Addressing Constraints to Private Financing of Urban (Climate) Infrastructure in Developing Countries

Full text

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Addressing constraints to private financing of urban (climate)
infrastructure in developing countries
Roland White, Global Lead: City Management and Finance, World Bank
Sameh Wahba, Director: Social, Urban, Rural and Resilience Global Practice, World Bank
Abstract
Urban infrastructure investment needs in the developing world are immense, particularly when the
additional costs associated with lower-carbon, more climate-resilient options are considered. These
cannot possibly be financed from fiscal sources and ODA flows alone; private financing will need to
be accessed. Focusing on the ability of city governments and subnational urban utilities to mobilise
private finance, this paper makes two core arguments. First, private investment in municipal
infrastructure requires robust institutional, fiscal and regulatory systems that are often absent in
developing countries. Establishing such systems often requires policy and institutional reform, much
of which lies beyond the competence and control of city governments themselves. Second, while the
marginal investment needs related to climate mitigation and adaptation complicate and aggravate
the picture, they do not alter the fundamental requirements of private investors. Put simply,
municipalities and utilities will need to satisfy the requirements of regular private finance before
they can attract green private finance. This paper looks across the main avenues for city
governments to mobilise private finance – municipal borrowing, public-private partnerships, and
land value capture instruments – and identifies four broad factors that determine the potential size
and scope of city leveraging activity. It then offers a new framework to understand where the most
pressing constraints to private investment readiness lie and proposes priority measures that local
and national governments, together with development partners and other stakeholders, can take to
address them.
Keywords
Municipal finance; municipal borrowing; private investment; climate change; public private
partnerships; land value capture; urban infrastructure

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1. Introduction
Two and a half billion people will be added to the world’s urban population by 2050 (UN DESA,
2014). Driven by sustained city growth and the need to adapt to and mitigate climate change, global
urban infrastructure financing needs are massive. The most comprehensive assessment of these
provides a conservative estimate of over USD 4.1-4.5 trillion per annum for “business as usual”
requirements (CCFLA, 2015). Mitigation costs add another USD 0.4-1.0 trillion each year (9-24 per
cent), and adaptation costs add a further USD 120 billion each year (3 per cent) – although this could
be much greater if the average global temperature increases by more than 2°C above pre-industrial
levels. While there is no reliable disaggregation of this requirement across developed and
developing countries, most is likely to be concentrated in the latter where historical infrastructure
deficits are most pronounced and the world’s urban transition is still underway.
Funding and financing this infrastructure is a massive challenge, and there is accordingly a growing
body of literature and practice devoted to financing climate-compatible infrastructure in cities. In
this article, we focus specifically on the role of city governments and utilities in raising and steering
private finance.
The expenditure assignments of city and municipal governments vary widely across developing
countries. In most cases such governments, together with state-owned utilities, have substantial
responsibilities for funding, building and operating core municipal infrastructure in areas such as
roads, drainage, solid waste management, sanitation and water supply. 1 Yet it is clear that these
infrastructure investment needs cannot be satisfied from existing city budgets alone. In sub-Saharan
Africa, for example, many city governments have per capita budgets of less than USD 20 per person,
much of which is committed to ongoing operating expenses such as salaries rather than available for
capital expenditure (Cartwright et al., 2018). Domestic public budgets will be insufficient even if
blended with ODA flows, which totaled around USD 146.6 billion in 2017 (OECD 2018) – far short of
global urban infrastructure investment needs. A substantial scale-up in mobilization of domestic
financial resources and extensive private sector investment will be required to meet this shortfall. A
step-change of several orders of magnitude above current levels is necessary.
Too often, work on this topic understands constraints to private financing primarily or exclusively in
terms of weak “project bankability”. We argue that this perspective does not recognize the
underlying reasons that city governments and utilities in developing countries are unable to leverage
private investment for urban (climate) infrastructure. This article responds to the gap in the
literature by making two core arguments.
First, private investment in municipal infrastructure rests on robust institutional, fiscal and
regulatory systems which are often absent in developing countries. Accountable, transparent and
efficient frameworks are a precondition for attracting private investment, regardless of financing
modality (e.g. municipal borrowing, public-private partnerships). Establishing such systems often
requires policy and institutional reform, much of which lies beyond the competence and control of
city governments themselves. Both the immediate and longer-term ability of city governments and
utilities to leverage and attract private finance is constrained by the appetite for and substantive
approach to reform on these fronts by national government agencies.
1 In regions around the world, local government expenditure as a proportion of general government expenditure varies from a low of
around 8 per cent in the Middle East and North Africa to a high of around 28 per cent in East Asia and the Pacific. (Based on IMF GFS,
2015. This excludes South Asia as data for only one country in that region were available.)

