the data,
which is obtained by the researcher, reflect the idea and perspective of the original
researcher. The author is aware of this limitation, but in this research the author would
be obtaining data from various sources of governments and agencies. These sources
release data, which are facts, and in whatever perspective its seen in it gives the same
meaning. So the author believes that whatever intention of the organization release
this data the author would be able to adopt this data to his research.
The author is not collecting a large number data from single sources in this research
the author would diversify and collect data from various governments, which are the
samples and bring it to a single database. The author collects data from various
sources and puts it together to perform the analysis and obtain results. The author
does not just copy a single statistics or table of data from other sources to this
research. The author collects data from various sources, which are mostly split in
various press releases, financial reports, document reports and finds and organizes it
to a single database.
5.10 Summary:
This chapter briefs the method the author is implementing to do this research. This
chapter starts with explaining the research methodology for doing this research. The
author has discussed the following factors in this chapter,
Commonly used types of researches
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Various Characteristics of research
Various research Approaches
Sampling for research
Research concentrates on Brazil, India, Nigeria, Indonesia
Research data sources
Research method chosen by author
Using secondary data collection method for this research
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Chapter 6:Development of Credit enhancement

6.0 Introduction:
In research this section is a significant part in which the author had carried out the
development of the credit enhancement for emerging economies. The author has
chosen the secondary data approach, and collected data for research samples by the
variables. The chapter starts with discussing the current status of infrastructure in the
research samples that were chosen at the earlier stage of this research. The author had
included the collected data about infrastructure funding in each of these countries. In
this available data the required funding for the project and in current infrastructure
deficit has been included. At the next stage the author had discussed about the credit
quality of each sample that plays a significant role in affecting funding for various
infrastructure projects. The collection of sovereign rating for each sample has been
compared with developed countries rating. Later, the author tries to find a relation
between the bond yield and credit rating of the sample by including the data of the
four developed countries into research so that comparing both the scenario that might
lead to a progressive research. By now the author would have conveyed the need for
improving the credit quality of the issues and recommend a credit enhancement
mechanism in which the credit quality of the issues issued by a public or private
entity. Then the author will discuss the various stages of the credit enhancement
option that might best suitable for the emerging economies. Then a discussion of the
alternatives that the author considered and would have been possible but due to
certain reasons it was not included in this research option.
6.1 Infrastructure funding by emerging countries:

The author had collected infrastructure spending by each sample countries and tried to
collect the infrastructure-funding gap. Governments introduce new infrastructure
projects for developing the living standard of people and to improve the nations
economy but governments fail to arrange enough funds for those projects. So project
delay and closure occurs due to insufficient funds. There are various reasons for a
government for not obtaining enough investments in the infrastructure sector. Credit
rating is one of the major issues that emerging countries governments face. These
governments of emerging economies are not assigned with a top-level bond rating to
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gain investments in ease from investors and some governments fall in junk or
speculative bond and forced to pay higher yield. So governments having low credit
rating obtain investments by offering high bond yield. Even though offering high
interest, some investors have a policy as to not invest in bonds lesser that A level such
as the institutional investor like insurance and pension fund companies.
6.1.1 Brazil:
Brazil is one of the countries that spend the least amount of its GDP in infrastructure.
According to Brazil ministry of finance, Brazil spends barely 1% of its GDP
compared to other emerging countries spending 4-12% such as Chile, China, and
India, (MOF, 2013) and also mentions that Brazil requires an infrastructure
investment of about US$235bn. According to (Economist, 2012) from 2011 to 2014
the government has spent US$80bn or 1% of the GDP in infrastructure. Brazil is also
the host country for 2014 soccer world cup, 2016 summer Olympics and has plans to
spend an ambitious $470bn to upgrade infrastructure in its country such as road, ports,
airports, telecommunication etc. The Brazilian national development bank in 2010
recommended increasing the GDP spending on infrastructure to 4 % due to the rising
demand for infrastructure. According to the world economic forum infrastructure
ranking, Brazil is ranked at 48th position.
6.1.2 India:
India in its 12th five-year plan from 2012 to 2017 planned infrastructure projects
costing $1tn USD. According to the planning commission of India, India has invested
8 percent of the GDP in infrastructure (2011-2012) and is planning to rise up to 10
percent during 2016-2017 (PWC, 2012). India being one of the fastest growing
economies in the world had major delays in many of its construction projects. In
2011-2012 government economic survey out of 583 infrastructure projects 235
delayed each project worth more than 1.5bn rupees and India has come forward
gaining private investments and foreign investments and is planning to obtain to gain
$1tn private investments before 2017. (Planning Commission, 2010) Released the
funding gap that occurred during 2010-2012 period. The estimated requirement of
funding for infrastructure projects were Rs7,078.64bn and estimated availability was
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Rs5,800.94bn resulting a funding gap of Rs.1,275.70bn, In global economic forum

