12 November 2020

Can we mobilise private capital to help establish infrastructure as an asset class?

12 November 2020

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.

These insights come at a time when mobilising private capital is more critical than ever, as the capacity of the public sector - traditionally the primary source of infrastructure investment- has been out into question by unprecedented fiscal spending in response to the COVID-19 pandemic. The latest IMF October Fiscal Monitor estimates that global public debt will approach 100% of GDP in 2020, a record high.

World Economic Outlook October 2020 notes that “there remains tremendous uncertainly around the future with downside and upside risks”. Policy interventions will play an unprecedented crucial role in amplifying the impact of limited global finance to its maximum potential. With this introductory blog, the GI Hub is launching a blog series to discuss policy implications of the identified data-driven insights, which might help pave way for a brighter future. 

What were the key trends in private infrastructure investment over the past decade?

Private infrastructure investment in primary market transactions (USD bn)

One of the key findings of Infrastructure Monitor (“Monitor”) is that worldwide, private infrastructure investment in primary markets is low and has been slowly declining over the past decade. Primary market transactions (i.e. new security offerings in either greenfield or brownfield infrastructure projects) normally represent an incremental investment in infrastructure and are a more important metric for private capital mobilisation. In 2019, it came in at US$106 billion (0.13% of total global GDP), down from US$156 billion (0.25% of global GDP) in 2010. In comparison, the GI Hub’s Global Infrastructure Outlook estimated in 2017 that the world was facing a US$15 trillion investment gap in providing adequate global infrastructure by 2040.

Another noteworthy trend is the simultaneous increase in secondary market transactions (i.e. the trading of existing infrastructure assets), which comprised 75% of private infrastructure investment in 2019, up from 34% 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 private sector, or lower borrowing costs for the public sector. 

Analysis by income groups reveal that 67% of private infrastructure investment was in high-income countries over the past decade, calling for renewed emphasis on the ‘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.

Monitor also sheds light on the sectoral composition of private infrastructure investment, revealing that transport and power (both renewables and non-renewables) 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% 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. 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.

Can infrastructure investment provide desirable risk-adjusted returns to private investors?

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, and transport and 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 best understand how public resources could mitigate higher risk during the initial period (i.e. the construction phase) to enable greater private investment in infrastructure projects and enhance overall performance. The forthcoming blogs in this series will be examining what might need to happen to successfully tackle this challenge and others like it.