How to finance Asia's vast infrastructure needs?
If Asia's emerging markets are to avoid the middle-income trap, they need to create foundations for the next phase of growth: they need to invest in infrastructure.
In the early stages of development, moving a worker from the land to a factory quadruples their value-added contribution to the economy on average. Much of Asia's extraordinary growth to date has been underwritten by this one-off transition, but the windfall gains of rapid industrialisation are starting to decline and if the region is to continue on the road to prosperity it needs to find ways to boost productivity and encourage new economic activity.
At the moment, inadequate infrastructure is possibly the biggest brake on emerging markets' medium-term growth prospects. It stunts both production and investment: few businesspeople will invest in large-scale production capacity when they cannot guarantee a reliable supply of electricity. Few farmers will upgrade their land if their crops are going to rot before they get to market because of bad roads and inadequate warehousing.
With some standout exceptions such as Hong Kong, Singapore and Japan, the problem is particularly acute in Asia: we estimate that urbanisation alone will require some $11 trillion worth of infrastructure investment in Asia over the next 15 years.
The latest data from the Penn World Tables indicate that the United States has more than five times as much capital stock per worker as China, and 14 times as much as India, and regional infrastructure investment as a percentage of GDP has been declining in recent years.
Infrastructure investment builds the bridge that connects the old growth engine of industrialisation with the new growth engine of sustainable productivity gains. Spending on roads, ports, power stations, water and railways increases aggregate demand in the short-term, and in the medium-term acts as an enabler, creating a cost-effective and flexible business environment that allows manufacturing and high-yield agriculture to fulfil their potential as drivers of long-term economic growth.
The first priority is to maximise the efficiency and impact of current spending by fast-tracking infrastructure delivery and clearing bottlenecks to create pipeline of transparent, well-structured projects. Infrastructure will also benefit from a robust and predictable regulatory environment that assures investors that schemes will not be cancelled or stalled halfway through construction.
But even while this is being achieved, two central inter-linked challenges to infrastructure investment will remain: what to build and how to pay for it.
Although basic infrastructure needs are relatively easy to determine at the early stages of the development cycle, there comes a point where the market mechanisms become the most effective way to allocate capital to the most economically productive infrastructure projects.
Infrastructure has traditionally been paid for by government, and although governments will continue to play a key role, the old model has inherent weaknesses.
The first is governments do not have the necessary human and financial resources: In the short-term a liquid banking market in Asia, working with export credit agencies and multilateral institutions, can provide significant amounts of cost-efficient financing. However, over time the sheer size of the funding required will mean that alternative financing sources will be vital to plug what will otherwise become an infrastructure funding gap.
Mobilising private capital on the scale needed to prepare emerging markets for their next phase of growth will not be easy, though.The money is there -- we estimate that the aggregate financial wealth of Asia ex-Japan alone comes to more than $50 trillion. But although Asian bond markets have developed rapidly since the 1997-98 financial crisis, they still lack the depth, liquidity and legal safeguards necessary to attract the sort of investment required to fund the region's infrastructure needs and serve as a more effective mechanism for converting Asia's savings into investment.
Policymakers, regulators and market participants are working together to develop regional bond markets, notably through the Asian bond market initiative, but it will not happen overnight. Initially we expect capital markets financing to gravitate towards less risky existing projects, allowing bank financing to be recycled into new greenfield developments. Multilateral institutions will have a key part to play.
Traditional institutions like the World Bank and the Asian Development Bank as well as newer entrants like the New Development Bank (otherwise known as the BRICS development bank) and the proposed Asian Infrastructure Investment Bank do not have sufficient resources to fill the infrastructure funding gap on their own. But they can leverage their credit-worthiness to guarantee infrastructure bonds issued by local entities to mobilise Asian capital for Asian growth.
The issuance of local currency infrastructure bonds with meaningful amount guaranteed by big multilateral agencies would achieve several goals simultaneously. It would raise the money needed to build roads, bridges and power stations; it would create deeper, more liquid bond markets that private enterprises could use to raise capital for investment in new growth opportunities created by improved infrastructure; it would eliminate the potential danger of currency and maturity mismatches; and, last but not least, it would provide a pool of secure long-term investments for Asia's ageing population.
The second key element to any infrastructure solution will be to tap into the skills and credibility of the private sector through public-private partnerships that offer reliable, legally enforceable long-term returns to private investors in exchange for creating the sort of public goods that give broader benefits to society as a whole.
Asia's economic linkages have grown faster than its physical linkages: it needs to improve connectivity through upgraded intra-regional roads, railways and ports that connect manufacturers with consumers. Regional banks, multi-lateral financing institutions and agencies like the Association of South East Asian Nations and the South Asian Association for Regional Cooperation can assist by promoting regulatory standardisation and designing financing structures that can be used across markets.
Asia's inadequate infrastructure could hobble its attempts to achieve strong, sustainable growth, but handled right it could also be the solution to a range of challenges. The sort of financial and legal architecture that will funnel resources towards building highways, power networks, and ports will go on to provide the capital to fund the new wave of growth that improved infrastructure will make possible.
The writer is the head of global banking and markets, Asia Pacific, at HSBC.