ranking for infrastructure, India is ranked at 58th position.
6.1.3 Nigeria:
Nigeria is spending $10bn USD on infrastructure annually, which is about four
percent of its GDP of about $250bn (AEO, 2012). Nigeria is one of fast growing
economies in Africa but has a poor state of road, rail and port infrastructure. Nigeria
has a rapid developing capital market and investor bases. Nigeria stabilized from high
inflation during 2005 to 2007 of 30% inflation to 5-10% by 2007. The fall of yield
rates have occurred past year but however the yield to maturity is above 12 percent
(Foster & Pushak, 2011). The global economic forum ranked Nigeria at 115th position
for quality infrastructure.
6.1.4 Indonesia:
Indonesia is spending 1.7% of its GDP in infrastructure. It is one of the least country
investing in-house infrastructures in the region comparing to Thailand 3.6% of its
GDP and Malaysia 5.4% of its GDP (World Bank, 2013). According to the Ministry
of National development and planning estimated Rp.430tn for year 2013 that is 5% of
its GDP of Rp.8.611tn. The ministry plan for infrastructure during 2010-2014
estimated at USD213,3bn. Indonesia is one fast growing countries in the southeast
region but has a speculative rating for its sovereign bonds. The global economic
forum for quality infrastructure ranked 50th position for Indonesias infrastructure.
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Infrastructure Spending
10%
8%
6%
% of GDP
4%
2%
0%
Brazil
India
Nigeria
Indonesia
Figure 3: Infrastructure Spending Data as of 2012
6.1.5 Attracting Institutional Investors:

The author discussed about the status of infrastructure in research samples of the
emerging economies and its significance in gaining investments. Most of the
emerging economies face a funding gap, and one of the major problems in attracting
the institutional investors is since institutional investors require a high credit quality
bonds to make their investments. The emerging economies taping institutional
investors might help reduce their financial burden. In most emerging countries the
pension and insurance funds are untapped sources. Using these funds will contribute
to a greater extent in developing infrastructure. The pension and insurance funds
offers a pool of non-bank capital to flow into infrastructure without any asset liability
mismatch. According to OECD private pension funds have accumulated $30tn that
could be possibly invested in infrastructure development and pension funds require an
A level bonds to invest. The author had discussed the sovereign ratings for the sample
assigned by various credit rating agencies below.
6.2 Credit Rating:

The author had collected the sovereign rating of each research samples provided by
the international credit agencies. Each credit rating agencies calculate the sovereign
rating considering various different factors that are not same as other credit rating
agencies. The author has chosen four sample countries from a list of emerging
countries during the sampling stage in the previous chapter. The author had chosen
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these four countries considering various factors that include the geographical location,
funding gap and each of these countries is assigned with rating for the issues in their
country and abroad. So the rating is a important factor for an investor to invest in any
bonds since the majority of investors invest according to the rating.
Sample
S&P
Outlook
Brazil
BBB
Negative
India
BBB-
Negative
Nigeria
BB-
Stable
Indonesia
BB+
Stable
Table 1: Sovereign Credit rating by S&P
Sample
Moodys
Outlook
Brazil
Baa2
Positive
India
Baa3
Stable
Nigeria
N/A
N/A
Indonesia
Baa3
Stable
Sample
Fitch
Outlook
Brazil
BBB
Stable
India
BBB-
Stable
Nigeria
BB-
Stable
Indonesia
BBB-
Stable
Table 2: Moody's Sovereign Rating
Table 3: Fitch Sovereign Rating
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Non-Investment Grade
Investment Grade
STRONGEST
WEAKEST
Moodys
S&P
Fitch
Aaa
AAA
AAA
Aa
AA
AA
Baa
BBB
BBB
Ba
BB
BB
Caa
CCC
CCC
Ca
CC
CC
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Table 4: Credit Rating Arrangement
Credit rating for sovereigns and corporate bond issues are assigned by these three
major credit rating agencies which is located and operating from the United States. In
the case of S&P the best rating is AAA and followed by AA, A, BBB, BB, B and
CCC. To make the rating more finer it assigns rating as BBB+, BBB, BBB-.
According to S&P the rating below BBB- is speculative or junk bond. Fitch is similar
to S&P and has categorized bonds at BB+ and below are junk bonds. In the case of
Moodys rating the best rating is Aaa and bonds with rating are considered not to face
any crisis in the near future. Followed by Aa, A, Baa, Ba, B and Caa. To make the
rating more specific Moodys assign rating as Aa1, Aa2, Aa3 it divides them into
three levels.
6.2.1 Bond Yield:
The yield is the return on investment from a bond and it is a fixed income
instruments. The yield of a bond is converse to the day today price of the bond, The
bond yield has direct impact from the price of the bond and vice versa. If the markets
yield or inter rate declines it results in a hike of bond price. If the cost of bond falls
the interest rate or the yield goes up and vice versa.
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Nominal Yield: That is other wise called as coupon yield is the annual
total of interest paid, which is divided by the principal or face value of
the bond.
Current Yield: It is also called, as market yield is the yield of the bond
at the current moment, which is the spot market price. The current
yield is annual interest divided by the clean price.
Yield to maturity: Otherwise called the redemption bond is the overall

interest rate earned by an investor purchasing the bond today and
assuming to hold till maturity having received all interest payments on
time.
6.2.2 Relation between Yield rate and Credit Rating:
The author had discussed a relation between the yield rate and the credit rating
assigned to various emerging economies. For example, the author had included few
high credit rating countries such as United States, Singapore, United Kingdom and
Germany. The author had taken the assigned sovereign rating and the current market
rate for a government bond 10Y to compare the same data with the research sample of
emerging countries such as Brazil, India, Nigeria, and Indonesia. As the author has
already collected the sovereign rating for these sample countries above and with
inclusion of the high rated sovereign in the table. The reason for including few
developed countries is that the author believes this would give an idea how different a
good credit quality rating from a poor credit quality actually are and also help view in
other perspective too. The author had shown how different an interest of a developed
country to that of an emerging country due its difference in the rating.
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Sample
S&P
Outlook
United States
AAA
Negative
Singapore
AAA
Stable
Germany
AAA
Stable
United Kingdom
AAA
Negative
Brazil
BBB
Negative
India
BBB-
Negative
Nigeria
BB-
Stable
Indonesia
BB+
Stable
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Table 5: Sovereign Rating by S&P as of Aug 2013
Market trend for Government Bond 10Y

