Infrastructure deficit is now high on the agenda for many emerging economies but how to finance it often gets left behind in the manifestos of elected governments. All too often, the financing burden falls on fiscal apparatus and ultimately, taxpayers.
Private sector participation in infrastructure projects in Asia is now more crucial than ever. The Asian Development Bank estimates private sector financing will have to increase from $68 billion to $250 billion every year from 2016 to 2020 to fill the financing gap in developing Asian countries (ex-China).
While much has been done on the multilateral and bilateral fronts, too often the financing is in US dollars. As the 1997-98 Asian financial crisis demonstrated, earning local currencies to service foreign currency-denominated debts is untenable for Asian companies and economies. Tapping foreign capital, which is typically provided on the foreigner’s terms, is not a sustainable solution either.
Thankfully, most Asian countries are prolific savers. But when intermediated by banks, the savings prove inefficient or inappropriate for financing long-term infrastructure projects via short-term floating-rate loans. Additionally, banks have to take punitive capital charges for long-term loans and put prudential limits on single borrowers and sectors. The case for boosting long-term local currency savings to finance infrastructure directly via local bond markets therefore becomes clear.
This call to create larger pools of domestic long-term savings to finance infrastructure – via pension/provident or life insurance funds – is getting louder. In its recent progress report to Asia Pacific Economic Co-operation (Apec) ministers, the Asia Pacific Financial Forum refers to this solution as a potential “triple win” – boosting returns for consumers’ long-term savings, pushing domestic capital markets ahead and relieving governments’ fiscal burden.
ADB’s “Local Currency Bonds and Infrastructure Financing in ASEAN+3” report highlights the shortage of institutional investors’ assets among pension funds, asset managers and insurers. Besides Japan, Korea, Malaysia and Singapore, where these amount to more than 100% of GDP, other countries in need of massive infrastructure build-up, including Indonesia and the Philippines, are considerably short of long-term savings.
There are three possible steps to mobilise domestic savings.
First, mandatory long-term saving plans like Malaysia’s Employees Provident Fund need to proliferate throughout the region. For emerging economies entering the “demographic dividend” stage like Indonesia, it makes sense to make the young invest in infrastructure projects for their old age, rather than paying for infrastructure via taxes today. Thailand is now setting up a mandatory provident fund, for example – clearly recognising that saving for an aging population needs to start when it is still young.
Second, regulatory reform is needed in the life insurance sector. Some countries, again like Indonesia and the Philippines, need to promote traditional life insurance products rather than investment-linked insurance products to provide insurers with discretion to invest in more complex long-term project finance bonds.
The last possible step may be the easiest – introduce strong tax and non-tax incentives to invest in long-term project bonds. Funnelling rolled-over short-term fixed deposits in the domestic banking sector to into long-term project bonds, either directly or via mutual funds, can help immediately mobilise existing domestic savings to finance infrastructure.
Long-term savings are like “grandma’s money” – conservative and expected to provide a comforting, stable return in the long run. But as long-term savings get mobilised, the call for “good projects” needs to extend to include “good project bonds”. For this, adequate bond structuring skills, robust national ratings frameworks and innovative credit enhancement products will be needed.
Well-run sovereign-backed guarantors can play a role in building confidence, absorbing project risks not yet well-understood by the guardians of local long-term savings. There is now sufficient expertise and track record for such institutions in the region – Malaysia’s Danajamin being a prime example. Multilateral guarantors like Credit Guarantee and Investment Facility and the global reinsurers behind them can further supplement the capacities of these multinational institutions – taking the model of separating funding and risk participation to new heights.
It may be hard to imagine grandma’s money financing infrastructure. But with the right interventions and supplements, it may be the solution we need today. After all, we will all get to her age and a pot of savings then would indeed be nice.
Boo Hock Khoo is vice-president, operations of Credit Guarantee and Investment Facility and formerly deputy chief executive of Danajamin.
