First appeared in Policy Center for the New South (July 7, 2021)
The world faces a huge shortfall in infrastructure investment relative to its needs. With some exceptions, such as China, this deficit is higher in emerging and developing countries.
The G20 Infrastructure Investor Dialogue estimated that the volume of global infrastructure investment needed by 2040 will be $81 trillion, of which $53 trillion will be needed in non-advanced countries. The Dialogue projected a gap—in other words, a shortfall relative to projected investment needs today—of around $15 trillion globally, of which $10 trillion is in emerging economies (Figure 1, left-hand panel). The World Bank has estimated that for emerging and developing economies to meet the Millennium Development Goals set for 2030, their investment in infrastructure would need to correspond to 4.5% of their annual GDP (Graph 1, right-hand panel).
In addition to the need for investment in infrastructure, there is a need for that investment to be ‘greened’ as quickly and extensively as possible, to minimize the negative impact in terms of increased global warming. For example, the energy sector must decarbonize by expanding the use of renewable sources instead of coal. Increases in the efficiency of use and the elimination of subsidies for the use of fossil fuels would be part of this strategy.
Transportation is now responsible for 25% of the world’s greenhouse gas emissions. This needs to be reduced by shifting transport to low carbon options, in addition to investments in energy efficient equipment, and supporting the transition to electric vehicles and fleets.
An important part of the ‘greening’ will be in the cities: better water supply and sanitation services, changes in the energy supply, waste recycling and greater energy efficiency through better construction standards and/or renovation of existing buildings . This transition, as for manufacturing and agricultural activities, will require investment in infrastructure.
A major obstacle holding back such investment is the lack of fiscal space, which limits public spending. This problem has been aggravated by the fiscal packages adopted in the wake of the pandemic. While the largest advanced economies can afford to increase their public debt, with a low risk of facing deteriorating financing conditions, this does not apply to most emerging economies, let alone developing countries. low incomes facing unsustainable debt trajectories (Figure 2).
Consequently, it is necessary to take measures to expand the options for private financing of infrastructure projects. In fact, according to data from the Institute of International Finance, during the last 15 years, institutional investors with long-term profiles in their assets, such as pension funds, have been gradually increasing their allocations to investments in infrastructure and alternatives to financial instruments. of fixed income, variable income and other traditional instruments.
The long-term, stable returns on infrastructure projects dovetail well with the long-term commitments of those financial institutions, particularly in the context of declining long-term real interest rates on government and private bonds, as discussed above. seen in recent decades in advanced countries. Surveys conducted by Preqin show that fund managers already point to energy decarbonization as a factor in attracting private investment in infrastructure.
The biggest challenge is to build bridges between, on the one hand, the infrastructure investment needs of non-advanced countries and, on the other, private sources of financing abundant in dollars and other convertible currencies with few opportunities to obtain returns compatible with their requirements. on your side of responsibility.
The construction of such bridges requires the completion of two tasks. First, the development of properly structured projects, with risks and returns in accordance with the preferences of the different types of financial intermediation, would help to close the private financing gap in infrastructure.
Investors have different mandates and skills with respect to risk management associated with project types and phases of project investment cycles. They demand coverage of risks whose exposure is not adequate or permitted by regulation. The absence of complementary instruments or investors is one of the most frequently identified causes of failure in the financial realization of projects. Figure 3 provides a snapshot of the diversity of instruments and vehicles through which private finance can participate in infrastructure projects.
Limited fiscal space in emerging and developing countries can be used primarily to hedge such risks and allow investment accumulation, rather than to replace private investment: attracting private finance rather than crowding it out. National and multilateral development banks could prioritize this instead of financing full investments.
Identifying attractive investment opportunities for different types of investors and combining these perspectives more systematically around specific projects or asset groups is a promising way to fill the infrastructure financing gap. The integrated planning and issuance —with different time profiles— of fixed-income securities, bank loans, credit insurance and others, for the different phases from the preparation of the project to its operation, make this combination possible.
The second task to boost private investment in infrastructure in emerging and developing economies is the reduction of legal, regulatory and political risks. Transparency and harmonization of rules and standards can increase the scale of comparable projects and enable the creation of project portfolios. Non-banking financial entities usually point to the absence of sufficiently broad project portfolios as a disincentive when it comes to launching lines of business focused on the area. This is a particular weakness in the case of smaller countries.
The contrast between the scarcity of investment in infrastructure—particularly in non-advanced economies—and the excess of savings invested in liquid and low-yielding assets in the global economy deserves to be confronted. Green infrastructure in non-advanced economies would benefit from being able to attract greenbacks into business.
Watch Uniting Private Finance and Green Infrastructure
Otaviano Canuto, based in Washington, DC, is a senior fellow at the Policy Center for the New South., a nonresident senior fellow at the Brookings Institutionprofessor of international affairs at the Elliott School of International Affairs – George Washington University, and director of the Center for Macroeconomics and Development. She is a former Vice President and CEO of the World Bank, a former Executive Director of the International Monetary Fund, and a former Vice President of the Inter-American Development Bank. She is also a former deputy minister for international affairs at the Brazilian Ministry of Finance and a former professor of economics at the University of São Paulo and the University of Campinas, Brazil.