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How Can Asia Finance the Infrastructure It Needs?

Article | 27 June 2017

Asia’s infrastructure gap will not close without much more private sector financing than the current $63 billion annually. #LetsBuildAsia

In just a couple of decades, Asia has halved extreme poverty and lifted most of its people from low income to middle income status.

These are massive achievements. But imagine how much more could have been done if the region’s infrastructure had been better.

Despite significant investments in recent decades, power outages and poor transport links are still a drag on economic growth in many countries. More than 400 million of the region’s people still lack electricity; 300 million have no access to safe drinking water and 1.5 billion go without basic sanitation.

The need for more infrastructure is outpacing the capacity of countries to fund it.  A recent Asian Development Bank report, Meeting Asia’s Infrastructure Needs, estimated that between now and 2030 the region will need to invest $26 trillion in infrastructure to keep pace with demand spurred by continuing economic growth.

That’s more than $1.7 trillion a year, and includes upgrading to ensure infrastructure can withstand and help mitigate climate change.

How can the region mobilize such huge amounts?

Currently, the public sector provides more than 90% of infrastructure investment. Governments need to find ways to mobilize more investment and to make infrastructure investment more attractive to the private sector.

“Governments need to find ways to mobilize more investment and to make infrastructure investment more attractive to the private sector.”

Governments can boost revenues by simplifying tax systems and broadening the tax base. Doing this in Sri Lanka, for example, could generate close to 3% of GDP in additional revenue. Further funds for investment could be released in a number of countries by reorienting budget expenditure away from wasteful and poorly-targeted energy subsidies, or reducing bloated public sector wage bills.

Another option is setting user fees for infrastructure services, like piped water, to cover not just operations and maintenance—which in some countries aren’t covered by user changes—but also capital costs. Governments might also consider innovative instruments such as land value capture, which channels money from rising land or property values to the public sector through various taxes, fees, or leases.

Land value capture has been used successfully in the People’s Republic of China, where more than one third of local fiscal revenue over the past decade has come from land transfer fees paid to the state by industrial developers.

Mobilizing private sector finance

But Asia’s infrastructure gap won’t close without much more private sector financing than the current $63 billion annually.

The problem isn’t a lack of private sector interest. Infrastructure investments offer attractive returns from long-term cash flows well suited to institutional investors such as pension funds. But these investors are often hampered by an insufficient supply of investible infrastructure projects in Asia, and by the fact that many of these projects are rated as too risky for their portfolios.

These constraints reflect four factors: inadequate project design, preparation, and due diligence at regional governments; regulatory and institutional frameworks that aren’t conducive to private investment; shallow domestic capital markets; and a lack of credit enhancement mechanisms.   

The Philippines has shown how the first two obstacles can be overcome. Through its Public-Private Partnership (PPP) Center, it has delivered clear, enforceable regulations and transparent institutions that private investors need before they engage in large PPP infrastructure projects.

A Project Development and Monitoring Facility has helped to overcome hurdles during preparation. It helps ensure projects are feasible and properly structured, and manages the all-important bidding process. In the past few years, 15 project contracts worth more than $6.2 billion have been awarded.

Building deeper bond markets

Infrastructure projects demand long-term financing that is often difficult for banks to provide. So it’s important also that the region’s economies deepen their bond markets to create other options for infrastructure developers to raise capital. Corporate bond markets are shallow in Asia; only Thailand has corporate bond issuance spanning the entire spectrum of investment grade ratings.

Most infrastructure bonds in the region are below investment grade, constraining institutional investors who often are restricted to investment grade assets. Governments can help overcome this by offering or arranging credit guarantees to protect creditors from losses. They can also improve local credit ratings agencies, as Malaysia has recently done, to give investors a clear view of the risks they might face.

Multilateral development banks like ADB also have a role. They combine finance with expertise in planning, implementing and climate-proofing infrastructure projects, supporting PPPs, deepening bond markets, and providing credit enhancement. ADB is scaling up its operations to $20 billion by 2020, of which 70% will go toward infrastructure—much of which will be used to catalyze further private sector investment.

Better infrastructure can help Asia deliver the sustained prosperity that its people deserve. #LetsBuildAsia