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Second, the climate imperative does not change these fundamental realities nor does it greatly
alter the requirements of private investors. Certainly, the emergence of the new technologies,
business models and greater capital needs related to climate mitigation and adaptation complicates
and aggravates the picture. Ultimately, however, the same prosaic agenda needs to be tackled to
mobilise finance at scale for either conventional or climate-oriented urban infrastructure.
In the next section, we explain our methodology. In Section 3, we outline the ways that
municipalities and utilities can mobilise private finance for urban infrastructure investment and
consider the extent to which these instruments are deployed. In Section 4, we consider the
preconditions for using these different financing instruments for any urban infrastructure projects.
In Section 5, we explore whether these preconditions might be different in light of the urgent need
for ambitious action on climate change. We offer concluding thoughts and recommendations in
Section 6.
2. Methods
The article draws on our individual and collective experiences with urban finance across the global
South over thirty years.
The World Bank is the largest multilateral development bank active in the urban space, with a global
portfolio of support to cities and local governments. The Bank’s urban portfolio, excluding
investment in sectoral systems such as mass transit and water supply, stands at about $25bn and
commits approximately $5 billion of new funding annually. The World Bank Group is increasingly
involved in enabling cities and sub-national entities to directly access finance for urban
infrastructure projects. The following are some of its relevant activities, particularly those with a
climate orientation:
• Lending directly to cities, utilities and other sub-national entities without sovereign
guarantees (see Figure 1);
• Offering guarantees against political risk or the non-honouring of sovereign financing
obligations to de-risk urban infrastructure projects;
• Providing technical assistance to identify and implement different financing modalities to
leverage private capital;
• Providing technical assistance to city governments to strengthen their creditworthiness and,
in some cases, follow-up support to facilitate access to credit and generate public-private
partnerships (PPPs);
• Providing technical assistance to national and city governments to analyse regulatory
constraints to private financing modalities and introduce appropriate reforms;
• Providing technical assistance to develop a pipeline of bankable capital investments,
mainstreaming climate resilience considerations into all prospective projects; and
• Participating in global partnerships to propel progress in this area, such as the City Climate
Finance Leadership Alliance.

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Figure 1. Municipal commitments by the International Finance Corporation by financial year, USD million (data source:
IFC)).
Within the Bank, we have led multiple analytic and policy advisory efforts in the urban finance space,
the design, delivery and evaluation of both municipal finance strategies and large infrastructure
projects, and supported partners in comparable efforts. Our deep and long-term exposure to the
perspectives and work of local governments and prospective investors has enabled us to develop a
rich understanding of their objectives, responsibilities and capabilities as well as the critical
constraints that they face. This article offers insights from this experience, bringing the perspective
of a large-scale, global financier into the academic literature. It draws both on data held within the
World Bank and available from secondary and published sources.
3. Options to mobilise private finance
Financing and funding are two different things. Finance refers to the raising of money for
investment; funding refers to the payment for the investment, including the financing cost, over the
long term. Finance thus does not obviate the need for funding. In fact, because finance comes at a
price (interest or return on equity), it aggravates the funding need. If municipal governments and
utilities are to mobilise finance, they need to demonstrate the ability and commitment to pay for
that finance with funding which, in a municipal (or utility) environment, comprises either local (“own
source”) revenues (taxes and service charges) or fiscal transfers (including aid grants). The greater
the volume of private finance, the greater the need for funding. In order to finance more, one needs
to fund better. This points to the importance of “fixing the fiscal fundamentals” of municipalities and
utilities as a core part of the urban – and climate - finance agenda.
Once a robust funding base is established, state agencies can deploy a range of mechanisms to
crowd in private investment. The avenues through which private finance may be leveraged into
urban infrastructure investment may be divided into three basic categories: debt financing,
contracting and land value capture instruments.
Debt financing encompasses instruments through which funds are borrowed by a government
agency. Repayments and returns are secured by the general balance-sheet of the borrowing entity
(general obligation borrowing) or by particular revenue flows which are dedicated to this purpose.
0
50
100
150
200
250
300
2011 2012 2013 2014 2015 2016 2017 2018

