Addressing the global infrastructure deficit—Can we rely on institutional investors?
By Oshani Perera, December 21, 2015
The global infrastructure gap is forecast to reach USD 50 trillion by 2030.
In Canada, the Canadian Centre for Policy Alternatives reports that CAD 145 billion worth of infrastructure is required in order to return infrastructure funding to historic levels—amounting to an additional CAD 20 to 30 billion a year for 10 years on top of current spending.
You might ask: why have governments not capitalized on historically long periods of quantitative easing and low interest rates to invest in infrastructure? In 2012 project finance for infrastructure fell to an all-time low of USD 186 billion, although it rose to approximately USD 260 billion in 2013. Forecasts for 2014 do not look that much brighter.
Why does this matter? Public assets such as roads, railways and ports are essential to bring goods and skills to markets, while hospitals, schools and sports facilities are fundamental in ensuring that products and skills are sufficiently sophisticated to be marketable in the first place. There can be no widespread economic prosperity without good public infrastructure, and we cannot address income inequality or climate change in its absence.
One reason why governments have refrained in investing in infrastructure is that they simply cannot afford it. The demand and sophistication of infrastructure development is such that governments no longer have the expertise or the capital to design, build and manage large projects in a manner that brings value-for-money, not just at the point of commissioning, but across the asset life cycle.
Some suggest that institutional investors can be persuaded to investment in infrastructure and that public–private partnerships (often referred to as PPPs or P3s) will usher in a new era of private financing for public assets. The reality is, of course, that both these expectations remain somewhat of a fallacy. At the Financial Times European Infrastructure Summit in November 2015, we observed firsthand the absolute bewilderment of British pension funds on expectations related to their investment in public assets. Many policy-makers are still waking up to the reality that not all public projects can be feasibly executed as PPP arrangements. PPP markets today are in the doldrums, financing through PPP has continued to fall since 2011 and at the close of 2013, and capital deployed through PPP globally was a paltry USD 43 million.
The reality is that institutional investors will continue to be shy of partnering with governments to invest in infrastructure for many reasons.
There are but few public projects that are investment-grade. Institutional investors can typically be expected to invest in infrastructure after the construction phase is over and the legal, institutional, environmental, design, technology and construction risks are over—which is not to say that pension funds and insurance companies in Canada, the United States and Australia have no investments in project bonds in the pre-construction phases. But only a few projects ever get to this stage—indeed, bankable infrastructure projects are few and far between. Most governments have yet to develop annual infrastructure plans that sync with national budget: as a result, they have no project pipelines for investors to consider.
Returns from infrastructure investments are also not exciting. At the 2015 Annual Business Summit of the European Investment Bank, banks (including Credit Suisse, ING and Santander) reported that the internal rates of return on infrastructure investments in the EU and in emerging countries were only marginally over the cost of capital. This, coupled with the higher transaction and due diligence costs typically associated with infrastructure investment decisions, render these assets rather unattractive.
We also observe that many pension funds and investment trusts do not make investment decisions on their own. They are rather custodians of capital and are massively dependent on the asset managers, investment banks and similar intermediaries that make investment decisions for them. While they do accept both the rationale and the fiduciary responsibility to invest in public goods, they perceive infrastructure to be a high-risk asset, and their financial advisers have little incentive to change this perspective.
The most fundamental reason for the global infrastructure deficit is, however, the fact that governments badly lack the skills and incentives to structure and tender projects. They also lack the expertise to address political and regulatory risks, forecast future demand and related revenues, and design projects that share these risks with investors and project promoters in an optimal manner. For that is how governments can realize value-for-money in the longer term. If governments do not mitigate political and legal risks and work with the private sector to share risks related to demand and revenue, taxpayers will certainly be shortchanged.
Here at the International Institute for Sustainable Development, we will continue to address the many market failures that hold back investment in infrastructure, particularly green infrastructure—assets that are resilient to extreme weather conditions, incorporate low-carbon technologies that require fewer materials, water and energy to build, operate and maintain, and generate less waste and toxicity across their life cycle. Admittedly, this brings additional challenges, in that project preparation costs, design budgets and construction capital outlays will be higher. New technologies also require additional thinking on the allocation of technology and revenue risks, which further complicates deal-structuring arrangements.
In times like today, when capital is abundant, we call on public and development banks not to offer additional capital and complain about poor project pipelines, but instead, to offer credit enhancement instruments that are directly targeted at reducing the capital costs of green infrastructure.
Because we all know that the costs of not spending on green infrastructure are far too high.