LONG-TERM FINANCE: Running on empty
How do you finance long-term projects in a short-term world?
In Samuel Taylor Coleridges Rime of the Ancient Mariner, becalmed seafarers can see water, water everywhere nor any drop to drink. Similarly, there is an ocean of short-term liquidity in the financial system now, but long-term funding is getting scarce.
At least this is what the many government bodies and international financial institutions that are currently searching for solutions to the perceived problem believe. These include the G20 group of advanced and emerging economies, the International Monetary Fund, the World Bank, the OECD and the G30 group of bankers and financiers to name but a few.
Regional development banks are also getting involved in the search for solutions. President of the Asian Development Bank Takehiko Nakao told Emerging Markets earlier this year that the Manila-based bank intends to go all out to catalyze private funds to leverage up the ADBs impact on infrastructure financing.
Quantitative easing (QE) efforts launched by leading central banks (principally the US Federal Reserve, the Bank of England and the Bank of Japan), as well as the European Central Banks twists in policy to allow the expansion of its balance sheet, have blown out the global monetary base. But by pushing down interest rates to historic lows in the process, central banks have reduced the attraction of long-term investment, some experts argue.
It appears that the lack of long-term finance is tied to the fact that the system is punishing those who save, while rewarding irresponsible spenders, says former International Finance Corporation (IFC) official Ernest Kepper. Meanwhile currency wars are undermining long-term confidence in the purchasing power of the currency investors will receive as repayment 20 years from now, Kepper says.
The potential multi-trillion dollar financing gap for funding everything from infrastructure through business investment to housing construction in emerging econ-omies especially (although by no means exclusively) is huge, the G30 warned in a report in February of this year, and this view was echoed by G20 finance ministers during their meetings later in the year.
But if there is general agreement on the seriousness of the threatened financing drought, there are also many views on its causes and how to deal with it. For example, Hans Timmer, chief economist, Europe and Central Asia at the World Bank, says that it is largely a problem of financial intermediation.
Savings are there in emerging markets, where they are needed, he says, but they are not being translated into investment. Financial markets in developing countries will quickly have to become a lot more mature and play a much bigger role in transferring savings into investment, Timmer tells Emerging Markets. They cant rely any more on the West and on the financial institutions in high-income countries.
Others, such as former vice-president and executive director of the Asian Development Bank William Thomson, argue that at the heart of concern over long-term investment funding is a savings crisis. This, he tells Emerging Markets, is caused by underfunded and over-promised entitlements for pensions and healthcare in rapidly aging societies, compounded by massive borrowing of governments and zero interest rate monetary policies of central banks.
G20 finance ministers have meanwhile declared that long-term financing for investment must become a global priority. A fall in bank lending and syndicated loans for infrastructure financing since the global financial crisis of 2008 is one key factor holding back investment, the group said in a report prepared by a host of international agencies led by the World Bank and issued in July.
In a separate report published earlier this year, the G30 suggested that the roots of the problem go deeper. Far-reaching reforms in the international financial system are needed to ensure that rising demands for long-term capital can be met efficiently, G30 chairman and former head of the European Central Bank Jean-Claude Trichet suggested at the London launch of the report. If such reforms are not undertaken, we will likely face significant shortfalls in finance in coming years, he warned.
The G30 went on to suggest that leading economies will need huge investment in the short to near term but are unlikely to get it without reforms that can strengthen the flow of capital into long-term investments by governments, institutional and individual investors.
In just nine economies (the US, UK, Germany, France, Japan, China, India, Brazil and Mexico) investment spending totalled $11.7 trillion in 2010, and could grow to $19 trillion by 2020, with China alone accounting for around half of the increase, the group said.
Major changes are needed in the ways in which the global financial system is configured in order to meet growing long-term capital needs efficiently and sustainably, suggested former Mexico finance minister Guillermo Ortiz, who chaired a special G30 committee. He urged authorities to create new instruments to boost savings that can be channelled into long-term investments and called for approaches that strengthen the ability of the public sector to leverage private-sector capital for long-term financing.
Axel Weber, chairman of the UBS banking group, suggested at the launch of the G30 report that policymakers should continue to review the broader systemic and macroeconomic impact of regulatory changes on the future supply of finance to support long-term investment. The complexity of regulation, across different financial sectors and geographies, engenders the potential for inconsistencies and conflicts among rules, he said.
Some of these themes were picked up by the World Bank in its Global Development Horizons report published in July, which explored patterns of investment, saving and capital flows as they are likely to evolve over the next two decades. Seventeen years from now, half the global stock of capital, totalling $158 trillion, will reside in the developing world, compared to less than one-third today, with countries in East Asia and Latin America accounting for the largest shares of this stock, the report said.
Developing countries share in global investment is projected to triple by 2030 to three-fifths, from one-fifth in 2000, the report (Capital for the Future: saving and investment in an interdependent world) suggested. Among developing countries, China and India are expected to be the largest investors, with the two countries together accounting for 38% of the global gross investment in 2030.
One of the conclusions of the Global Development Horizons report is that it is unlikely that there will be a major shortage of savings, the World Banks Timmer says. The resources are there potentially, and the reason is that developing countries, as they grow very rapidly, will save enough to finance their high-investment needs.
Whether that also means that there will be a sufficient supply of long-term capital is more uncertain because another conclusion of the report is that there might be a shortfall of intermediation of institutions. One of the reasons is that the financial markets in developing countries will very quickly have to become a lot more mature than they are now, play a much bigger role in the economy, and will have to find an efficient way of transferring savings in those countries into investment.
Within about 15 years from now, the size of the developing countries in global investment and global saving will be two-thirds of global investment and saving whereas for decades it has been 25%, says Timmer. So it is a dramatic turnaround, and that is a very short period for those financial markets to become very mature. Even very successful [emerging market] countries are hardly integrated into the global financial markets. You still see a lot of financial repression.
The pattern has been for developing country savings to find their way into western institutions, from where they are lent back to Asia. But, says Timmer, this was not a sustainable pattern because it was a sign that those financial structures were underdeveloped in the developing countries. It is not efficient to put all your savings into US or European government bonds with very low yields. What is needed in many developing countries is for savings to be invested productively, either directly in those economies or in other [developing] economies to allow the emerging companies in the developing countries to internationalize.
He believes the trend in the coming decade will be even more unsustainable, mainly because of the sheer size of the emerging countries and their ability to use the financial institutions in the West, which in their turn are shrinking in size, and their role as global financial players is diminishing.
Initiatives by the G20, G30 and others to help solve the potential shortage of long-term finance are important, says Timmer. You need international cooperation, but it should be driven by the emerging economies themselves. He applauds the idea of a Brics (Brazil, Russia, India, China, South Africa) bank, calling it consistent with what the world will ultimately look like many more initiatives coming from the emerging market institutions. This will allow intermediation that is not there yet, and that will also allow the currencies in emerging economies to play a more important role. The Brics bank is one vehicle for that, but there is room for many, he says.
The search for solutions goes on. At their meeting in Moscow in July, G20 finance ministers promised to undertake further work on measures to facilitate greater intermediation of global savings for productive investments, including in infrastructure.
We will explore how private sources of financing and capital markets can be better mobilized, they pledged. With the political will seemingly in place, it will be up to the private sector to step up to the challenge.