How to bridge the financing gap in Asian infrastructure
We must make it easier for Asia’s institutional investors to finance infrastructure projects.
A landmark ADB study in early 2017 calculated that 45 developing countries in Asia and the Pacific would need to invest $26 trillion over the next 15 years to keep their growth momentum by 2030. However, this estimate pays most attention to hard infrastructure such as roads, bridges, ports, and telecommunications.
There has been much less focus on social infrastructure – mainly health and education services. Receiving even less attention are the practical policies and innovations needed to address the financing gap, which amounts to roughly $459 billion a year for physical infrastructure through 2020 and almost as much, $448 billion, for social infrastructure.
If only one quarter of the net outflow of the region’s famously large savings pile were invested in infrastructure in the region, the financing gap would be filled. Yet by December 2016 Asia still invested $6.2 trillion in the rest of the world, while the rest of the world invested only $4.4 trillion in Asia.
This nearly $2 trillion gap is at the heart of a conundrum that, if solved, could make up the shortfall for physical and soft infrastructure and unlock Asia’s now obvious vast economic potential.
So, what needs to be fixed? We must make it easier for Asia’s major institutional investors to keep their savings in the region. The many factors at work, detailed in our recent working paper, fall into three broad categories.
The first is financial, fiscal, and other institutional constraints. The region’s lack of innovative financing products hinders private investment, as does its failure to recognize infrastructure as a distinct asset class like other regions do.
When recognized as an asset class, projects can become subject to similar laws and regulations, easing assessment and thus lowering costs. In Asia, a lack of standardization requires investors to assess each project separately, which can increase project costs by 1%–5%, says a 2016 study by McKinsey Global Institute.
Second, weak and poorly designed projects offer returns insufficient to attract investment. Many governments in developing Asia still struggle to prepare strong, bankable projects. About 70% of the pipeline available to equity investors in Asia is in risky greenfield projects instead of brownfield ones, according to McKinsey. And governments lack the capacity, experience, and understanding of the private sector to prepare investment-ready projects.
Third, high infrastructure investment risks—some specific to Asia—make investment in the region less attractive. This is a major reason why infrastructure investment in Asia falls short despite huge demand for such projects.
For example, political and financial risks dampen the appetite of institutional investors for infrastructure projects, even though these can yield more than long-term government bonds at relatively low risk. ADB rates 41% of economies in the region in the bottom categories of country risk, while Standard & Poor’s puts 26% of developing Asia below investment grade, at BBB-.
Solving these problems will require innovative measures. Multilateral development banks can introduce schemes such as wholesale banking through financial intermediaries, or B-loan syndications that commercial banks and other eligible financial institutions can fund, acting as lender of record.
In India, ADB partnered with the government-owned financial intermediary India Infrastructure Finance Company Limited to leverage private funds for infrastructure development. By 2011, the partnership had funded 30 projects, including the Delhi and Mumbai International Airports. It was expected to fund over 60 public-private partnerships, and mobilize over $24 billion from the market.
To ensure more bankable projects, more project preparation facilities are needed, from project design to the commercial close of a project. The Multilateral Development Bank Working Group on Infrastructure says this would involve grant-financed instruments to streamline preparation of infrastructure projects such as the ADB-hosted Asia Pacific Project Preparation Facility; it is estimated that the cost of such facilities for complex public-private partnerships is 5-10% of total project cost.
We may address the constraint of high investment risks through contingent subordinated guarantees that help raise debt ratings, or with a regulatory risk cover facility to help cover debt service default caused by regulatory changes. A counterparty risk cover facility may be established to cover nonpayment or late payment by less creditworthy state-owned enterprises without a counter indemnity from the government.
In the Tiwi–Makban Climate Bond, the first project bond ever issued in local currency in the Philippine power sector, ADB enhanced credit with a guarantee of 75% of principal and interest to fund investment in geothermal power plants.
Closing Asia’s infrastructure gap will require a sustained effort involving innovation and partnership among government, development organizations, and the private sector. Multilateral development banks such as ADB have an indispensable role to play in alleviating government financial constraints and risk sharing.