The world economy faces huge needs of infrastructure finance…
Last year, a report by McKinsey Global Institute (2013) estimated that, in order to realize its potential global growth from then to 2030, the world would have to invest in infrastructure (roads, bridges, ports, power plants, water facilities, and other forms) in the range of US$57-67 trillion, depending on three different methodologies (Chart 1). To give an idea of what a tall order such a challenge will be, the report notes that the lower bound of the range corresponds to nearly 60 percent above the amount spent in the last 18 years and it is larger than the estimated value of today's infrastructure.
Chart 1: Estimates of needed infrastructure investments, 2013-30 ($ trillion, constant 2010 dollars).
Source: McKinsey (2013).
The share of infrastructure finance requirements in emerging market economies (EMEs) in those figures corresponds to 37 percent. As those estimates do not embed "development goals" beyond where emerging market and developing economies are nowadays, as well as additional expenditures associated with adaptation to climate change and sustainability needs, they may be considered a lower bound ( Swiss Re and IIF, 2014 ). The World Bank estimates that these countries need to invest in infrastructure at a rate of an additional US$1 trillion per annum through 2020, just to keep pace with the demands of urbanization, growth, climate change, and global integration.
… but the financing gap is yawning
Several factors have been leading to a shortfall of infrastructure finance supply, including in advanced economies. Public sector funding has faced stringent conditions. With a few exceptions - like China - most advanced and emerging market economies have become more fiscally constrained in the last few years, as counter-cyclical fiscal policies have reached their limit, either for political and/or debt sustainability reasons. On the private sector financing side, there is an ongoing transition toward a new configuration of infrastructure finance that has left a void: while banks have been retrenching, their replacement by non-bank institutions, wherever feasible, has been inadequate.
Some combination of bond issuance and bank lending is what usually works best in debt finance of greenfield investments in new projects and the creation of new productive assets. Banks are better equipped to address issues of information asymmetries, particularly at the early stages of project design in cases of complex financing needs - like infrastructure - whereas the arm's-length relationship typical of long-term bond issues and institutional investors is more appropriate for extending and consolidating investment financing. Infrastructure assets are appropriate investments for pension funds, insurance companies, and other long-term financial institutions (mutual funds, sovereign wealth funds etc.) because they tend to match their long-term liabilities, provide inflation-protected yields, and have a lower correlation to other financial assets. A significant presence of mature long-term debt markets and institutional investors as ultimate asset holders enhances the risk-transfer and risk-transformation functions of financial intermediation as a whole and can make the system more stable.
The problem is that the financial crisis has been followed by a bank retrenchment from the field, without non-bank institutions filling the finance gap. The weight of banking can be gauged by its share in global project finance (Chart 2). In that context, infrastructure financing by banks has been curtailed as part of a deleveraging process, which is still in course.
This is particularly the case for European banks, which had traditionally played a significant international role in infrastructure financing prior to the global financial crisis. Their balance sheet repair and capital ratio adjustment, since the eurozone crisis - as depicted in Chart 3 - has been obtained mainly by retrenchment on the asset side of their balance sheets, by unwinding existing positions and shunning new commitments.