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Contracting or public-private partnership (PPP) arrangements are those in which either (a) private
funds are secured as equity contributions and/or debt for infrastructure projects and the returns are
secured through the future revenue streams directly attached to those projects, or (b) where funds
are indirectly borrowed for projects and repaid from the general revenues of the city
government/utility through dedicated fee arrangements.
Land value capture instruments describe mechanisms whereby governments partially capture the
appreciation in the value of urban land, which may be catalyzed in part by investment in
infrastructure adjacent to or otherwise linked to that site. Land value capture instruments range
from relatively straightforward mechanisms, such as the imposition of impact fees or development
charges on private developers, to much more complex approaches, such as Tax Increment Financing
(TIF) which leverages capital for public infrastructure investment on the basis of future increases in
property tax revenues.
For decades, even centuries, cities in developed countries have received significant inflows of private
finance into urban infrastructure through all these channels. The municipal bond market in the
United States, which originated in the 1850s, grew to USD 2.8 trillion by 2010 (Farvacque-Vitkovic F,
Kopanyi M (eds). 2014. Chapter 7). PPPs have long been used to finance urban infrastructure
projects, including parts of such iconic projects as the London Underground and Sydney Harbour
Bridge. Land-based financing is perhaps the oldest of all: property taxes were used in Babylon, China,
Egypt and Persia. Land value capture approaches are perhaps newer, but have been utilized
extensively in larger and more capacitated cities such as New York, Washington DC, London, and
Hong Kong. In the US alone, Tax Increment Finance bonds issued totaled over USD 39 billion
between 2000 and 2015 (Layton, 2016).
Such activity is much more limited across both middle and low-income countries in the developing
world. The difference is clearly illustrated in Figures 1 and 2, which show total municipal borrowing
liabilities accumulated in a spectrum of countries from the developed and developing world. Note
that the scales are different in the two figures.
In terms of debt financing, there are really only a few countries across the global South where cities
can effectively access credit for infrastructure investment. Foremost among these are the emerging
markets of East/Central Europe, and particularly those at higher income levels. In sub-Saharan
Africa, the only country in which cities can effectively access credit markets is South Africa; in East
Asia, outside of China, the Philippines is similarly an outlier; and in South Asia, it is only in India
where municipalities can effectively borrow – and there borrowing volumes are extremely low
(World Bank, 2011). Municipal borrowing in Latin America is also very limited, one exception being
Colombia where municipalities can borrow from a government-owned municipal development bank,
FINDETER. In China, city borrowing was legally prohibited until 2013, although significant borrowing
took place off-balance sheet. Municipal borrowing is also highly constrained in the Middle East and
North Africa.
PPP activity in developing countries at the subnational level is estimated at around USD 10 billion
per annum, less than a fifth of national PPP volumes (World Bank, 2016).
Many public authorities in developing countries use property taxes and the direct sale or leasing of
land (often after appropriation and rezoning, as in China and Ethiopia) to raise finance. However,
land value capture transactions are generally scarce, and only a few cities have experimented at a
significant scale with these. Latin American cities are among the leaders. For example, Sao Paulo in
Brazil has generated over USD 800 million for public works between 2004 and 2009 through the
auctioning development density bonuses. Quito in Ecuador has sold transferable development

