EAST ASIA: Study exposes infrastructure gap

Analysis

Last September, the World Bank, the Asian Development Bank (ADB) and the Japan Bank for International Cooperation (JBIC) undertook a study of infrastructure in several Asian countries. It is due to be completed next January. For the purposes of the study, "economic infrastructure" includes electrical power, piped gas, transport, information and communications technology and water and sanitation, in both urban and rural areas. Countries covered include Cambodia, China, Indonesia, Laos, Malaysia, Mongolia, Myanmar, Papua New Guinea, the Philippines, Thailand, East Timor, Vietnam and the Pacific Islands.

The tripartite study's initial findings suggest that the balance between public and private sector provision of infrastructure in the region (and possibly elsewhere) will need to be re-examined in the light of major deficiencies in hoped for private investment (see INTERNATIONAL: Bank re-thinks power sector provision - November 26, 2003). Governments may need to reconsider fiscal positions and tax policy in the light of probable demands on the public sector for infrastructure funding and subsidies. Multilateral development banks may need to step up infrastructure lending again, and the development of local capital markets in East Asia will need to be prioritised to help finance infrastructure.

Emerging gap. The study takes place at a time when economic activity in the region is accelerating rapidly, following downturns caused by the 1997-98 East Asian financial crisis and the bursting of the IT bubble. Meanwhile, infrastructure development, both publicly and privately financed, has slowed sharply and remains well below pre-1997 levels. There are fears that demand for new infrastructure services will outstrip supply, resulting in an "infrastructure gap".

During the 1990s, consensus shifted from belief in state provision of basic infrastructure services, to emphasis on the private sector's ability to provide these services more efficiently (see ASIA-PACIFIC: Infrastructure Development - February 23, 1994). There is an attempt now to find a middle way, recognising that neither public nor private sectors can meet the challenge in isolation. The three institutions involved in the study believe that a new framework and approach is required in order to prevent an infrastructure gap growing to the point of threatening economic growth and poverty reduction. The study aims to identify new approaches, such as public-private sector partnerships, to bridge the gap on infrastructure provision.

Spending shortfall. Of the countries included in the study, only in China, where the state has been heavily involved in building new infrastructure -- including some 30,000 kilometres of new highways over the past decade or so -- has infrastructure provision taken place on a major scale. Even here, demands for new construction will strain the country's financial resources. Elsewhere in the region, public funding has fallen sharply as many governments have sought to reduce unmanageable levels of debt. There has been a major slowdown in infrastructure provision, caused partly by the 1997-98 crisis but mainly by a severe shortfall in expected private sector investment.

East Asia and the Pacific will require at least 200 billion dollars a year to meet infrastructure needs over the remainder of the decade, according to the World Bank. At present, only about half of this sum is assured:

• Global private investment in infrastructure, which peaked at 120 billion dollars a year in 1997, has since fallen back to under half that level.
• After peaking at more than 40 billion dollars in 1997, private sector investment in infrastructure in East Asia has fallen to around 12 billion dollars.
• The World Bank, ADB and JBIC -- the main providers of multilateral infrastructure funding in East Asia -- are together supplying only about 8 billion dollars a year for infrastructure investment.
• Funding from private sources (defined as public projects that have a private sector component) totals only about 12 billion dollars a year.

Investment obstacles. Despite some recent signs of a recovery in private infrastructure investment in the region, the obstacles to private participation on any significant scale remain formidable. Many contracts involving foreign operators, contractors and financiers have been either cancelled or renegotiated since the 1990s (the outstanding example being Enron's withdrawal from a power generation deal in India (see INDIA: Maharashtra Muddle - July 7, 1995). The region's ability to manage risk is relatively poor, and potential providers of future infrastructure funding are cautious about country and contractual risks. Several other factors also deter private investment:

• Local currency financing is seen as a key element in negating risk, but development of the long-term local capital markets (particularly bond markets) this requires is likely to be outpaced by the need for new infrastructure facilities (see ASIA PACIFIC: Regional bond market advantages - November 23, 2001).
• The legal and regulatory environment governing contracts and markets is inadequate.
• Certain services (such as power) have traditionally been provided to the poor at subsidised rates, and this is not readily compatible with private provision of such services.

The study will consider the issue of subsidies with a view to determining whether they should be permitted, provided the subsidy process is transparent and can be administered in a way that does not interfere with the operation of infrastructure services by private entities.

Growing pressures. The overall situation with regard to infrastructure provision in East Asia is more severe now than it was a decade ago when the infrastructure gap first began to appear. Economic integration within ASEAN and elsewhere, and closer linkages with the economies of China and Japan are placing heavy demands on transport, power and other systems (see EAST ASIA: ASEAN+3 enhances regional integration - January 8, 2004). Foreign manufacturing investment is also straining infrastructure while the growth of 'megacities' threatens potential crises. Poverty reduction targets, which form part of the UN Millennium Development Goals, also require heavy investment in rural infrastructure.

Region and centre.Moreover, at a time when governments need to cooperate across borders in linking basic infrastructure, responsibility for providing such infrastructure has been devolved from the centre to provincial and municipal governments. This has implications for tax policies if, as appears likely, greater public sector involvement in infrastructure financing is required (at least on an interim basis). It also has implications for structuring bond markets so that they are more readily able to absorb municipal debt instruments for financing infrastructure.

Meanwhile, urban and rural areas are competing to be provided with new infrastructure facilities, or upgrading of existing ones. In the former case, this is because migration from rural to urban areas is producing population explosions in many of Asia's megacities. In the latter case, it is because rural communities need improved linkages to major transport, communications and power networks.

Bridging the gap. The World Bank, ADB and JBIC study is likely to recommend that interim arrangements be made for providing new infrastructure systems and upgrading existing ones, pending the emergence of more robust private sector structures capable of financing, building and operating infrastructure services. This will almost certainly involve an increased role for multilateral development banks (especially the World Bank, whose infrastructure lending in East Asia halved during the 1990s), and for governments in the region.