Photo: BAY ISMOYO/AFP/Getty Images
The global fiscal response to the Covid-19-caused recession is rightly focused in the short term on strengthening public health systems and social safety nets. However, now is the time for Asian emerging markets, which are suffering more from the global economic downturn than the direct health effects of the virus itself, to also start planning for sustained fiscal measures to support growth and job creation during what is likely to be a long and painful recovery.
The International Monetary Fund (IMF) has recently warned that in past crises, “Discretionary fiscal support during previous downturns often came too late and was not well targeted” and called on policymakers to act swiftly to establish a pipeline of appraised investment projects that can be implemented quickly as the health crisis abates. Special Covid-19-related assistance of $20 billion from the Asian Development Bank (ADB) and $160 billion from the World Bank over the next 15 months should include funding efforts to help borrowing countries prepare bankable infrastructure projects, which will be key to economic recovery over the next five years.
Maintaining robust infrastructure investment is needed to put workers back to work, offset the collapse of domestic and export demand, and attract investment by global companies seeking to reorient supply chains due to the U.S.-China trade conflict. China would not have become a global supply chain hub without massive infrastructure investments, particularly in ports, airports and roads, which allowed components and finished products to move efficiently in and out of the country.
While the main drivers of Asian infrastructure investment—urbanization, demands of a growing middle class, and the desire to link more closely with foreign markets—have not changed, Covid-19 will likely accelerate infrastructure building to support digitalization and enhance renewable energy, which has increased its share of power generation since the pandemic began.
The Trump administration has made infrastructure investment in emerging Asia a pillar of its Free and Open Indo-Pacific (FOIP) strategy to counter Chinese influence and encourage diversification of supply chains away from China. The Covid-19 recession makes that effort both more important and more complicated, particularly as Asian emerging markets incur more debt to prop up safety nets, suffer falling tax revenues, and face competing investment priorities, especially investment to strengthen health systems.
The FOIP strategy will need to address the debt issue and shrinking fiscal space for emerging markets to remain relevant. It is true that despite a run-up of debt since 2010 due to cheap capital, debt levels in emerging Asia as a percentage of GDP are still modest—mostly under 50 percent—allowing room for some growth in debt. Swiss Re’s analysis concludes that emerging Asia can comfortably continue to run primary deficits through 2022. However, debt levels will still be a constraint on robust infrastructure investment, especially since Asian emerging markets were not covered by the G20 debt moratorium announced in April.
There are three ways the United States could bolster FOIP by helping open more fiscal space for emerging markets in Asia to invest in infrastructure during the Covid-19 crisis.
First, Washington should support domestic policies in Asia that increase government revenue. Some Asian emerging countries have made important progress in pulling up tax revenues; the Philippines, for example, has increased its share of tax revenue from around 10 percent of GDP to 14 percent in the last few years. In contrast, Indonesia only raises tax revenue of about 10 percent of GDP. The United States should push the World Bank and ADB to step up their support of tax reforms to increase tax collections through technical assistance and policy loans.
Second, Washington should encourage borrowing countries to renegotiate the terms of their loans from China—or even repudiate them. Typically, the Paris Club, a group of official creditors, requires a borrower to restructure its debt with non-Paris Club creditors (such as China) on no more generous terms than those decided at the Paris Club. However, the G7 economies should go beyond that requirement and encourage borrowers who have a credible case that Chinese lending ignored debt sustainability guidelines to seek restructuring or forgiveness of those loans, even in the absence of an immediate liquidity problem.
The G7 will need to give borrowing countries leverage to use in their negotiations with China. First, Paris Club members should make it clear to borrowers that China, if it lends in a financially irresponsible manner, should not receive the protections that global creditors receive, such as cross-default clauses, IMF policy support, and legal enforcement in cases of default. Second, they should make it clear that national territory of the borrower is not acceptable as collateral in a sovereign loan. In fact, in practice, it is very difficult for China to enforce such provisions, short of military invasion of the borrower. The IMF should discourage the use of such provisions in sovereign borrowing. Last, if China threatens to cut off new financing for countries seeking to renegotiate, G7 countries should be ready to offer alternatives to Chinese financing.
This leads to the third point. G7 countries should support project preparation activities and offer infrastructure financing packages to emerging market countries, either as sovereign loans if debt sustainability permits or as private sector financing. While the multilateral development banks (MDBs) and Japan can mobilize large amounts of official financing, the key alternative to Chinese financing of infrastructure is Western institutional investors, i.e., life insurers and pension funds.
The win-win benefits of this source of long-term financing are well-known. Institutional investors need long-term assets that have low risk and consistent cash flows over a long period of time to cover their long-term liabilities; in contrast, banks lend on shorter terms to minimize maturity mismatch with their short-term liabilities such as deposits. Borrowers would benefit from more and cheaper capital and more certainty. The United States, Japan, and Europe are home to two-thirds of all institutional assets under management in the world. Shifting just 5 percent of institutional investor assets to infrastructure globally would easily fill the so-called “global infrastructure funding gap.”
Unfortunately, institutional investors still account for only 0.67 percent of developing country infrastructure investment, according to World Bank data. The reasons for this failure are well-known. Infrastructure projects are large, lumpy, complicated, highly political, and open to corruption, and so incur high political, regulatory, and commercial risk. On the other hand, many investors exaggerate that risk: a 2018 Moody’s study found that emerging market infrastructure debt is significantly less likely to suffer credit losses than non-financial corporate debt over a 10-year horizon.
The relative lack of emerging market infrastructure financing by institutional investors is both a market failure and a golden opportunity for the United States and other Western countries, which are home to most of the institutional investors in the world and champions of the rule of law and regulatory transparency. China has neither of these competitive advantages.
The ADB and World Bank should establish a task force made up Bank staff, emerging market government officials responsible for infrastructure financing, chief investment officers of life insurers and pension funds, and executives from banks, asset managers, and dedicated infrastructure funds, to explore practical ways to encourage more institutional investment in emerging market infrastructure. The group could look at practical ways to expand private co-financing of MDB infrastructure projects; public support, including guarantees and subsidies, to seed participation of institutional investors; and integration of short-term bank finance and long-term institutional investor finance in one financing package.
As emerging Asia seeks to avoid excessive dependence on China and expand alternative financing sources for infrastructure projects while institutional investors seek return in a low interest rate environment, this is a rare opportunity for the United States and other Western governments to take concrete steps to significantly expand private investment in emerging market infrastructure.
Larry Greenwood is a senior associate (non-resident) with the Economics Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C.
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