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rights, while Bogota has raised over a billion dollars through betterment levies between 1993 and
2013 (Smolka, 2013). Many African cities are experimenting with in-kind contributions, development
charges and betterment levies, but these are typically imposed in an ad hoc manner rather than as a
systematic financing strategy (Berrisford, 2018).
In short, few towns and cities across the global South are currently deploying the diverse bundle of
instruments necessary to systematically leverage private finance at scale. This is despite the fact that
it is these urban areas that need to attract investment most urgently, both to redress historical
underinvestment and to keep pace with growing urban populations and economies. The next section
seeks to explain this phenomenon.
Figure 2. Stock position of municipal debt liabilities (percent GDP) of various developing countries, 2016 (data source: IMF,
2018).
Figure 3. Stock position of municipal debt liabilities (percent GDP) of various mature markets, 2016 (data source: IMF,
2018).
4. Constraints on mobilizing private finance

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The factors constraining the flow of private finance into urban infrastructure in developing countries
are powerful and deep. Across all types of financing avenue, four generic factors determine the
potential size and scope of city leveraging activity (World Bank. 2011):
1. The intergovernmental fiscal and institutional framework. The ability of municipalities to
attract private finance will depend, in part, on the revenue sources to which they have access to
cover financing costs. This includes both revenues which are assigned to local governments
(“own source revenues”) and fiscal transfers instituted to address fiscal gaps. Moreover, the
scope to use land value capture instruments depends substantially on the system of land
property rights, including the quality of the land and property registry, valuation systems, and
ease of transactions. Much of this is typically established at the national or state level, rather
than by city government.
2. The quality of city financial data, accounts and management systems. In order to make sensible
credit and investment decisions investors need to be able to understand municipal accounts and
balance sheets and have confidence in the overall quality of financial management systems, not
least those pertaining to the enforcement of revenue collection. Where project-related revenue
streams are used to secure investment obligations (e.g. in revenue-backed bonds or certain
types of PPP transaction), the feasibility and quality of the projects in which private funds will be
invested is also directly relevant (this is often referred to as “project bankability”).
3. The depth and character of the financial sector. The size and sophistication of domestic capital
markets will influence quantum of capital available for investment, the returns required, risk
appetite and scope to deploy more complex financing arrangements. The domestic financial
sector is in turn is affected by the surrounding macro-economic conditions that may influence an
expansion or contraction of such credit. International financing sources could also be taken into
consideration, but most governments in developing countries do not allow local governments to
take on private foreign currency liabilities (including important emerging economies such as
South Africa, Brazil and Vietnam). These policies are informed by historical experiences in which
liabilities denominated in foreign currencies have sometimes created severe financial difficulties
for sub-nationals when exchange rates plummeted.
4. The regulatory framework pertaining to municipal borrowing, PPP and LVC transactions. This
comprises the “rules of the game”, including matters such as whether cities can borrow and how
much, what currencies they can borrow in, the type of collateral that they may pledge to secure
borrowing, events in cases of default; their rights to enter into long-term PPP contracts and to
determine tariff levels; whether cities can sell and trade development rights; the rules governing
rights exchanges; and so on.
In general terms, factors 1 and 2 determine the perceived attractiveness of an investment or
borrower and hence form the demand side of the financing equation. Factor 3 determines the scope
to provide finance, and hence the supply side. The quality of the regulatory framework, factor 4,
intermediates demand and supply, shaping the incentives and behaviours of both investors and
municipal governments. If conditions across all four areas are not conducive to private investment,
investment will not take place. For instance, it does not follow that cities which have good credit
may necessarily be able to borrow. Actual borrowing potential relies on a sufficiently well-developed
financial sector and a regulatory framework that clearly articulates the legal rights of municipalities
to borrow.
Analysis undertaken in countries such as India and Vietnam (World Bank, 2011; World Bank, 2016),
and the experience of countries such as South Africa where nominal municipal borrowing expanded