14.00%
12.00%
13.16%
10.00%
11.20%
8.00%
8.14%
6.00%
Interest
4.00%
2.00%
0.00%
7.64%
2.60% 2.35% 1.69% 2.67%
Figure 4: Government 10Y Bond Market Trend (Trading Economies, 2013)
There are various factors that affect the interest rate of a bond such as inflation,
economic policy, national debt etc. Credit rating agencies taking into account various
factor and assign a rating. From the above table it clearly shows that, more the credit
quality of the bond lesser the interest rate. Countries having good sovereign rating
have low interest rate while the emerging countries research samples having low
credit quality have a high interest rate. So emerging countries have the increased cost
of borrowing than the developed countries. The Brazil government bond averaged
12.3% during 2006 to 2013 having a record high rate of 17.9% and low to 9.1%.

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Indian government bond yield averaged 9.3 % during 1994 to 2013. During this
period it also has reached all time high of 14.8% in April 1996 and low in October
2003 to 5.0%. Nigeria government bond during the period of 2007 to 2013 averaged
at 11.3% all time high if 16.5% in February 2012 to a 5.9% low rate in March 2010.
The Indonesian government bond during the period of 2003 to 2013 had averaged at
10% and reaching a all time high of 20.8% in October 2008 and low of 5.0% in
February 2012 (Trading Economies, 2013). The author after collecting the history of
the interest for the sample its been quite a long and these countries got used to pay
high yield so as to attract investors and gain investments. The high interest rate might
have affected the emerging economies around the world by the high cost of borrowing
and are unable to tap the institutional investors. So its clear that credit rating plays a
major role in gaining investments and during period of crisis such as inflation,
currency depreciation the government had to increase the interest rate to compensate
the increasing deficit during tough economic conditions and sometimes governments
even after introducing reform measures are pushed to speculative grade for
investments due to economic instability. Borrowers face problems during such
situations and a simple credit enhancement to the issuers will provide cover to the
possible loss that might occur. The author had recommended credit enhancement
process that emerging economies obtain assurance from that might help gaining
investments. The credit enhancement option and procedure had been given below.
6.3 Credit Enhancement:

The credit enhancement option would channelize long term funds from untapped
sources, such insurance companies and pension funds towards infrastructure sector. It
helps the issuer of the bond with a guarantee, which reduces the credit risk, and
increases the credit quality rating of the issuer. So the issuer can borrow at a cheaper
interest rate and would be able to tap pension and insurance funds. The various credit
enhancement option available was discussed in the literature review chapter in this
research. International financial institutions such as World Bank and regional banks
such as African development bank, Asian development bank, European investment
bank and others can offer the credit enhancement for the research sample.
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6.3.1 Working of Credit Enhancement for Emerging Countries:

In most emerging countries there is a gap for long term infrastructure finance and is
significant for governments to take steps in encouraging or promoting investments
such as bonds. As the author discussed above the status of infrastructure in various
developing countries and their investment in the development of their in-house
infrastructure such as road, ports, railways, airports, power sectors are very low.
Emerging countries have large growing infrastructure funding gap, and can be
reduced with credit enhanced bond issues. There are many ways that currently exist
for governments to improve infrastructure. There are many projects in each of these
sample countries that are financially viable but due to insufficient funds, there is huge
delay in progress of construction and in many cases the projects are yet in papers after
years of the proposal. Example if the government plans a port in a strategic location
of its coast which may increase trade as well as improve the economy of that region
and not only that it may also generate income to the governments and can meet its
own debt. Even if the government thinks a project can pay for itself after completion,
it is not able to start or complete within the scheduled timeline due to insufficient
funding and now days its very common for developing countries that has projects yet
to be funded that has been proposed a decade ago. So the government needs to find a
way to fund strategically viable infrastructure projects. The author had recommended
a path or can be called as a process in which the governments can improve
infrastructure its in house infrastructure through credit enhanced bonds.
The author recommends a procedure and structure that the credit enhancement can be
assigned and working of that credit enhancement option from already existing
initiative and the alternative that might also fit in but not suitable. The author as
discussed in the literature review of existing initiative in developed countries and the
goal that credit enhancement option should achieve in improving the credit quality of
infrastructure bonds. Since the emerging countries are having a low rating its
essential to implement credit enhancement but not all credit enhancement options are
suitable for emerging countries. The author had recommended a procedure of a single
credit enhancement that would fit in for emerging countries.
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6.3.2 Credit Tranching Mechanism:

The credit enhancement for infrastructure projects can be provided by separating the
debt of the project company into tranches into senior and subordinated tranches. Since
the company does not have enough or no security to protect the bonds the loss that
would damage the bonds. So in the case of insufficient security to protect the issue the
borrower can separate the issue in various classes. (Wood, 2007) Also states that if
the surety is invalid or insufficient to protect the senior tranche then junior creditor
claims must rank after the senior creditor. Subordinated bonds are more exposed to
risk than the senior bonds and incase of a problem the first damage is absorbed by the
subordinated bonds. So separating debt of the project company is the first stage that
separates the risk from the senior bonds that eventually contributes to the quality and
credit worthiness of an issue.
Investors
Project cost
Senior
bonds
Junior
bonds
Guarantor
Figure 5: Credit tranche working
Then the agreed international or regional institutional banks provide subordinate

bonds so as to enhance the credit quality of the senior bonds. Which increases the
credit rating of the bond. Each sample located at various locations can request from
regional banks. For example, in the case of Nigeria it can request from the African
development bank that is a part of the African union and it differs according to the
region.
The primary purpose of this initiative is to enhance the credit quality of the senior
bonds through a guarantee. So it does need to undertake risk such as monoline
insurance companies, but to a certain agreed limit not 100%. The institutional bank
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can fix certain rules so that it can avoid intolerable financial crisis. It can fix certain
condition before starting the credit enhancement option such as
It can limit the transaction amount by giving a cap when it reaches the
maximum or fix a percentage of nominal of credit enhanced bonds
Require counter guarantee
It can avoid sharing its own AAA credit rating since the banks only give
subordinated guarantees.
It can structure and fix a price for the credit risk involved.
It can monitor projects after providing enhancement.
The transaction limit is common among the institutional banks as the banks like EIB,
IFC, IDA have their own set of conditions. (EIB, 2012) Has a limit on the transaction
that its guaranteeing on. EIB covers maximum of EUR200 million or 20% of senior
bonds. And (World Bank, 2013) World Bank group instruments like IDA requires a
counter guarantee from the governments so incase of crisis a demand request can be
raised for the guarantee provided and institutions also can monitor the progress of the
projects.
6.3.4 Eligibility Criteria:
The author finds that certain criteria are important to filter and provide support for
eligible companies and projects.
Firm size
Transaction Size limit
Sectors
Capital funding requirement
These criterias are considered by multilateral agencies and commercial banks widely.
The firm size limit requirement differs for different countries. (World Bank, 2013)
Its one of the major priorities for multilateral agencies to consider the size of the firm
and the guarantee its applying. (EIB, 2012) EIB offers credit enhancement in its bond
initiative only for energy and transportation sectors like that agencies can prefer
sectors for investments and there are some other eligibility criteria where the EIB in
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its bond initiative uses can also be included such as coverage by rating agency, legal
framework, and a funded pension plan that could also possibly be considered.
6.4 Implementation:
The implementation of the credit enhancement for the issuing entity can be achieved
with cooperation of the three major participants that are the multilateral agency, home
government and borrowing entity. The multilateral agency will issue credit
enhancement in association with the home governments SPV. Which is financing
company functioning under and a part of the home government. The multilateral
agency with the government can guarantee through the governments SPV. According
to the (World Bank, 2009) mentions that any of the World Bank group institutions
(IFC, MIGA, IDA etc.) will be able to provide guarantee alone or in cooperation with
other guarantors. In this case the multilateral agency will be cooperating with the
home government for providing credit enhancement to the obligator through SPV.
The author has discussed about creating a SPV and also about the need behind the
SPV in the following section of this chapter.
Figure 6: Credit enhancement co-operation triangle
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6.4.1 Creating Special Purpose Vehicle (SPV):

The governments should create a subsidiary or state owned company exclusively for
developing in house infrastructure. The Entity can be created and also fully owned by
the government can act as Investment Company. The company can issue bonds,
invest in key infrastructure projects that are publically or privately owned and the
public private partnership projects. The company can borrow and guarantee projects
with the tie up from multination financial institutions to improve its credit quality. So
why does the government create a SPV than doing it on its own?
The author recommends a SPV for various transactions to pass the risk and debt of
borrowing money to the company. (IMF, 2006) Backs the above point calling SPV
can be used to shift the debt off from the government balance sheet. The SPV is an
entity that isolates the parent firm from financial risk even during bankruptcy. It is
common among companies to blur their legal and tax reason. And SPV are legally
recognized and used all over the world by corporates and governments (Gregory,
2012). The government can sanction SPV a considerable capital to get started and
function. The SPV will then be able to raise the long-term debt from the capital
market with a guarantee from the government. The SPV can establish links with
multilateral agencies such World Bank, African investment bank, Asian development
bank and request a guarantee to improve its credit quality for rising long-term debt
from the capital market. (Sandipan, 1998) Justifies the need for a SPV saying that it is
necessary for the central government to set up an institution with a tie up possibly
with multilateral agencies exclusively for a specific objective of providing credit
enhancement improving credit standing of the projects. So with improved credit
quality and increased investors the SPV can help funding and arranging funds for key
strategic infrastructure projects in the country.
6.4.2 Providing Guarantee:
Key strategic infrastructure projects can request for guarantee from governments
infrastructure financing company (SPV). Then the SPV would grant credit
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enhancement to the project. The SPV is already guaranteed by the government and
multilateral agency, it would help improving the credit quality of the bond issues.
Such as building a highway connecting a number of towns in a region, which increase
the economy of the region and benefit the developer through tolls. In this Instance say
a company called ABC infrastructure limited. Which is involved in building road,
ports, power plants, etc. The ABC infrastructure can create a SPV called ABC
highways exclusively for the purpose of borrowing. It may issue bonds but it is not
possible to for the company to gain investment if it has a low credit quality.
Especially attracting pension and insurance funds since it requires AA credit quality.
It can request for credit enhancement from the governments SPV for infrastructure
that is backed by the institutional banks. The ABC highways can request for credit
enhancement for its senior bonds to improve its rating and Governments SPV can fix
a price for the risk involved and provide a credit trenching accepting the risk involved
to certain agreed limits. When the Government SPV provides credit enhancement for
company that funds project by issuing long-term infrastructure bonds with improved
credit quality can attract pension and insurance companies.
6.4.3 Improving Credit Quality:
Even after providing credit Enhancements will the Issuer receive AA or AAA rating
for sure? So that it could gain institutional investors. The author believes that each
credit rating agencies have different requirements or criteria for giving a top level
rating after credit enhancement. If an Issuer has a rating of BBB and later provided
with the guarantee the rating might change according to the scenario. It depends on
the expected loss a particular company may face and protection or enhancement that
the guarantor provide. For example, the need of credit enhancement for a issue
requires a four times the expected loss to obtain an AAA rating and three times
expected loss for a AA rating. So the amount of credit enhancement required might
change on rating agency requirements, and it is not necessary assign the same rating
(Fabozzi F. , 2001). So the credit enhancement will be calculated for each case to
expected loss that makes the credit level to AA or AAA rating.
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ABC Highways Bonds
Par value (Millions)
Class A (senior bonds)
$68
Class B (Subordinated or junior
$12
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bonds)
Total
$70
Table 6: Example Bond class
For example, a company ABC highway as discussed above planning to construct

