INTERNATIONAL: Global capital fails infrastructure

Analysis

Brazilian President Luiz Inacio Lula da Silva arrives in Beijing on May 22 at the head of a large commercial delegation seeking Chinese support for infrastructure development in Brazil. The visit reflects the growth in trade between the two countries, which has been constrained by inadequate Brazilian infrastructure and lack of finance to develop it (see BRAZIL: Investments may boost exports if not jobs - March 11, 2004). The situation is symptomatic of wider infrastructure financing troubles in the developing world. Infrastructure financing accounts for a small fraction of total private (domestic and foreign) investment in emerging economies. Capturing the lion's share of investment are manufacturing and service industries, which themselves are heavy consumers of infrastructure services (see EAST ASIA: Study exposes infrastructure gap - January 28, 2004).

Installed electric power capacity per thousand people in developing countries as a whole amounts to 272 kilowatts compared with 2,044 in advanced nations. At 0.15 kilometres per square kilometre of land, road density in developing nations is one-quarter the ratio in advanced nations. Developing nations have only 95 telephone main lines per thousand people compared to 501 in advanced nations.

Private shortfall. The World Bank's 1994 World Development Report on infrastructure assumed that private investment would finance the bulk of developing country infrastructure. Marking a sharp change, the Bank's 2004 Global Development Finance report acknowledges that the public sector will remain the predominant provider of infrastructure. Over the 1990s as a whole, 22% of such investment came from private sources, 70% from governments or public utilities and 8% from official development assistance.

The global capital market is not channelling finance to infrastructure. Total international investment in developing country infrastructure (through bank loans, bonds and equity issuance) amounted to 622 billion dollars between 1992 and 2003. In 2003, less than 20% of total international bank lending and less than 7% of international bond financing was for infrastructure. International financing for infrastructure is currently running at under 3.5% of total gross domestic capital formation in the developing world. Two-thirds of this flows to East Asia and Latin America.

Multilateral shortfall. Spending by multilateral development banks on developing country infrastructure fell from 18.3 billion dollars in 1996 to 13.8 billion dollars in 1999. It recovered somewhat to 16.6 billion dollars in 2002, but the World Bank is still providing under 60% of what it did in the early 1990s. The Bank attributes these shortfalls to macroeconomic shocks such as the 1997-98 financial crises; changes in the global electricity and telecommunications environment, including a slump in global stock prices and 'accounting irregularities'; weakness of local capital markets in developing countries; and lack of reforms needed in developing nations to put their infrastructure sector on a commercial footing.

Other contribution factors include discrepancies between financial returns demanded by private-sector providers and the ability of developing country consumers to pay, as well as the high commercial and other risks entailed in infrastructure projects. Ideological factors such as the 'Washington Consensus' preference for private finance are also responsible.

Solutions. Most global infrastructure demand is likely to come in future from the developing world, where economic growth will be concentrated, and because developing nations as a whole are home to two-thirds of the world's population. This will require investment of the order of 120 billion dollars per year in the electricity sector alone over ten years, while water and sanitation will require an additional 50 billion dollars annually, the World Bank suggests. China alone will need overall infrastructure investment of 2 trillion dollars in the ten years from 2001 to 2010. The Bank suggests several methods of connecting international capital to the job, namely:

• establish transparent rules so investors can form expectations of future returns and risks -- contracts must be enforced, with legal remedies in case of default;
• strengthen the capacity of capital markets in developing countries as a source of long-term local currency financing and as hedging instrument against currency risk;
• develop risk-mitigation and financing instruments in both public and private sectors that are capable of dealing with the host of political, currency, credit, contractual and regulatory risks involved in infrastructure;
• find ways to enable sub-sovereign public utilities such as municipal authorities to tap capital markets; and
• help public providers of infrastructure services to achieve the creditworthiness needed in order for them to achieve sustainable access to capital markets.

This is a long-term agenda. As the Bank acknowledges, the public sector will be the predominant provider of infrastructure for some time to come. Multilateral development banks probably need to re-engage with developing countries on the infrastructure front, not only in the amount of lending allocated but also in boosting reforms needed for private provision. A primary role for the development banks will be in reducing infrastructure risks in developing countries to levels where they become acceptable to private providers. The key task is to connect global capital to infrastructure investment. As the Bank notes, this calls for an international mechanism to deal with cross-border investment regulation; in addition to competition rules and consistency between national regulatory regimes.