Optimizing scarce public finance can unlock sustainable private sector participation in infrastructure. © Shutterstock
In a world that has become more and more divisive, there is one thing most people can agree on: the past several years have been some of the most difficult in recent memory. In addition to the huge toll on human life, the COVID-19 pandemic—plus Russia’s invasion of Ukraine—has impacted economic growth, supply chains, borrowing costs, and inflation. All of this has left governments in emerging economies scrambling for funding and solutions to provide the infrastructure services needed for the millions of households left behind.
We at the World Bank wanted to gather market intelligence from financiers to understand how the infrastructure financing landscape is responding to global events, specifically on the availability and affordability of finance for emerging markets and developing economies. In collaboration with PricewaterhouseCoopers, the World Bank conducted a survey to gather perspectives on these dynamics from international and domestic commercial lenders, export credit agencies, insurers and reinsurers, international and domestic equity sponsors, and development finance institutions.
Four major conclusions from the study are:
1. COVID-19 did not have a lasting impact on the risk appetite of most international financiers surveyed. However, the war on Ukraine and the higher interest rate environment impacted risk appetite. The pandemic depleted fiscal space, forcing emerging economies to push already record-high debt levels past their limits, reducing their ability to cope with future shocks, and making it harder for them to catch up with high-income countries. While COVID’s impacts on the risk appetite of international financiers are starting to fade, survey participants cited country risk as their primary concern, listing political instability, inflation, high interest rates that make borrowing more expensive, and lack of foreign exchange availability to repatriate earnings as barriers to investment.
2. The next point is related to the Basel Accords, a set of agreements on international banking regulations - specifically relating to capital, market, and operational risk to ensure that commercial banks have enough capital to absorb unexpected losses. The last set of guidelines, referred to as Basel IV, introduced new regulations which set conservative capital reserve requirements for financing infrastructure projects, especially in emerging markets and developing economies, which means that the interest rate that commercial banks have to charge on infrastructure projects will increase. What is clear is that Basel IV will make it more challenging and expensive for emerging markets to attract project financing from international banks.
3. Financing for low-carbon transitions in emerging markets is at risk of being displaced by investments in developed economies. As Europe and the United States accelerate their low-carbon transition efforts, survey participants mentioned that emerging markets cannot compete with the large-scale subsidy schemes put in place by developed economies. For instance, the U.S. Inflation Reduction Act targets $369 billion investment in energy security and climate change, while the European Green Deal targets €600 billion in investments. These programs have made it very attractive for investors to finance projects in developed economies. Do these policies divert funds away from emerging markets? This remains to be seen, but in a world of limited funding, the role of MDBs and philanthropies in emerging markets is more important than ever.
4. Project investment costs have increased substantially, raising affordability concerns. Combination of all of the above means that the all-in cost of an investment is now higher, making it less affordable, in particular for low-income populations. For example, we calculated that increased inflation, higher commodity prices and higher borrowing costs have led to total project cost increases of about 45% for an average solar project, which is much higher when calculated in local currency.
Access to affordable private debt and equity is a must for emerging markets to transform their economies and provide basic services for households. The survey results reinforce the theory that it is becoming increasingly difficult for emerging markets and developing economies to access long-term financing and procure projects on affordable terms.
Our experience at the World Bank Group has shown that this is a multi-faceted problem which requires a combination of complementary interventions:
- The key to our approach is not to de-risk a specific transaction, but to help governments a.) create macroeconomic and sector environments that enable private capital mobilization, and b.) create a steady pipeline of high economic value projects that the private sector can invest in. With a flood of projects seeking financing in developed markets, it is now more important than ever for these countries to communicate a clear intention for partnering with the private sector and undertake necessary measures to develop a robust pipeline of projects to attract international finance at scale.
- In combination with these steps, our guarantees can be a catalyst in attracting private capital to emerging markets by mitigating residual risks. This is why the World Bank Group recently announced a new guarantee platform that will streamline offerings and innovate with new product offerings so we can deliver efficiency and simplicity to boost impact. These can be combined with concessional funds, in the form of viability gap funding, to improve project affordability.
- There is a need for innovative solutions to foster the development of local currency financing ecosystems and affordable exchange rate risk mitigation to deepen and broaden sustainable sources of capital. Similarly, countries need to continue developing ESG and green financing frameworks so as not to be locked out of these growing financing markets.
- In parallel, greater regulatory capital relief should be sought for project finance loans benefiting from MDB guarantees by engaging with the Basel Committee and the national and regional regulators. When offering guarantees and loans, MDBs such as the World Bank Group work closely with governments in project selectivity, due diligence, and supervision. Automatic granting of lower capital reserve requirements can be justified for project finance loans benefiting from MDB involvement on the basis of improved financial strength and ESG components of these projects.
Given the increasingly challenging layers of global dynamics over the past three years, a concerted effort on all these fronts offers a pathway toward a more hopeful future. There is no silver bullet, and all stakeholders must do their part. We stand ready to leverage the collective expertise and the resources of all our institutions to meet these formidable challenges head-on.
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