roads connecting various towns needs an issue of $70 million par value. In most
developing countries there are various political and economical risk that would result
in delay of the project. So the credit agency calculates a possible or expected loss, say
$4 million. And to get a top level rating the cover it should be certain times the
expected loss as mentioned above by (Fabozzi F. , 2001) which may differ from
different rating agencies. One may require 2 times cover another may need 3 times.
So if the company wants to get absolute triple AAA rating it may need highest
expected loss cost as a cover. Say 3 times the expected loss in this case requires a $12
million cover for credit enhancement for triple A rating any lower might result in
double AA or even lower. It depends on the rating agency formula. In the case of
crisis the first loss would be absorbed by the Sub
Ordinated debt and if the loss is less than $12 million then it causes no damage to the
senior debt. So by this process the credit quality can be improved for infrastructure
projects and would be able obtain funding and repay through the given timeline of
payments. In fig 6.5, the author has separated the borrower issue into two classes.
Class A is senior bonds and class B is the junior bonds and as the author mentioned
above (Wood, 2007) that its important to separate the debt to mitigate the risk of
damages to the senior debt improving the quality of the issue.
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Figure 7: Bond issue credit support structure
6.4.4 Claims and Repayment:

The multilateral agency has to get into legal agreements before providing a guarantee
that the governments SPV that is being already funded and part of the government
body. Multilateral agency can get into an indemnity agreement with the host
government. Certain institutions require counter guarantee for providing credit
enhancement some does not. For example, in the world bank group, the International
Bank for Reconstruction and Development (IBRD) and International development
association (IDA) has policy for its guarantee instruments that requires a counter
guarantee from the government at the same time, the international finance company
(IFC) and Multilateral Investment Guarantee Agency (MIGA) which are also under
the world bank does not require a counter guarantee (World Bank, 2013). So in this
situation the author recommends an indemnity agreement with the government. Under
the agreement in which the multilateral agency has the right to request the money that
has paid under the guarantee in single or regular terms or it can be converted as loan
by the multilateral agency to the government that owes. (World Bank, 2009)
Mentions that it has the right to demand immediate repayment that has been paid for
the guarantee it provided or can be repaid at agreed terms. In some cases the
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repayment amount can be converted to loan to the country by the multilateral

agencies, which is also possible in indemnity agreement. For example, IDA and Peru
had an indemnity agreement in which the government of Peru fails to make the
payment and guarantee is triggered, IDA will pay the guaranteed amount and the
amount would be converted to loan from IDA to Peru (Matsukawa & Habeck, 2007).
So when the claim is raised, it can be repaid immediately through a single payment or
can be paid at agreed regular intervals or can be converted into loan. In any of the
method the guaranteed amount can be repaid to the multilateral agency but the type of
repayment depends on the size and risk of the project and agencies in which the credit
enhancement requested.
6.5 Alternative Option

6.5.1 Stand-alone Government Guarantee:
Stand-alone credit enhancement is a option for governments that does not want any
external support to credit enhance its projects. Above the author recommends bilateral
guarantee for infrastructure projects than the governments alone. For the argument
why does the government need any of the multilateral agency support instead
providing credit enhancement on its own. The author finds that it is not simply
enough due to the scale and number of projects that will need to be provided.
In this research the author had discussed about the emerging markets and countries
that does not have AAA rating to offer credit enhancement to projects. As mentioned
in earlier section in this chapter the sovereign rating of most emerging economies are
assigned with BBB and lesser. And its difficult for the government to share credit
risk with wide range of projects with a low credit quality itself. As the sovereign
rating of a country play a significant role in a rating of a project carried out in its
territory. According to (S&P, 2011) due to the unique power and resource of a central
government that can affect financing, operating environment of an entity in the
country borders. For organization which are assigned with better rating have the
capacity to mitigate the possible risk that might occur but that cannot be expected in
majority of the cases. But even if the above cases are also possible, Government just
cannot bear the load alone providing credit enhancement to hundreds of projects. It
will result in financial burden to the government affecting the budget. (Sandipan,
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1998) Says that the extensive use of credit enhancement to the projects will cause
strain on the government that might even lead to affecting the overall sovereign rating
and its not good for the countries economy. So for a emerging economies its not
viable option to provide credit enhancement by the government alone without a
support of the international agencies. As the author recommended a bilateral
agreement from a multilateral agency and national government to share credit risk and
improve the credit quality. This will reduce the burden on the government and at the
same time will be able to achieve the target that could have not been possible by the
government credit enhancement offers alone.
6.5.2 Bond Insurance:
Bond insurance companies also called as monoline insurance companies insure bonds
to cover all the loss to an agreed limit. Bond insurance is suitable for issues that are
very large in size and the bond issue is expected to be less than a high quality bond
since bonds with a AAA rating does not need to improve their credit quality and at the
same time its very difficult for non investment grade bond to obtain a bond insurance
hence it is expected to be less than high quality level so that when insured it credit
quality improves to better level. (IMF, 2001) Mentions that bond insurance is
important for large bond issuers and less than high quality bond issuers that need to
gain investments in weak market conditions. And it also bond insurance are no longer
an efficient way of financing since it has become less competitive. So the author finds
it is not suitable since most issues that need support are not investment grade or low
investment grade issues and it is below the eligibility for guaranteeing the issue. And
also (Khn & Pischke, 2011) mentions that bond insurers provide guarantee only in
high investment grade countries. So the author finds that even though some emerging
countries are investment grade most of them have speculative market. As the author
even mentioned above the sovereign rating countries like Nigeria have a speculative
markets and issues from those countries are called junk bonds. And from the above
statements its clear that bond insurance are not possible for low or non-investment
grade countries. So the author finds that this option might fit very few nations but
most of them does not pass the criteria for gaining a bond insurance.
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6.5.3 Letter of credit:

The letter of credit plays a major role in financing infrastructure project and being one
of the common used credit enhancement options. A letter of credit issued by the
commercial banks that have a feature of when needed can be used at times to make
payments or interest on the bonds. The letter of credit cant be pulled back but can
renew or replaced after certain period. Normally a letter of credit is issued for 10
years where the bonds are 20 to 30 years to maturity and need to be renewed
periodically. (O'hara, 2011). (Frank, Fabozzi, & Kothari, 2008) states that the issue of
LOC has declined due it became a high cost credit enhancement. The author finds that
the use of LOC even though it covers the short fall of revenues there has been
significant low in banks issuing anymore LOC. This credit enhancement is obtained
from top triple A rated commercial banks but the number of bank has currently
declined due a risk based capital requirement and the LOC has become much costlier
way of credit enhancement, which is no longer a viable option. So the author finds
this way of credit enhancement bit complicated than the others and banks inability to
carry out this option makes it not preferred.
From the stages recommend by the author to credit enhance a bond issue would
increase the infrastructure funds and it would also attract significant long-term debt
investors such pension and insurance companies. And with improved credit quality
and having the opportunity to tap the institutional investors for the first time the
infrastructure companies in developing countries would be able to carry out projects
at large scale that gradually improve the size of the infrastructure sector in these
countries and the scale of projects carried out.
6.6 Summary:
In this chapter the author started with discussing the infrastructure funding in
emerging economies by collecting information for the sample countries such as
Brazil, India, Nigeria and Indonesia. The author collected the sovereign credit rating
of each country by various credit agencies to understand the credit quality of each
sample. And next the author collected the sovereign rating for few top level credit
rated countries such as United States, Singapore, Germany and United kingdom to
compare these top level credit quality countries yield interest rate with the interest rate
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of the samples. The author sees a relation between the rating and interest rate. And
saw a credit quality impact on the interest rate of a 10Y bond. And the author was
also aware that having a low credit quality would also increase cost borrowing and
would also not be able to attract pension and insurance funds. So considering the
above factors and to increase the infrastructure funding the author recommends a
credit enhancement to bond issue. The author discussed the credit trenching method
about its working and how it could be implemented. The later the author discussed
about various steps that developing countries governments can take to start carrying
out funding infrastructure project and how a infrastructure company can obtain those
and how it contributes to funding its project. So the author tried to structure the credit
enhancement process and later its structure. And recommends the process that could
possibly improve the credit quality and attract institutional investors as well.
As the need for long-term finance is growing and rising funding gap in most of the
emerging economies as discussed above its essential to use available source of
funding or increase funding. The credit enhancement for bonds above is one of the
ways. Many credit enhancement options to rise funding for infrastructure are being
implemented in developed countries and are most are in pilot phase such as European
2020 project initiative. And its not popular and a method of choice in majority of
developing countries. So the author recommends the above way of credit
enhancement to implement in developing countries.
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Chapter 7: Conclusion
7.1 Introduction:
This chapter is intended to bring forward the aims and objectives that were set at
starting of the research and up to what extent the objective were addressed. This
research deals with the problems the emerging economies face in gaining investments
from infrastructure bonds. Bonds being one of the major financing instruments, it is a
important medium of rising funding for projects in emerging economies but due to
adverse economic condition and uncertainty there has been high risk in those markets
that affects the investments to the public and private companies in the markets.
Especially factors like low credit rating affects the investments to a large extent.
There is increased need for mitigating techniques for the risk involved in the markets.
For this purpose, the author recommends a credit enhancement technique but with a
structure that could be suitable for emerging economies.
The author to come up with a suitable credit enhancement option needs to be covering
three key topics use of bonds, problems in emerging markets and credit enhancement
options. The objectives need to cover these three significant topics and after that a
credit enhancement option procedure can be developed.
7.2 Existing Use of Bonds:

