Q&A: Innovative Financing Can Help Bridge Southeast Asia’s Infrastructure Financing Gap – EQ Mag

Southeast Asia faces a burgeoning infrastructure financing gap in urgent need of attention to ensure sustainable economic expansion. A new Asian Development Bank (ADB) report provides member countries of the ASEAN+3 — comprising of the Association of Southeast Asian Nations (ASEAN) plus the People’s Republic of China, Japan, and Republic of Korea — a roadmap towards tapping vast funding sources through innovative financing mechanisms to support the development of critical infrastructure projects across the subregion.

Reinvigorating Financing Approaches for Sustainable and Resilient Infrastructure in ASEAN+3 urges ASEAN+3 governments to take steps in easing project financing risks and expanding the investment funding pool by actively engaging with institutional investors and the private sector in tapping an estimated $200 trillion of private capital invested in global capital markets.

The report’s lead author, Southeast Asia Department Principal Economist James Villafuerte, says it is crucial for ASEAN member countries to be aware and to adopt innovative financing instruments and collaborate with the private, public, and institutional investors to enhance the attractiveness of the region as a destination for infrastructure investment.

Why is there an urgency for Southeast Asia to expand infrastructure investment?

Infrastructure underpins all vital aspects of economic activity. It is the key to national prosperity in a competitive global environment. So it follows that underinvestment in infrastructure could slow down economic growth and development and contribute to higher levels of economic deficit or retardation.

The reality is that Southeast Asia’s rapid economic development, urbanization, and population growth have led to an ever-widening gap between the actual spending and the funds needed to meet the increasing demand for infrastructure in the subregion. In addition, the current inflationary conditions, the COVID-19 pandemic, weather-related disasters, and adverse impacts of climate change have also intensified demand for and the cost of developing sustainable infrastructure. We need to close this infrastructure gap to meet commitments toward Sustainable Development Goals (SDGs), improve competitiveness, and address environmental challenges.

How costly is this infrastructure gap in Southeast Asia?

ADB estimated ASEAN’s total infrastructure investment need at $2.8 trillion (baseline estimate) and $3.1 trillion (climate adjusted estimate), placing the annual investment need at $184 billion and $210 billion, respectively. These estimates do not include the additional expenditure related to natural disasters and extreme weather events that have become more frequent.

As climate-induced extreme events intensify and populations and ageing infrastructure become more compromised and vulnerable, there is increased urgency to put in place adaptation and mitigation measures to make communities more resilient. Disaster risk reduction norms and standards also have to be mainstreamed in the design and planning of all infrastructure works. SDGs also need to be integrated into the development architecture to ensure that investments in sustainable infrastructure become a pre-requisite to any developmental activity. Adequate financial and implementation support can then achieve a “triple win” by building infrastructure that reduces emissions and climate risk, stimulates economic development, and increases returns for investors.

Can Southeast Asian governments afford to cover the cost of meeting the region’s infrastructure spending requirements?

Southeast Asia’s public sector has traditionally been responsible for virtually all public and social infrastructure development in the subregion, up to 92%, but it has been unable to bridge the widening deficit between funding needs and actual capital spending. Tight public finances on account of increased energy costs and reallocation of funds to social protection and food security programs due to the COVID-19 pandemic and geopolitical risks have further limited government spending on infrastructure development.

Infrastructure financing requirements are extremely large and limited public funds stand in the way of sustained large-scale investments. There is a need to set a new standard in sourcing and mobilizing capital resources. While foreign direct investments (FDIs) have returned to pre-pandemic levels, ASEAN member countries have not been able to effectively tap them as the subregion receives only 11% of total global FDI inflows.

Another impediment is the perception that infrastructure funding is a public responsibility, and this has kept private investors at bay as few participation opportunities are made available to them. In addition, political instability, weak governance, inadequate regulatory capacity, and the absence of a solid pipeline of viable investment-ready projects also contribute to underinvestment in infrastructure. These projects often involve high up-front capital cost, long gestation periods, risk of uncertain return, and a social benefit that may not meet the financial risk–return appetite of private investors. These obstacles and perceptions have prevented the mobilization of vital funds resulting in stalled investment decisions.

So how do we address these constraints? Do we have measures that can fill the infrastructure financing gap now facing Southeast Asia?

There are wide-ranging constraints limiting infrastructure development but closing the infrastructure financing gap is doable. Innovative finance provides fresh approaches that could mobilize increased capital investment to close the infrastructure gap.

Innovative finance mechanisms refer to new and evolving models beyond commercial debt finance that act as a magnet to attract private and institutional investors for sustainable development. Some inventive mechanisms also crowd-in small investors for local projects that are unable to raise capital from traditional sources.

What sets apart innovative financing is it encourages collaboration among private, public, and institutional donors to inject much-needed capital into social and environmentally sustainable projects often ignored by capital markets that traditionally view them from a return-on-investment lens.

Innovative financing targets the private sector and large institutional funds by creating investment opportunities for collaboration on sustainable infrastructure projects that are usually outside the boundaries of their existing investment portfolio. It provides new sectors for investment through a combination of risk distribution, liquidity enhancement, volatility reduction, capital timeliness and adequacy, and positive risk-adjusted returns.

To ensure the success of these innovative financing mechanisms, countries across Southeast Asia need to ensure an enabling environment that promotes innovative financing solutions and sustained by the right technology that can mobilize funding to help bridge the infrastructure gap.

Source: adb