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Thursday 17 Aug 2017 | 05:10 | SYDNEY
Thursday 17 Aug 2017 | 05:10 | SYDNEY

Infrastructure: Overcoming sovereign-debt phobia



28 November 2013 08:00

Infrastructure is high on the agenda for G20, yet most aspects of infrastructure are essentially domestic policy matters, with little need — or room — for international cooperation. So what exactly might the G20 do? 

There is a disconnect between the many viable infrastructure projects in emerging economies and the many investors in advanced economies facing low yields at home. Public-private partnerships (PPPs) are held out as the answer to this disconnect, but the promise is oversold. The G20 could, instead, help connect investors with projects by bringing together the official multilateral development banks and the private credit rating agencies to produce better assessments of infrastructure debt.

Whenever infrastructure is discussed, PPPs always feature prominently, holding out the hope of a rich funding source. Foreign Minister Julie Bishop made this argument in setting out the agenda for Australia's chairing of the G20. Emerging economies also see PPPs as the answer to shortages of official funds and government inefficiencies. For example, Indonesia looks to PPPs for well over half of its planned spending, despite the minuscule share provided by the private sector at present. 

The history of PPPs demonstrates why this reliance is unrealistic. In the initial PPP model, the private sector in theory took the risk. The idea was that this would make them vigilant gatekeepers to filter good projects from bad, with the profit motive ensuring accurate project appraisal, proficient execution and efficient operation. PPPs promised to protect the taxpayer from repeating the many past examples of extravagant white elephant projects run by governments.

The practice has turned out rather differently.

The private sector has often been skillful in shifting risk back to the government. In Australia and elsewhere this initial PPP model saw successful construction of important infrastructure, but with high funding costs and fat management fees. With the high level of uncertainty in emerging-economy infrastructure, a funding model where the private sector takes on the full risk will have limited application.

The PPP model is evolving. When bureaucrats eventually learned how to counter risk-shifting, the private sector became unenthusiastic about taking on risky infrastructure. The current Australian PPP model envisages that the government will do the risky part — project appraisal, construction and providing a take-or-pay contract — with the private sector taking on some low-risk funding after the project is operational.

To give the private sector this funding role is puzzling at first sight. Governments can raise funds far more cheaply than the private sector. If the government takes the project-assessment risk and can achieve operational efficiency through contracting-out to the private sector, why shouldn't the government simply fund the infrastructure by issuing its own bonds?

The answer is that governments are often constrained in the amount of debt they issue. Budget history demonstrates why governments feel constrained: short-term populism can promote overspending, yet the democratic process makes it hard to unwind such excesses or raise taxes. Further discipline comes from the credit rating agencies; concerned about a ratings downgrade, governments refrain from borrowing as this would reflect badly on their competence and popularity.

The result is that infrastructure has fallen victim to sovereign-debt phobia. In advanced countries viable infrastructure projects are either left unimplemented or funded with more expensive private borrowing. In emerging economies the result is a debilitating lack of vital infrastructure.

The first step in addressing this problem is to separate spending on physical infrastructure from routine budget expenditure (social welfare, public sector salaries and so on). A separate balance sheet, perhaps in the form of a development bank, can be judged in the same way that a commercial balance sheet is judged, weighing assets against liabilities, earnings against funding costs and risk versus return. 

The second step is to get the credit rating agencies – the gatekeepers for funding – to make competent assessments of these infrastructure balance sheets. Their rating performance to date has been woeful. In the run-up to the 2008 crisis, the CRAs gave entirely fictitious AAA ratings to mortgage-backed securities. They have done little better with sovereign ratings, being pathetically slow to identify the debt problems in the European peripheral countries before 2010. Having been too lenient before the crisis, they are now too tough on emerging economies.

The G20 has the heft to encourage the CRAs to think differently. Instead of conservative rules-of-thumb driven by concerns about repeating pre-2008 mistakes, they could develop the specialised capacity needed to evaluate complex infrastructure projects. They will also need to judge the intricate intersection between budgets and these infrastructure balance sheets.

They won’t have capacity to do this by themselves. They need the active involvement of the IMF, World Bank and other multilateral development banks (eg. the Asian Development Bank), all of which have expertise to offer. Bringing together this expertise would establish a public dialogue which will inform investors, giving them confidence to make the right investment decisions.

This won’t happen without a kick-along from G20. None of these institutions is currently thinking beyond its traditional role. But the benefits from restructuring infrastructure funding would be considerable. No one disputes the need for substantially increased infrastructure spending. In the process, the increased investment will boost a global economy in sore need of additional expenditure.

(Ed. note: An incomplete version of this post was published yesterday and later taken down when the error, which occurred in the editing process, was discovered.)

Photo by Flickr user Goop on the lens.

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