International financial institutions can help stimulate infrastructure investment through mitigating policy risk and improving local financing, say Erik Berglöf and Alexandru Chirmiciu, European Bank for Reconstruction and Development
Infrastructure is the battle cry of the day. The International Monetary Fund, of all institutions, even made it a theme of its recent annual meetings. In advanced economies with currently very low interest rates, infrastructure investments are viewed as an opportunity for governments to stimulate growth and improve competitiveness, but in emerging economies infrastructure needs are existential – the pressures from high growth expectations, environmental and climate-related challenges, and, in many cases, expanding populations are immense.
Rethinking infrastructure funding
The planning and implementation of infrastructure investments in emerging economies normally end up within the realm of public authorities, because market-based solutions are too complex and require more coordination than these authorities can handle. Climate change mitigation and adaptation have added yet another layer of complexity, stretching their administrative capacity and governance arrangements. Structuring these projects also requires substantial upfront costs – understandably it is often difficult to incentivise investors to incur these costs before having been granted the contract. Increasing the institutional capacity of the public authorities is key to addressing all these planning and implementation challenges.
Creating a favourable environment
The financing question is closely tied to that of policy risk. Perhaps the best illustration of policy risks is in the energy and climate sector. Obviously, there are risks related to the price of different fuels – both short and long term – and in technological development, but arguably the biggest risks are in the consistency of policies over time. Policy risks emanate from both the cost and the revenue. Returns to investment in this area are very sensitive to policy variables, for example a carbon price floor, feed-in tariffs and various capacity mechanisms. The support for different policies obviously depends on the fuel price. These risks have to be allocated between consumers and producers, or ultimately absorbed by the government or IFIs.