By Kensuke Tanaka, Head of Asia Desk, and Prasiwi Ibrahim, Economist at Asia Desk, OECD Development Centre
Agreeing on the need for new infrastructure is one thing; finding a sustainable way to finance it is another. According to the ADB, an estimated USD 26 trillion (or USD 1.7 trillion per year) will need to be invested in infrastructure in its developing member countries1 between 2016 and 2030 if these economies are to maintain their growth momentum, eradicate poverty and respond to climate change2 .Given the scale of investment needed, countries in the region will not have sufficient funds to meet demand. Indeed, financing infrastructure investment has been a considerable challenge for the region. Political factors can further complicate financing when they lead to the inefficient allocation of public funds. How best to finance infrastructure is, therefore, a key concern for policy makers in the region.
Infrastructure investment entails different types of risks to investors. Risks typically associated with transport projects are cost overruns during construction, delayed completion, general market risks (e.g. interest rate and inflation shocks) and political risk, such as the possibility of a future change in policy direction. These risks arise from the nature of investment inherent in large infrastructure projects that have long periods of gestation (often 10-20 years). To address the risks involved in infrastructure investment, policy makers in OECD countries, for example, are increasingly looking towards public-private partnerships (PPPs). PPPs introduce competition and innovation (financial, technological and managerial) into infrastructure markets and help the parties involved to handle the risks in more efficient ways (OECD 2010). In the Emerging Asia region (Southeast Asia, China and India), increasing private-sector involvement in infrastructure investment in PPPs has been a common approach. In some countries, such as the Philippines and India, centres or units have been established to support and facilitate PPP projects. However, ensuring successful implementation of PPPs is not an easy task. This requires, for instance, appropriate legal and institutional frameworks, proper risks allocation in contracts, and appropriate incentives for the private sector to participate.
Further diversifying financing methods to accelerate infrastructure investment is therefore crucial. Financing approaches through PPPs and private investment may be complemented by the use of public finance, including tax revenues, government debt financing and fiscal loan mechanisms, and the increased use of public incentives for investors. In OECD member countries, a wide range of fiscal instruments have been used to finance infrastructure development, including tax revenues, user charges and public sector borrowing. These options could be further explored in Emerging Asian countries.
Tax revenues, in general, offer a stable source of funding for infrastructure investment. Tax mobilisation in the region, however, still has significant room to improve. In 2014, tax to GDP ratios in Indonesia, Malaysia, the Philippines and Singapore were 12.2%, 15.9%, 16.7% and 13.9% respectively, significantly lower than the OECD average of 34.2%3 , according to the OECD’s Revenue Statistics in Asian Countries 2016. Tax revenue – either generally or from specific infrastructure-related taxes – can be used to fund infrastructure. Earmarked taxes and energy-related taxes are some of the instruments that are commonly used in OECD economies. Countries like Switzerland and
the UK, for instance, apply carbon taxes and petroleum taxes. Switzerland earmarks its revenue from gasoline, petroleum and road transport-related taxes for financing its transport infrastructure.
In addition to tax revenue, public sector borrowing through bond issuance at the national and sub-national levels of government is another potential financing option. Forms of borrowing range from general government bonds to infrastructure revenue bonds, which are more likely to be project-specific. Infrastructure revenue bonds offer an attractive means to solicit private sector involvement in infrastructure investment. Revenue bonds have been commonly used to finance infrastructure in some OECD countries, for instance in the United States and Canada. At the sub-national level in the United States, municipal bonds are largely used to fund infrastructure projects, including schools, hospitals and transport infrastructure. Although some countries in Emerging Asia such as the Philippines and India already have started using municipal bonds, the potential to further explore the use of this tool in the region is still large.
The initial injection of public funds through viability gap funds4 also is critical for making large infrastructure projects financially viable. The combination of infrastructure revenue bonds and viability gap funds constitutes a promising platform for partnerships and is particularly well suited for the construction and maintenance of infrastructure facilities in emerging economies.
In sum, to finance the various types of infrastructure that Emerging Asia’s development demands, options beyond PPPs need to be considered.
ADB (2017), Meeting Asia’s Infrastructure needs, Asian Development Bank, Mandaluyong City, Philippines.
OECD (2016), Revenue Statistics in Asian Countries 2016: Trends in Indonesia, Japan, Korea, Malaysia, the Philippines and Singapore, OECD Publishing, Paris, http://dx.doi.org/10.1787/9789264266483-en.
OECD (2010), Southeast Asian Economic Outlook 2010, OECD Publishing. http://dx.doi.org/10.1787/9789264096004-en
1.↩ The estimates cover all 45 ADB Developing Member Countries (DMCs).
2.↩ Without climate change mitigation and adaptation costs, USD 22.6 trillion (or USD 1.5 trillion per year) will be needed (as a baseline estimate). ADB (2017), Meeting Asia’s Infrastructure needs, Asian Development Bank, Mandaluyong City, Philippines.
3.↩ The taxation capacity of each economy needs to be taken into account when determining whether the collected taxes are too little or not. The OECD average is cited simply for reference.
4.↩ Government fund to finance the gap between the expected project revenues and the revenues needed to make the project financially viable for investors.