The author had carried out a study on bonds and its markets involved. The author
wanted to check whether the bond is a viable and suitable instrument for financing the
infrastructure financing. Meeting the increasing demand for funding infrastructure in
emerging markets bonds could play a major role. The author studied bonds and its
different functioning markets that are valued in trillions, which could possibly
contribute in meeting emerging economies rising demands. Bonds being separated
into various types such as conventional bonds, indexed-linked bonds, asset backed
bonds by its issue such sovereign bonds, sub sovereign bonds, corporate bonds and by
its markets domestic bonds, international bonds etc. But risk involved in bonds differs
from its issue type and markets. Apart from the above, Bonds can be and is used at
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various sectors but bonds could be a great tool for financing traditional and PPP
infrastructure projects. Use bonds as financing tool are increasingly growing against
the other financing instruments such bank and equity financing due to their inability
and the increased cost of borrowing and has gained as a prominence viable method
for financing compared to the bank and equity financing for large infrastructure
projects. So the author found that the use of bonds could be a viable and efficient
method of financing infrastructure projects than the alternative options such as bank
and equity financing and size of the bond market would be capable of funding
increasing number of projects.
Bonds valued at over a $10 trillion market around the world, which makes to calculate
the possibility of the number of projects that could be financed through bond markets
and it becomes significant to tap this huge pool of funds for any entity. Currently
bonds are issued by various entities for their needs in different markets. Bonds issued
by various entities involves risk by its issue in markets such as government can issue
in the domestic bond market with no risk but corporate cant be risk free. Since
governments issuing in its domestic market at its own currency can simply print
currency to pay the debt but at the same time the use of bonds by governments and
corporates are subjected to all risk when issuing out of the domestic market.
Financing project by the use of bonds has been increasingly growing against other
financing instrument such as banks and equities. Bonds are replacing bank financing
due to banks inability to sanction long tem funding and their initiative to refinance the
capital and use of bonds is also growing against the use of equity in financing
projects. Equity is considered of high cost than the bonds. Apart from the cost certain
entities dont prefer the use of bonds such as government entities do not prefer selling
their equity in order to raise finance. Bonds that is process of borrowing finds, which
does not require selling their ownership. Hence making use of bonds an ideal option
of financing for government entities. Use of bonds has been increased in financing
traditional and PPP infrastructure projects. Governments have increasingly resorting
to PPP projects through bonds. Since bonds generally have long term to maturity and
PPP project also take long term to generate income and repay the debt. So Bonds as a
financing tool for PPP projects is very significant. Even though bonds can contribute
to infrastructure in emerging economies there are certain obstacles to the use of
bonds.

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7.3 Infrastructure funding challenges in emerging markets:

The author tried to find the problems that caused and increased the demand for
infrastructure and its funding in emerging markets. Increased consumption and
economic growth raised demand for infrastructure facilities in emerging markets but
there is a heavy shortage for infrastructure funds to keep up demand for infrastructure
in emerging markets. Bank loan has been one of the key players in funding
infrastructure projects but in recent times there has been a decline in banks funding
long-term infrastructure loans. Equity finance has become increasingly costlier
affecting companies in emerging markets to large extent in their need for funding
their projects. Making bonds one of their major choices of raising funds. But entities
in emerging markets suffered due to their low credit rating due to adverse economic
condition. As credit rating is one of the major factors that an investor refers before
investing on any bonds. Poor sovereign ratings to emerging economies not only
affected governments but other entities under its border. Entities had to pay high
interest rate and also had to sell their issues at lower prices that made them borrow at
an increased cost. So the author found out that instability in the economy that causes
uncertainty in the market increasing the credit risk that affects the credit quality that
continuously affects investments into markets resulting in insufficient funding. The
borrowers in emerging markets are forced to pay high interest to gain investments
resulting in increased cost making it is non viable for funding projects. This affected
funding for the projects that left the emerging economies far behind the actual
infrastructure requirement. Providing credit support for the borrowers might help
reducing the funding gap.
As the author states one of the main problems in infrastructure in emerging markets is
due to the economic condition that causes uncertainty in the market resulting in
increased risk and reduced credit quality affecting investments. It forms a chain of
problems. This state of increased uncertainty in future economic conditions and
increased interest rate affected infrastructure sector investments. Even though bonds
might be a suitable instrument for financing but the emerging economies becomes
less attractive to investors due to their credit rating. As ratings act as a reference to
investors for making their investment decisions and entities cant gain investments
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since most investors prefer rated than unrated. Institutional investor prefers credit
rated issues than unrated issues due to possible credit risk involved in the issue. So
bonds could be suitable instruments for financing large scale of infrastructure projects
but without good quality they would not fit in for the purpose of the emerging
economies infrastructure needs.
7.4 Existing Credit Enhancement option:

The author from previous objectives found that credit risk of bonds influenced
infrastructure investments. The author has studied credit enhancement options that are
implemented by various institutions for the purpose of developing infrastructure and
the author is aware of significance of credit support. As in the above objectives the
author found the problems in the emerging economies for gaining investments due to
the economic instability that increases the credit risk and reducing credit quality. Its
very complicated and nearly impossible to improve the stability of the economy of
any country for a specific purpose but it is possible to credit support entities to
mitigate the credit risk and help gain investments. The author while researching came
across various credit enhancement initiative that is in functioning and pilot phase but
majority of the initiative is carried out in developed countries. Those initiatives are
mostly offered by multilateral agencies to the company in that region for key strategic
project or a government alone offering credit support for boosting infrastructure
schemes and all credit enhancement options was to attract credit investors such as the
pension and insurance funds. The author finds the emerging markets require more
sophisticated support than the credit enhancement option used in countries with high
investment, and it required developing a credit enhancement.
The author finds a requirement for more developed credit enhancement option in
emerging economies. Since the existing credit enhancement process wont be suitable
for the emerging markets. Credit support for bonds are well established and is more
used in and by developed countries. Bond support by insuring the bonds is common in
developed countries but only very few bond insurance companies will be insuring
bonds in emerging markets due to the risk involved and possible loss the insurance
company would face. And the credit enhancement structure used in developed
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countries cannot fit in for emerging markets. Developed markets carry less risk than
emerging markets when any agencies or home government in the emerging markets
start credit enhancement scheme alone the scale of guarantee it has to offer and risk it
has to carry would be very high increasing the burden but when a government and
financial institution jointly guarantee projects the burden on the organizations would
be less and credit enhancement initiative might be more effective.
7.5 Development of credit enhancement for emerging markets:

The author from the above objectives found a development of a credit enhancement
process is required that is different from one used in developed countries and could
mitigate the risk involved in an emerging market. To mitigate the credit risk the
author recommends tie up between the government and any multilateral agencies.
Their joint venture can support key strategic infrastructure projects in emerging
economies and contribute to the development of the economy. This joint venture
would be able to support companies by guaranteeing subordinated bonds. The author
has developed the credit enhancement process in chapter 6 that would be suitable for
emerging markets. So the author believes that this process of credit enhancement
would reduce credit risk for a borrower and increase the infrastructure investments.
There are various significant factors possible by implementation of the improved
credit enhancement process suitable for emerging markets. The borrower after
obtaining improved credit rating will have first time credible market access that
would not have been possible without a good credit quality. The borrower with a label
of high investment grade bonds can issue in markets and obtain investments at
reduced cost. The Issuer can secure long term funding for its projects and also having
a good credit quality the issuer may be able to extend it further. The issuer is
introduced to a new investor base. The issuer would be able gain investments from
dedicated investors; the pension and insurance funds can be also tapped. On the
whole, this will increase the flow of investments into the emerging markets
contributing in reducing the funding gap.
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7.6 Recommendation:
In this research, the use of bonds is recommended for gaining investments for the
projects. The author finds bonds as a suitable instrument for financing long-term
infrastructure projects than bank and equity financing. The author recommends creditenhanced bonds for the problem the emerging economies undergoing due to their high
market risk and low credit quality. The credit-enhanced bonds would fit in for the
emerging markets and reduce the increasing gap for infrastructure financing. It is
recommended for governments in emerging markets rather than offering credit
enhancement alone it should tie up with the financial institution for improved credit
quality and avoid the burden that it might have to carry if offered alone. The author
recommends the use of subordinated bonds to increase the quality of the senior bonds
that is being sold to investors attracting pension and insurance companies. So the
credit enhancement procedure developed in research is recommended for
implementation and altering it according to the scenario.
7.7 Limitation:
There are certain countries like China, Russia, South Korea and many others, even
though they come under the emerging economies category the case with these
countries is completely different due to their high investment grade sovereign rating
and this credit enhancement process is not of any significance for these emerging
economies with high investment grade credit quality. So the research was carried out
without considering these countries. Even though the author discussed about
developing countries at various stages the research problem has been addressed
keeping in mind about the countries with investment grade BBB- rating and
speculative rating quality BB+ ratings that are have a growing economy and
struggling to gain infrastructure investment. This process might not work for all
developing countries with junk bond ratings as the heading in the research itself
mentions the emerging economies and not developing countries. Since many
developing countries does not have established capital markets, and it is possible to
recommend a capital market financing instrument in general for a country without
even having a fully functioning market and even if it is the credit enhancement cant
be viable or efficient way of financing infrastructure. So there is limitation for
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application to emerging markets alone with low investment grade quality or just
below investment grade. The application of the credit enhancement process differs
according to the scenario and it is not a standard method that is compatible to all
situations.
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Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

Chapter 4: Credit Enhancement option & Existing Credit Enhanced schemes . 35

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

6.2 Credit Rating: ....................................................................................................................... 70

Chapter 7: Conclusion ..................................................................................................... 88

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

Figure 1: EIB project financing model __________________________________________________________________ 42

Table 1: Sovereign Credit rating by S&P _______________________________________________________________ 71

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

Gaining investment is a significant task for any entity whether it may be a

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

To study the existing use of bonds in infrastructure

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

To investigate the challenges in developing infrastructure in emerging

To study the existing credit enhancement options

Development of a credit enhancement option for bonds suitable for emerging

1.3 Literature Review:

1.4 Research Methodology:

1.5 Limitation and exclusion:

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

1.6 Dissertation outline:

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

Chapter 2: Existing Use of Bonds

The bonds and its types

Various bond markets and its significance

Overview of Infrastructure bonds

Traditional and PPP infrastructure Financing

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

2.3 Types of Bonds:

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

2.3.2 Indexed Bonds:

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

alternative source of financing for business and is capable of providing attractive

2.4 Bonds by Issue:

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

2.5 Bond Markets:

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

2.6 Domestic Bond Markets:

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

2.7 International Bond Markets:

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

2.8 Foreign Bonds:

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

2.9 Infrastructure finance through bonds:

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

2.9.1 Traditional Infrastructure financing:

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

Bonds are debt instruments, loans lasting from 12 months to 30 years.

Governments, corporations, banks, international organizations, and individuals

Government bonds are risk free in domestic issue.

Bonds are open to Individual and Institutional investors but Institutional

Government and corporate bonds are subjected to risk in International market

Bonds seen as suitable method to Long term funding.

Bonds play major role in governments initiative to PPP projects.

Credit Enhanced Infrastructure Bonds in Emerging Markets by Venu Prasath

Chapter 3: Challenges in infrastructure funding in emerging markets