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significantly once regulatory and other issues were addressed in the early-2000s, show that the
binding constraints tend to lie in the demand (or “creditworthiness”) and regulatory areas. This
analysis underscores that city governments cannot singlehandedly overcome the constraints to
mobilising private finance. The design and nature of national frameworks and systems also dictates
municipal or utility “readiness” to secure private investment for climate-compatible urban
infrastructure.
Figure 4. Lending to municipalities in South Africa (data source: National Treasury of the Republic of South Africa. 2016)
In this context, cities in developing countries can be placed on spectrum comprising two dimensions.
One pertains to matters largely under the control of national governments such as the revenue
sources that cities are permitted to collect, the borrowing powers of subnational entities, the quality
of land and property systems, accounting standards and so on. The other pertains matters which are
largely under the control of city governments such as the quality of their financial data, financial
management systems, balance sheets and so on. This spectrum and a stylised plotting of a few city
positions on it is outlined in Figure 5. It should be noted that this spectrum, and the position of cities
on it, can be disaggregated according to different transactional types. For example, Johannesburg
and Bogota may have clear borrowing powers and capacities, but the regulatory regime governing
their ability to enter into PPP or LVC transactions may be more constrained, in which case they
would fall further down the spectrum with respect to these leveraging avenues.

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Figure 5. Stylised illustration of the “private investment readiness” of cities, highlighting the need for robust frameworks
and systems at both the national and municipal level. The named cities are only indicatively positioned. 2
A systematic global analysis of cities across developing countries in terms of both these dimensions
has not, to the best knowledge of the authors, yet been undertaken. However, it is broadly evident –
and substantiated by credit-rating data - that most cities in the developing world would tend to
cluster towards the lower left end of the spectrum. These towns and cities face constraints at both
the (national (policy/systemic)and local levels. Such cities may be subject to a national regime in
which, say, borrowing and PPP transactions are not permitted or are highly constrained.
Simultaneously, the quality of their accounting and financial management systems may be poor and
their capacity to develop bankable projects weak. Many African and South and East Asian cities fall
into this part of the spectrum. To unlock access to private finance in these contexts, there is a need
to reform national institutions and frameworks as well as to improve the quality of city financial
data, accounts and management systems.
At the other (highest) end of the spectrum are cities (and utilities) with an enabling national and
local environment. Such cities enjoy an intergovernmental fiscal system that provides them with
strong revenue powers, permits municipal borrowing and LVC transactions, authorizes cities to
pledge revenues, and mandates good practice municipal accounting standards. These cities also
have robust financial management practices and the capacity to prepare (in house or on an
outsourced basis) bankable projects.
There are a handful of developing country cities at the top end of the spectrum. An indicator of this
might be the ability to issue a municipal bond, as this demonstrates that a city has a sufficiently
robust policy, fiscal, institutional and credit environment at both the national and local level. As of
2018, only 32 cities across 12 developing countries (Argentina, Bolivia, China, Colombia, India,
2 The chart is not based on hard numerical data. The plotting of the named cities represents the judgements of the authors. This spectrum
could be further disaggregated according to different transactional types. For example, Johannesburg and Bogota may have clear
borrowing powers and capacities, but the regulatory regime governing their ability to enter into PPP or LVC transactions may be more
constrained, in which case they would fall further down the spectrum with respect to these leveraging avenues.

