Infrastructure needs unfilled despite big promises
The infrastructure asset class is not clearly understood or standardised; money is attracted to high value projects such as energy and telecoms but less to basic needs such as water and roads; and low income countries tend to fail one-size-fits-all assessments by investors.
On one day in September, initiatives in two neighbouring countries highlighted the continued split in thinking over how to tackle even a small part of the multi-trillion dollar global deficit in infrastructure spending.
The Scottish National Party set a target of increasing annual capital spending by £1.5bn a year or the equivalent of about 1% of Scotland’s GDP by 2026 based on new ways to draw private sector involvement into infrastructure development.
Meanwhile in England, the left-leaning thinktank, the Institute for Public Policy Research, bemoaned the failure of the private sector to provide sufficient capital, calling instead for the creation of a National Investment Bank to lend up to £200bn funded by increased public borrowing and higher taxes on wealth.
While neither initiative will do much to fill the infrastructure shortfall, particularly in emerging and developing economies, they highlight the tensions between public and private led solutions.
Global infrastructure finance needs are vast. According to McKinsey, the world must invest 3.8% of GDP, or an average of $3.3tr a year, to 2030 in economic infrastructure, just to support expected rates of growth. This adds up to a cumulative need for $49tr. Emerging economies account for some 60% of that need.
Some estimates are even higher. The Global Infrastructure Hub (GIH), an initiative of the G20 group of nations, has calculated the need as $3.7tr annually by 2040, while the OECD estimates global investment needs of $6.3tr a year in 2016-30 to support growth and development, without considering further action needed to combat climate change.
Despite these dramatic and repeated siren calls, the world is simply not spending enough. According to McKinsey, countries currently invest around $2.5tr a year leaving a vast shortfall needed to invest in the transport, power, water and telecom systems that underpin economic activity and provide essential services.
However, infrastructure investment has actually declined as a share of GDP in 11 of the G20 economies since the 2008 global financial crisis, with the European Union, the United States, Russia and Mexico among those where spending has fallen.
The fiscal fallout from the crisis is one reason why many believe direct public funding can no longer be the solution. The state bailouts of banks across the US and Europe have left many economies nursing large public deficits and less able either to fund their own infrastructure projects or contribute to multilateral efforts by the IMF and the World Bank.
Attracting institutional investors such as insurers, pension funds and sovereign wealth funds, which according to PwC together hold about $120tr in total assets under management, is therefore more important than ever. Allocations of 5% of the portfolios of these asset pools to infrastructure would equate to $6tr.
On paper at least it is a win-win situation as institutional investors are offered stable, long term, inflation protected returns to match their obligations, while governments get to deliver popular improvements in public services without racking up more debt.
Matching the two has proved to be a tough nut to crack.
But there are signs of progress. In the decade since the crisis, more than $200bn has been raised by investment funds to deploy long term capital into infrastructure investments, according to PwC and the Global Infrastructure Investment Association, whose members have $500bn assets under management.
But particularly in developing countries the most important step will be to improve the pipeline of bankable projects that can attract private sector investment. A good example is Africa that faces a shortfall of £1.4tr a year of infrastructure finance through to 2040, according to a report by the GIH and Oxford Economics in July.
The analysis of 10 African countries identified $2.4tr in transport, electricity and water and other services to keep pace with economic growth and close infrastructure gaps. But only $1.4tr is expected to be delivered based on current spending levels.
“Attracting private sector investment into African countries remains a major challenge,” says Chris Heathcote, chief executive of the GIH, who came from a long career in private sector banking including positions at Macquarie, WestLB and Lloyds Banking Group. “The key to addressing this is creating the right environment to encourage investors to turn their interest into action.”
Attracting private investment is central to World Bank president Jim Yong Kim’s ambition to move the discussion from
“billions” in official development assistance to “trillions” in investments by leveraging the huge volumes of capital sitting on the books of global insurance companies and pension funds.
There is an attractive pipeline for investments in the coming years. The World Bank estimated there were more than $380bn of investment-ready projects in energy generation and renewables at end-February 2017 in a wide range of countries and regions.
