At a time when mobilising private capital is more critical than ever, the capacity of the public sector – traditionally the primary source of infrastructure investment – has been put into question by unparalleled fiscal spending in response to the COVID-19 pandemic.
Private investments in middle and low-income countries have provided less attractive risk-adjusted returns
The latest International Monetary Fund October Fiscal Monitor estimates that global public debt will approach 100 percent of GDP in 2020, a record high, while the World Economic Outlook October 2020 states that “there remains tremendous uncertainty around the future with downside and upside risks.” Policy interventions will play a crucial role in amplifying the impact of limited global finance to its maximum potential.
The Global Infrastructure Hub (GI Hub) recently launched Infrastructure Monitor, an analytical report and website that provides data-driven insights into selected G20 infrastructure priorities. The inaugural 2020 annual report focuses on mobilising private capital and establishing infrastructure as an asset class, by highlighting 10-year trends in private infrastructure investment levels and financial performance. The findings have significant implications for investors and regulators and are a building block on the road to infrastructure as an asset class.
Trends over the past decade
One of the key findings of Infrastructure Monitor is that worldwide, private infrastructure investment in primary markets is low and has been slowly declining over the past decade. Primary market transactions (new security offerings in either greenfield or brownfield infrastructure projects, for example) normally represent an incremental investment in infrastructure and are a more important metric for private capital mobilisation. In 2019, it came in at $106bn (0.13 percent of total global GDP), down from $156bn (0.25 percent of global GDP) in 2010. Private investment of $100bn per year is a drop in the ocean compared to the estimated $15trn global infrastructure financing gap. While mobilising private capital is key, Infrastructure Monitor shows a lack of private sector appetite for new infrastructure investment.
Another noteworthy trend is the simultaneous increase in secondary market transactions (the trading of existing infrastructure assets, for example), which comprised 75 percent of private infrastructure investment in 2019, up from 34 percent in 2010. Possible explanations for the declining level of primary market private infrastructure investment could include: a limited pipeline of bankable deal flow available to the private sector as PPPs or privatisations, regulatory impediments, higher perceived risk by the private sector, or lower borrowing costs for the public sector.
Analysis by income groups reveals that 67 percent of private infrastructure investment was in high-income countries over the past decade, calling for renewed emphasis on the United Nations Financing for Development action agenda. Private investments in middle and low-income countries have provided less attractive risk-adjusted returns. In particular, foreign exchange risk is fundamentally higher as the deals are almost entirely denominated in foreign currencies. With capital markets development in the Asia-Pacific and Latin American regions, the local currency component of deals has appreciably increased.
The study also sheds light on the sectoral composition of private infrastructure investment, revealing that transport and power (both renewable and non-renewable) have been the top preferences for investors over the past decade. Despite growing interest in cleaner energy sources, for middle and low-income countries, private investment in more carbon-intensive and less sustainable energy has remained greater than renewables. With emerging and developing countries expected to account for 90 percent of global power demand growth over the next decade, there is a huge opportunity for private investors to tap into this market and for renewables to play a more prominent role.
Meanwhile, we have also seen a notable decline in private investment in social infrastructure, such as schools, hospitals and public housing. Private investment in social infrastructure declined the most from $19bn in 2010 to $3bn in 2019. This is despite Moody’s data showing that social infrastructure typically experiences lower default rates than other infrastructure sectors, in both developed and developing countries.
Desirable risk-adjusted returns
Over the past decade, about three-quarters of private infrastructure investment globally was debt financed, and about a quarter was equity financed. In private investments, equity financing is typically higher than debt financing to compensate for higher intrinsic risk. On a relative basis, equity financing was higher in lower-middle and low-income country groups, the regions of Asia-Pacific and Sub-Saharan Africa, not to mention the transport, water and waste infrastructure sectors. Compared to other investment options, infrastructure equities have been less volatile and provide attractive risk-adjusted returns. Infrastructure debt is higher risk during the construction period, after which the yields are very predictable and stable. There is limited recognition of this distinct performance of infrastructure as an asset class compared to other assets having similar risk levels regardless of time duration.
A public policy challenge is to better understand how public resources can mitigate higher risk during the initial period (the construction phase, as an example) to enable greater private investment in infrastructure projects and enhance overall performance.
Now is the time for the industry to explore other options, with true partnership between the public and private sectors, to help close the infrastructure gap. This has become critical as governments around the world face fiscal challenges as a result of the COVID-19 pandemic. A global discussion on the policy implications of the data-driven insights identified in Infrastructure Monitor could help pave the way for a more resilient, sustainable and inclusive future.