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Mexico, Paraguay, Peru, Russia, South Africa, Uruguay, Vietnam) have issued municipal bonds (see
Table 1). At the time of issuance, these cities would all have fallen into the top right quadrant of
Figure 4.
Table 1. The breakdown of large and investment-grade cities by region. (Data source: World Bank City Creditworthiness
Database)
East Asia
and the
Pacific
East and
Central Asia
Latin
American
community
Middle East
and North
Africa
South Asian
Region
Sub-Saharan
Africa
Cities in top
500
178
44
92
43
82
61
Investment-
grade rated
cities
12
9
34
0
35
8
Cities in
region with
investment-
grade rated
cities
China*
Indonesia
Thailand
Vietnam**
Armenia
Belarus
Kazakhstan
Russia
Serbia
Ukraine
Argentina
Bolivia
Brazil
Colombia
Mexico
Paraguay
Peru
Uruguay
India
Côte d’Ivoire
Senegal
South Africa
Uganda
* Does not include local government financing vehicles
** Three cities in Vietnam have issued bonds, but their credit ratings are not public.
In some cases, private investment readiness will be constrained primarily at the local level. In Figure
4, this would explain cities in the top left quadrant. Many smaller or lower-income or poorly
managed cities will fall into this category, particularly those in the 23 countries listed in Table 1.
These countries demonstrably have enabling national environments since some cities have achieved
an investment-grade credit rating; however, municipalities with weaker capacities, a smaller tax
base or weak financial management systems may not have sufficient revenues to anchor access to
credit or may present unacceptably high credit risks, or may not possess the skillsets necessary to
wield complex financing instruments such as LVC. However, this characterization should be treated
with some caution as, in federal systems, “nationally determined” conditions (such as municipal
borrowing frameworks) may in effect be determined at the state level and conditions between
states may vary considerably. India is a good example.
In other cases, private investment readiness will be constrained at the national level (represented by
cities in the bottom right quadrant of Figure 4). This would include cities such as Kampala, which has
recently received an investment-grade rating but is prohibited by domestic law from borrowing at
level which would make any transaction attractive to investors. In a rather different country,
Vietnam, city (provincial) borrowing has been limited and sporadic. Here, national support is
required both to improve the sub-national borrowing regulatory environment (which is not
conducive to sustained borrowing at scale) and to improve the quality of sub-national financial
management.
The basic challenge of leveraging increased private sector finance into urban infrastructure –
climate-oriented or not – involves shifting cities to the top right quadrant of the spectrum. Although
the specific reforms and activities required will vary across particular countries and cities, this
broadly requires two broad areas of work:

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(i) National authorities (or, in some federal countries, state authorities) may need to
reform policies and rules pertaining to the intergovernmental fiscal system, city
accounting and financial management systems, and regulatory regimes governing
municipal borrowing, PPPs and LVC. These reforms often raise fundamental political and
policy issues (such as the degree of fiscal autonomy of city governments or the tariff-
setting/ powers of national ministries) that national decision-makers may be reluctant to
address. Even if there is the political will to address them, reform generally takes a
continuous effort over a lengthy period.
(ii) City authorities may need to improve the quality of their financial data, financial
management practices, strengthen their balance-sheets and improve the bankability of
their projects. This requires substantial fiscal discipline at the local level and raises
similarly difficult political and policy issues. Many city authorities may be reluctant to
limit public spending if the political benefits will be largely enjoyed by subsequent city
administrations.
In short, improving the ability of city governments and utilities to attract and absorb private
investment will typically demand sustained political commitment, comprehensive reform of national
(or state) policies and strengthening of systems at both the national and local levels.
An additional area of intervention is possible to mobilise private finance in the near-term in
imperfect policy and institutional environments. Investment “de-risking” requires that the risks to
private investors generated by suboptimal regulatory regimes and below investment-grade
municipalities are transferred to other entities, typically national governments, MDBs or donor
agencies. This may be done through various forms of guarantee or credit enhancement. Notable
examples include the Local Government Unit Guarantee Corporation in the Philippines, the
Development Assistance Committee facility of USAID, and the World Bank Group’s guarantee
products.
Interventions of this type need to be treated with caution. Because they inherently create moral
hazard (Noel, 2000), they tend to generate perverse incentives and fiscal risks. Over time, they can
threaten the sustainability of the very system they are trying to expand. However, if appropriately
targeted and designed, credit enhancement facilities may usefully accelerate private investment
while avoiding egregious systemic distortion. For example, it is common among those developing
countries which permit city borrowing to prohibit those cities from incurring forex liabilities as they
cannot easily hedge currency risk. In such circumstances, providing a forex-risk credit enhancement
to transactions in which cities borrow from foreign investors could address the regulatory hurdle and
mitigate city currency risks without generating severe moral hazard impacts.
A long-term, coherent strategy coordinated across different levels of government is essential to
improve municipal access to private finance. The next section considers these preconditions in light
of the growing threat of climate change.
5. Implications for financing climate action
The need to address climate resilience and mitigation imperatives adds both urgency and magnitude
to the financing need for urban infrastructure and services. Accordingly, the challenge of financing
climate action has drawn increasing attention in the academic and technical literature. A number of
articles and reports have been published on themes such as the financing instruments that are
potentially available to leverage private investment in municipal infrastructure, the way in which
such instruments can be used to accommodate climate investment needs, and other supportive

