Strong evidence reveals that infrastructure investment is central both for growth, for reducing inequality and making growth patterns more pro-poor.
While growth is positively affected by the stock of infrastructure assets, income inequality declines with the higher level of services provided by the infrastructure.
However, insufficient public funds to fulfill the required financial needs have made the development of infrastructure stagnant. Since the beginning of this century, major international efforts started to look to private capital and to tap it for financing infrastructure.
These efforts were based on the assumption that global funds are abundant and the increasing appetite of the private sector to participate in infrastructure financing.
The World Bank and Asian Development Bank are among those international development finance institutions that are in favor of this innovation and operate a separate facility to stimulate Public Private Partnership (PPP).
The government, with the support of these institutions, has conceptualized an infrastructure guarantee fund and financial facility — an instrument which only recently opened its door for business, to finance PPP projects.
A state-owned company was established last year to provide guarantees over certain investment risks to increase PPP project bankability, i.e. the creditworthiness of projects, offering comfort to private investors.
Another public company established earlier, through its Infrastructure Investment Facilities, provides co-financing toward infrastructure investment.
This effort however was designed before the last global financial crisis took place, before the appetite of investors was interrupted.
Unlike at the beginning of this century, when there was a slow but steady movement with private sector financing gradually becoming the driver for infrastructure projects, after September 2008 infrastructure financing has dramatically changed as the financial global crisis hit and confidence sunk. Private debt and, even more, private equity in infrastructure projects have nearly dried up.
The World Bank, in a press release on Feb. 3, announced that net capital flows to developing countries fell to US$780 billion in 2008, reversing an upward trend that began in 2003 and peaked at $1,222 billion in 2007. Particularly hard hit were private capital flows, which fell by almost 40 percent.
The question is now whether or not the context of the Infrastructure Investment Facilities has been severely affected by the global crisis, and whether or not the impact of the global crisis on the climate of private investment is significant.
In the power sector, we are still feeling the impact of the former financial crisis, when in 1998 one of the monopolies was not able to meet its obligations to honor power purchase agreements with private investors in the geothermal sector. The country had to pay billions of dollars in court cases.
The need to break the agreements was caused due to a very basic mismatch which often happens in infrastructure finance. The income, if it is from toll roads, or from electricity tariffs, is in local currency, in our case rupiah, yet the investment and repayment is in foreign currency.
When, through external economic shock, the exchange rate is
off, our monopolies don’t have a fall-back mechanism to guarantee against these foreign currency fluctuations.
This cancellation of power purchase agreements had a number of consequences. Since the cancellation, no new significant geothermal private investments have been made. Thus in 2008, when the price of fossil fuels quadrupled, 95 percent of the energy sector was exposed to these higher costs. If we had had 12 percent of our energy portfolio in geothermal energy as planned, instead of 5.5 percent, it would have saved $2.25 billion or about 0.5 percent of the GDP.
Infrastructure investment has one other important characteristic over commercial finance. Both the development time and repayment time often span decennia. A mass transit system will take 10 years to design and another 10 years to implement. A geothermal power plant will take five years from design to commissioning and 25 years to repay the investment.
Due to their long gestation period, infrastructure projects are susceptible to changes in government and changes in political outlook. It is one of the consequences of the glo-bal crisis that we should look proactively to the creation of a domestic or regional investment guarantee agency particularly for infrastructure projects.
For sure, as private appetite diminishes and investors retreat from infrastructure financing, the government has to step up to sustain its growth path and comprehensively review and revisit, in light of the crisis and past experience, if the current model is to be an effective mechanism.
More creative and innovative guarantee mechanisms are needed to maintain and increase the flow of domestic and foreign investment in infrastructure. Assistance from international financial institutions might be necessary to provide guarantees for volatile foreign exchange fluctuations.
But the real challenge for the government after the global crisis is to be smarter, more proactive, without stifling the entrepreneurial private sector drive.
A quote from an officer of one of the international development finance institutions alarms us — money isn’t always the only problem, clever financial engineering is no substitute for good policy, and changes in ownership are not a great substitute either. We know from painful experience that a policy environment that is lousy for the private sector will be lousy for the public sector too.
Montty Girianna, PhD is director of energy, mineral resources and mining at the National Development Planning Agency(Bappenas). This is a personal opinion.