Gyude Moore, a former minister of public works for Liberia and now a fellow at the Center for Global Development (CGDev), agrees there is a need to develop a framework for pairing that money with the massive infrastructure deficits. “The problem is that the underlying fundamentals are not in place to allow the scale of transfer that would be necessary.”
He cites three hurdles: the infrastructure asset class is not clearly understood or standardised; money is attracted to high value projects such as energy and telecoms but less to basic needs such as water and roads; and low income countries tend to fail one-size-fits-all assessments by investors. On top of those sit technical problems including a lack of an efficient market for financing the assets and constraints on the supply side of financing, including capital charges from regulations such as Basel III and Solvency II.
One answer being heavily promoted by the multilateral development banks is credit enhancement schemes and financing windows. By offering, say, a first loss guarantee of 10%, the World Bank’s Multilateral Insurance Guarantee Agency (Miga) can create an investment grade risk profile on a loan portfolio of emerging market infrastructure investments.
The EBRD first used an innovative credit enhancement mechanism in a €288m bond to finance a €360m state-of-the-art hospital campus in the Turkish city of Elazig, in eastern Anatolia. To boost the bond rating and increase its attractiveness to investors, the AAA-rated EBRD pledged to provide €89m as interim liquidity to mitigate the risks of construction and operation.
This unfunded liquidity facility combined with Miga political risk insurance enabled Moody’s to assign a rating of Baa2, two notches above Turkey sovereign rating at the time, enabling participation by a larger pool of investors and mobilising new sources of funding. Once completed it will be a 1,038-bed facility serving a population of 1.6m.
However, the transaction only crowded in $5m in private investment derived from local pension funds and banks. “It ended up being financed by the private sector arms of the development banks,” Moore says. “And this is Turkey. You can imagine the difficulties for a Ghana to be able to copy this.”
Indeed, Turkey is a fast growing emerging market currently on investors’ radars despite the recent turmoil caused by government interference in monetary policy. Private investors are less keen to look at poorer, developing economies.
Moore’s concern is that even if the billion-to-trillions strategy could work, it will not deliver money to low income countries where the need is greater for some time to come.
At the moment the infrastructure in sub-Saharan Africa is insufficient to support a population that is expected to double within 25 to 30 years. “The timeframe required to put all the fundamentals in place to allow the billions to trillions is just not realistic for these countries.”
This story of huge needs and insufficient finance may explain the positive reception of September’s Summit of the Forum on China Africa Cooperation (FOCAC). President Xi Jinping unveiled a $60bn pledge for new projects in front of the 53 African nations attending the Beijing event.
But behind the razzamatazz are emerging doubts. A groundswell of criticism of China’s Belt and Road Initiative for “neo-colonialism” and creating a giant “diplomacy debt trap” for the recipient countries has raised doubts about whether China will maintain its infrastructure investment. Governments have cancelled projects including a dam in Pakistan, a Malaysian rail link and a Myanmar hydropower plant.
China courted bad publicity by taking a 99-year lease on the Sri Lankan port of Hambantota after a failure to pay its debts. CGDev’s Moore plays down the debt trap fear saying that while Sir Lanka grabbed the headlines, China has also restructured 84 transactions without taking back any assets. In August Botswana and China signed a protocol exempting the African state from repaying three interest free loans worth $8m.
Research by Aid Data based at William & Mary, an American university, into Chinese-financed projects in 138 countries between 2000 and 2014 found they reduced economic inequality within and between regions.
John Ashbourne, senior emerging markets economist at Capital Economics, notes that the $60bn pledge at the triannual conference was the same as the one in 2015, the first time it had not been raised. “This may reflect a reduced African appetite for debt as much as a lack of Chinese interest, but it does suggest that the narrative of a consistently strengthening relationship is misleading,” he says.
Moore believes the debate over China’s investment is an opportunity for fresh collaboration between Beijing and the World Bank, which recently joined the G20 Compact with Africa aimed at helping 11 countries get project-ready. “If I were president of the World Bank, having realised that ‘billions to trillions’ was at least 10 years in the future, I would want to see how interactions between Bank resources and Chinese resources could deliver the same outcome."
It may not exactly be the public-private partnership the authors of the Scottish and London reports had in mind, but it could move the world a step closer to closing the infrastructure gap.