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interventions which may be helpful for cities to attract increased private financing flows. There is a
particularly strong focus on electricity generation and urban transport infrastructure, which have the
most significant implications for urban emissions. Valuable as such contributions may be, they tend
to focus on instruments and approaches which, with some important middle-income country
exceptions, are currently feasible only in developed countries (e.g. Merk et al., 2012).3 In other
cases, the research fails to recognise that responsibility for funding and financing large urban
infrastructure does not fall to city governments, but will – particularly for smaller cities – remain the
responsibility of much larger state agencies.Alternatively, the literature calls for a radical change in
the priorities and approaches of financiers that seems unlikely (e.g. Brugmann, 2012).
Climate change does not in itself alter the fundamentals of infrastructure finance. Simply put, before
a city can issue a green bond, it must first be able to issue a (regular) bond. The relative
insignificance of climate considerations (from the perspective of financiers) is demonstrated by
comparing the relative cost of finance for conventional versus sustainable infrastructure. A number
of global studies have indicated that the pricing of green bonds is practically identical to the pricing
of traditional bonds (GIZ, 2017). One analysis suggests that the relative desirability of green labelling
is offset by the perceived additional risks associated with green financing (OECD, 2015).
It is difficult to get a clear picture of relative spreads specifically for urban climate infrastructure
because the municipal market in developing countries is so limited. To date, to the knowledge of the
authors it appears that only three developing country cities have issued “green bonds”:
Johannesburg, Cape Town and Mexico City. The coupon on the Cape Town green bond was only 35
basis points less than that of a regular bond issued by another South African city (Ekurhuleni) with a
similar Moody’s credit rating at roughly the same time. Certainly, there are classes of investor which
will be particularly attracted to impact financing of this type; this might help explain why the green
bonds for Cape Town and Johannesburg were so oversubscribed (Gorelick, 2018). However, it does
not appear that such investors are likely to be more risk-averse or provide such finance on terms
which are significantly discounted relative to conventional investments. Even where the financial
case for climate-compatible investments may be attractive, investors continue to be deterred by
other barriers such as poor provision of information, transaction costs and capacity deficits
(Colenbrander et al., 2017).
Similarly, climate change does not inherently change the preconditions for city governments to
utilise PPPs or LVC. They might choose to fund more sustainable infrastructure projects in light of the
need to reduce emissions or enhance resilience, but they will still need to have their fiscal,
institutional and regulatory essentials in place: national legislation authorising municipalities to use
these instruments; effective project preparation capacities; strong contracting capacities; integrated
spatial, infrastructure and financing strategiesand so on (Ahmad et al., forthcoming). Without these
fundamentals in place, private investors will lack confidence irrespective of the environmental
sustainability of the project.
In sum, early indications are that cities will not be able to attract private green or climate finance on
terms which are very much easier than that for regular finance. And there are a wide range of
barriers to mobilising infrastructure investment of all kinds, particularly in the global South (Granoff
et al., 2016). Compliance with the non-financial terms of “green finance” may even impose greater
implementation challenges and reporting duties on cities than conventional debt finance. For
instance, ensuring that a green bond is certified under an appropriate standard and that the
proceeds are allocated to sufficiently green projects requires higher degrees of sophistication and
capacity. There are therefore incremental costs to the issuer that – to date – have not been
compensated for through a lower cost for green capital.
3 Yaounde, Cameroon, is a notable exception to this norm (Gorelick, 2018).

