First appearance at Policy Center for the New South (July 7, 2021)
The world faces a huge infrastructure investment gap compared to its needs. With a few exceptions, such as China, this deficit is greatest in emerging and developing countries.
The G20 Infrastructure Investors Dialogue estimated the volume of global infrastructure investment needed by 2040 at $ 81 trillion, of which $ 53 trillion will be needed in non-developed countries. The Dialogue forecast a gap – in other words, a deficit from today’s forecasted investment needs – of around $ 15 trillion globally, of which $ 10 trillion in emerging economies (graph 1, left panel). The World Bank has estimated that for emerging and developing economies to meet the Millennium Development Goals set for 2030, their infrastructure investments would need to be 4.5% of their annual GDP (Figure 1, right panel) .
In addition to the need for investment in infrastructure, it is necessary that this investment be “green” as quickly and as widely as possible, in order to minimize the negative impact in terms of increased global warming. For example, the energy sector needs to be carbon-free by expanding the use of renewable sources instead of coal. Increasing use efficiency and eliminating subsidies for the use of fossil fuels would be part of this strategy.
Transport is today responsible for 25% of global greenhouse gas emissions. This needs to be reduced by shifting transport towards low-carbon options, in addition to investments in energy-efficient equipment, and supporting the transition to electric vehicles and fleets.
Much of the ‘greening’ will take place in cities: improving water and sanitation services, changes in energy supply, recycling waste and improving energy efficiency through better building standards and / or the renovation of existing buildings. This transition, as with manufacturing and agriculture, will require investments in infrastructure.
A major obstacle hindering these investments is the lack of fiscal space, which limits public spending. This problem has been exacerbated by the tax packages adopted due to the pandemic. While the largest advanced economies can afford to increase their public debt, with a low risk of their financing conditions deteriorating, this does not apply to most emerging economies, let alone countries with low levels of government debt. income struggling with unsustainable debt trajectories (Chart 2).
Therefore, steps need to be taken to expand the options for private financing of infrastructure projects. Indeed, according to data from the Institute of International Finance, over the past 15 years, institutional investors with long-term profiles in their assets, such as pension funds, have gradually increased their allocations to investments. infrastructure and alternatives to fixed income instruments, equities, and other traditional instruments.
The stable and long-term returns of infrastructure projects dovetail well with the long-term commitments of these financial institutions, especially in the context of falling real long-term interest rates on public and private bonds, such as we have seen this in recent decades in advanced countries. Surveys conducted by Preqin show that fund managers are already indicating that the decarbonization of energy is a pull factor for private investment in infrastructure.
The biggest challenge is to build bridges between, on the one hand, the infrastructure investment needs in non-developed countries and, on the other hand, the private sources of financing abundant in dollars and other convertible currencies with little possibilities of obtaining returns compatible with their requirements on their civil liability.
Building such bridges requires the accomplishment of two tasks. First, the development of well-structured projects, with risks and returns in line with the preferences of different types of financial intermediation, would help close the private financing gap in infrastructure.
Investors have different mandates and skills when it comes to managing the risks associated with types of projects and phases of project investment cycles. They require coverage of risks whose exposure is not adequate or authorized by regulations. The absence of additional instruments or investors is one of the most frequently identified causes of failure in the financial implementation of projects. Figure 3 provides an overview of the variety of instruments and vehicles through which private finance can participate in infrastructure projects.
The tight fiscal space in emerging and developing countries can be used to primarily cover these risks and enable investment build-up, rather than replacing private investment: attracting private finance rather than crowding it out. National and multilateral development banks could prioritize this instead of funding all investments.
Identifying attractive investment opportunities for different types of investors and combining these perspectives more systematically around specific projects or asset pools is a promising way to close the infrastructure financing gap. The integrated planning and issuance – with different time profiles – of fixed income securities, bank loans, credit insurance, etc., for the different phases from project preparation to operation, make this combination possible.
The second task for stimulating private investment in infrastructure in emerging and developing economies is to reduce legal, regulatory and political risks. Transparency and harmonization of rules and standards can increase the size of comparable projects and help build project portfolios. Non-bank financial institutions often highlight the absence of sufficiently broad project portfolios as a brake on the creation of business lines centered on the zone. This is a particular weakness in the case of small countries.
The contrast between the scarcity of investment in infrastructure, especially in non-advanced economies, and the excess savings invested in liquid, low-yielding assets in the global economy is worth addressing. Greening infrastructure in non-advanced economies would benefit from attracting greenbacks to the business.
To concern Bridging the gap between private finance and green infrastructure
Washington, DC-based Otaviano Canuto is a Senior Fellow at the Policy Center for the New South, a non-resident principal investigator at the Brookings Institution, lecturer in international affairs at the Elliott School of International Affairs – George Washington University and Director of the Center for Macroeconomics and Development. He is a former vice-president and former executive director of the World Bank, former executive director of the International Monetary Fund and former vice-president of the Inter-American Development Bank. He is also a former Deputy Minister of International Affairs at the Brazilian Ministry of Finance and a former Professor of Economics at the University of SÃ£o Paulo and the University of Campinas, Brazil.