Date Submitted: 27 Dec 2017
This article is published on Asia Asset Management December 2017/ January 2018 issue.
Infrastructure development is the route to Asia’s future and the scale of investment required is staggering. Asian Development Bank believes emerging economies across the region will need as much as US$26 trillion to build everything from transport networks to clean water systems through 2030.
Government agencies across the region are promising major spending on public works. But with limited public funds available, a critical question remains: how can governments entice more private investment? The answer is to create a sustainable model that returns part of the tax revenue to the private sector; a concept known as the “spillover” effect.
It’s easy to visualize how good infrastructure creates tangible spillover effects for the community – for example, railways bring more manufacturing into regions, which results in more jobs and spending. Corporate, income, sales, and property taxes then rise as a consequence.
However, the spillover for private investors is usually low and downside risks are plentiful: a project may be halted due to political leadership changes; delays in land acquisition can hike interest expenses; or lengthy planning and permitting processes can slow projects ready for investment. In most cases, the stream of revenue (for example, the toll on a new highway) is set low, which depresses the investment rate of return.
To change this, Asian Development Bank Institute has embarked on intensive research and discussions with governments around the region to help them understand how the spillover effect is key to long-term infrastructure development. We studied the economic impact of dozens of projects and used advanced analytics to compute the effect of spillover on tax revenues - including a cross border arterial road project in Manila; a railway project in Uzbekistan; and a high-speed bullet train project in Japan.
Private investors can participate in an infrastructure project through buying revenue bonds, a type of municipal bond that finances income-generating projects. The revenue bond, in this case, will consist of user charges (e.g., road tolls) plus part of tax revenues collected.
Infrastructure development becomes attractive where spillover effects are large. Importantly, the projects also attract the right kind of investors, such as pension funds and insurance firms, who have a long-term investment horizon.
What’s important for governments and the private sector to consider is that infrastructure projects impact regions in different ways. In Japan’s Nagoya City, a hub for Japanese manufacturing industries, industrial plants and road projects generate high returns. However, expecting similar projects on, for example, the northern island of Hokkaido where tourism is the key industry, is unreasonable. An industrial region requires reliable roads, railways and ports; whereas tourism looks for airport, hotels, and recreational infrastructure.
No discussion of infrastructure in Asia would be complete without mentioning China’s One Belt, One Road initiative. To succeed, each project needs to be assessed based on the region where it will be built. A railway project in Bangladesh, for example, will generate a different set of spillover effects one built in Pakistan.
Importance of connectivity
The spillover effect is also impacted by connectivity, which is bolstered by returns from infrastructure development. A railway that eventually connects to bigger and busier cities generates significantly more revenue compared to a rail line with limited connectivity. Under China’s plan to revive trade along an ancient Silk route, the benefits of development could spread across countries in Asia and Europe.
Thinking differently about how roads, power and bridges are financed and operated can substantially improve a region’s infrastructure without necessarily imposing further burden on an already stressed local government budget. By bolstering private investment returns with spillover effects, governments can attract more long-term private capital, boost investments and increase regional economic activity.