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Yet climate change exacerbates the need to rapidly mobilise private finance for sustainable urban
infrastructure while also creating new investment risks that need to be managed (Martimort and
Straub, 2016). Since it may take decades for towns and cities to develop sufficient robust fiscal
underpinnings, a subsidy may be required to facilitate investment in urban climate projects. The
argument in favour of such subsidisation – by central governments or by donor organizations –
derives from the vital global, regional and local public good that low-carbon and climate-resilient
infrastructure provides.
There are many ways to provide such a subsidy to cities in developing countries. A plethora of
instruments for both regular and climate-oriented infrastructure investment has been developed
and utilized in more sophisticated markets for decades. For instance, there is scope to de-risk
climate projects through expanding credit enhancement activities, if facilities are adequately
capitalized, appropriately institutionalized and professionally managed (Schmidt, 2014). Or there is
scope to support aggregation of projects and therefore spreading of risk, which many cities are
pursuing within and across national borders (Colenbrander et al., 2018). The need to reduce or
respond to climate-related impacts provides the rationale for underwriting credit risks or improving
credit access in an appropriate, non-distortionary manner, and financial engineering expertise is
widely available globally (with donor organizations often willing to pay).
In the medium to long term, however, the expanded use of “city climate finance” instruments in the
global south will only be possible to the extent that the conditions which underpin access to finance
more generally emerge. The hard, long, most essential task is to develop the policy, regulatory,
fiscal and institutional environments which allow such instruments to be utilized in the many
countries where such environments do not yet exist.
6. Conclusion
While climate change has galvanized attention regarding the challenge of financing climate-smart,
resilient urban infrastructure – and the importance of attracting private finance to such investment -
the reality remains that, across the developing world, municipalities and other urban entities have a
long way to go before they will be able to do so at scale.
For city governments to systematically leverage private investment, there is a need to (i) reform the
intergovernmental fiscal and institutional framework, including the fiscal transfer system and the
own source revenue structure of city governments; (b) strengthen cities’ financial management
systems and processes, and the overall quality of city governance; (c) deepen the financial sector,
specifically domestic capital markets; and (d) enhance regulatory frameworks pertaining to
municipal borrowing, PPP and land value capture transactions. These four factors must be addressed
whether or not the urban infrastructure projects are climate-compatible or otherwise.
Municipalities and urban utilities certainly have work to do to need to strengthen their financial
management practices, improve the quality of their data, increase revenue yields, prepare
“bankable” projects, and explore ways of generating greater revenue security for private
investments. However, towns and cities in the global South cannot overcome the barriers to
infrastructure investment alone. Enhancing private investment readiness successfully will require
action from multiple actors.
National governments need to strengthen domestic institutions and reform policy and regulatory
frameworks relating to subnational financial management and financing activity. Multilateral
development banks, bilateral donors, city networks and other agencies can support national and

14
local governments in these efforts with a combination of funding support, technical assistance,
capacity building and facilitation of knowledge exchanges. Finally, assuming that suitable conditions
are created, private investors will obviously need to expand their business with respect to
subnational lending, PPPs and LVC transactions.
Conscious, sustained focus and innovation will be required for towns and cities across the global
South to achieve private investment readiness. Even if the prospect of a global temperature increase
exceeding 2°C does not change the fundamental preconditions for infrastructure finance, it may
provide the necessary motivation for governments to act. Such efforts will ultimately be justified by
the social, economic and environmental returns that are potentially available in this vast sector of
the infrastructure market.
Acknowledgements
Thanks to Takaaki Masaki who researched and generated some of the data and charts.
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