First appeared on The New South Politics Center (July 7, 2021)
The world is facing an enormous shortfall in infrastructure investment compared to its needs. With a few exceptions, such as China, this shortage is greater in emerging and developing countries.
The G20 Infrastructure Investors Dialogue estimated the global investment in infrastructure required by 2040 at $81 trillion, of which $53 trillion will be needed in underdeveloped countries. The dialogue projected a gap—in other words, a shortage in terms of today’s projected investment needs—of about $15 trillion globally, of which $10 trillion is in emerging economies (Figure 1, left panel). The World Bank has estimated that for emerging and developing economies to reach the 2030 Millennium Development Goals, their infrastructure investment must correspond to 4.5% of annual GDP (Figure 1, right panel).
In addition to the need to invest in infrastructure, there is a need to “green” this investment as quickly and widely as possible, in order to reduce the negative impact in terms of further global warming. For example, carbon must be removed from the energy sector by expanding the use of renewable sources in place of coal. Increasing efficiency of use, and eliminating subsidies for fossil fuel use, will be part of this strategy.
Transportation is now responsible for 25% of the world’s greenhouse gas emissions. This should be reduced by shifting transportation to low-carbon options, as well as investments in energy-efficient equipment, and support for the transition to electric vehicles and fleets.
Much of the “greening” of cities will be: improved water supply and sanitation, changes in energy supply, waste recycling, and increased energy efficiency through better building standards and/or renovation of existing buildings. This transformation will require, for industrial and agricultural activities, investment in infrastructure.
A major obstacle to such investment is the lack of fiscal space, which limits public spending. This problem has been exacerbated by the financial packages approved due to the pandemic. While the largest advanced economies can afford to increase their public debt, with a low risk of facing deteriorating financing conditions, this is not true for most emerging economies, let alone low-income countries grappling with unsustainable debt pathways (Figure 2).
Thus, measures must be taken to expand private financing options for infrastructure projects. In fact, according to data from the Institute of International Finance, over the past 15 years, institutional investors with long profiles in their assets, such as pension funds, have gradually increased their allocation to infrastructure investments, alternatives to fixed-income and equity instruments, and other traditional machines.
Stable, long-term returns from infrastructure projects align well with the long-term commitments of those financial institutions, particularly in the context of lower long-term real interest rates on public and private bonds, as seen in recent decades in developed countries. Surveys by Preqin show that fund managers are already citing energy decarbonization as a factor in attracting private investment into infrastructure.
The biggest challenge is to build bridges between, on the one hand, the infrastructure investment needs of the underdeveloped countries, and on the other hand, the abundant private sources of financing in dollars and other convertible currencies with few opportunities to get returns compatible with their requirements on the side of their responsibility.
Building such bridges requires two tasks to be accomplished. First, the development of properly structured projects, with risks and returns in line with the preferences of different types of financial intermediation, would help close the infrastructure private financing gap.
Investors have different mandates and skills in terms of managing risks associated with project types and project investment cycle phases. They require coverage of risks whose exposure is insufficient or not permitted by regulation. The absence of complementary tools or investors is one of the most frequently identified causes of failure in the financial delivery of projects. Figure 3 provides a snapshot of the diversity of tools and means by which private finance can engage in infrastructure projects.
The fiscal space constrained in emerging and developing countries can be used to essentially cover these risks and enable investment building, rather than substituting private investment: crowding out rather than crowding out private finance. National and multilateral development banks can prioritize this rather than financing aggregate investments.
Identifying investment opportunities that are attractive to different types of investors and more systematically combining these perspectives on specific projects or asset pools is a promising way to bridge the infrastructure financing gap. Integrated planning and issuance – with different time profiles – of fixed income securities, bank loans, credit insurance, etc., for the different stages from project preparation to operation, makes this combination possible.
The second task of promoting private investment in infrastructure in emerging and developing economies is to reduce legal, regulatory and political risks. Transparency and harmonization of norms and standards can increase the size of comparable projects and make it possible to build project portfolios. Non-bank financial institutions often highlight the lack of large enough project portfolios as a disincentive to deter the creation of regionally focused business lines. This is a particular weakness in the case of smaller countries.
The contrast between the dearth of infrastructure investment—particularly in underdeveloped economies—and the excess of savings invested in low-return, liquid assets in the global economy is worth confronting. Green infrastructure in undeveloped economies will benefit from its ability to attract dollars to business.
Watch Bridging private finance and green infrastructure
Ottaviano Canuto, based in Washington, DC, is a senior fellow at the Policy Center for the New SouthAnd Non-resident Senior Fellow at the Brookings InstitutionLecturer 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 Executive Director of the World Bank, a former Executive Director of the International Monetary Fund and a former Vice President of the Inter-American Development Bank. He is also a former Deputy Minister for International Affairs in the Brazilian Ministry of Finance and a former Professor of Economics at the University of São Paulo and the University of Campinas, Brazil.