At the World Economic Forum in Davos this week, global leaders will discuss how best to harness the power of transformational advances in business, society, and technology to maximize economic growth. One of the most fundamental questions that must be addressed this year is how to effectively finance the physical infrastructure necessary to support that growth.
Demand is already high. Emerging markets need new transportation, telecommunications, and energy networks to serve constantly ballooning populations and industries. At the same time, developed countries are struggling to keep up with the rising tide of inefficient and unsafe conditions created by outdated equipment, crumbling roads, bridges, and tunnels.
All told, an estimated $57 trillion will be needed to fund global infrastructure development through the year 2030, according to McKinsey & Co.
But there’s a problem. For the last few years, governments around the world have been tightening their purse strings due to budgetary concerns and financial uncertainty. As a result, the public funds traditionally relied upon for infrastructure investments are in steady decline, creating a significant financing gap. In fact, Standard & Poor’s Ratings Services research estimates that the annual gap between investment needs and available public funds will be at least $500 billion over each of the next 15 years, assuming governments continue to provide funding at current levels.
Fortunately, a potential solution has already begun taking shape in certain markets around the world.
In the absence of public financing, the funding gap can, and should, be bridged by the private sector, as institutional investors are naturally suited to step in and play a considerably larger role in infrastructure development.
For investors, these kinds of investments often present opportunities for stable, predictable, and comparatively higher yields over the long-term, as well as lower default rates than those of similarly rated corporate debt. As an added bonus, the nature of infrastructure financing provides the chance to diversify into a broader investment pool, one with low correlation to other asset classes.
In the U.K., for example, six large insurers have pledged to invest $40.9 billion in the British government’s National Infrastructure Plan, a program that plans to pump hundreds of billions into national energy, transportation, water, and waste projects over the next five years.
S&P research has found that under the right conditions, institutional investors could fill the funding gap if they increased their infrastructure allocations to a weighted average of four percent, which would provide approximately $200 billion per year in additional funds for the sector.
But there are still plenty of obstacles that must be overcome in order to fully realize the potential for private investment in public infrastructure projects. Target markets are often fraught with political uncertainty, comparatively low credit quality of sovereign borrowers and issuers in the region, and unpredictable regulation.
These obstacles are significant and help explain why institutional investors allot less than an average of two percent of their portfolios to infrastructure projects, despite their relatively high appeal.
Given these conditions, governments and policymakers must create appropriate incentive structures for investing in infrastructure. Enticing investors requires implementing initiatives that minimize risk and maximize stability and transparency, such as creating clear project pipelines and standardized transaction structures and disclosure standards.
In the end, the sustainability of global growth will be determined by the world’s ability to build and maintain the infrastructure necessary to support itself. The task isn’t easy, but through creative collaboration between the public and private sectors, the global community has the potential to bridge the infrastructure funding gap and support real economic growth for years to come.
Douglas L. Peterson is President and CEO of McGraw Hill Financial Inc.