The Crucial Role of Financial Markets in Infrastructure Financing

Infrastructure development is essential for economic growth and societal well-being. Governments worldwide invest in critical infrastructure projects such as roads, bridges, energy facilities, and water supply systems. However, financing these projects can be challenging. That’s where financial markets come into play.

1. Background

• Infrastructure Challenge: Developing robust infrastructure remains a major challenge for many regions seeking to achieve their full potential.
• Traditional Banking: Historically, banks have played a significant role in financing infrastructure projects. However, relying solely on banks can lead to overexposure and risks due to maturity or currency mismatches.

2. Capital Markets as a Solution

• Reducing Pressure on Banks: Capital markets offer an alternative by reducing the pressure on the banking system.
• Equity Financing: They provide fresh equity to finance or refinance infrastructure projects.
• Diverse Financial Systems: Asia, with its diverse financial systems, including emerging markets, is an ideal place to explore capital market financing.

3. State of Capital Markets in Asia

• Depth and Sophistication: Asia’s financial systems vary in depth and sophistication.
• Underdeveloped Markets: Some Central Asian and Pacific countries lack developed capital markets, hindering their role in infrastructure financing.
• Addressing Limitations: Capital markets can address limitations of bank-dominated systems, such as refinancing risks and single borrower limits.

4. Institutional Investors and Infrastructure

• Long-Term Nature: Infrastructure projects align well with the long-term liabilities of institutional investors.
• Correlation: The size of the institutional investor base correlates with the size of capital markets.
• Challenges: Underdeveloped equity and bond markets limit institutional investors’ ability to finance infrastructure.

5. Investment Modalities

a. Infrastructure Companies in Stock Markets

• Stock Market Capitalization to GDP (2015):
  • Kazakhstan: 7.6%
  • Sri Lanka: 8.6%
  • Philippines: 16.1%
  • Indonesia: 21.2%
  • Malaysia: 29.1%
  • Vietnam: 36%
  • India: 50.9%
  • Korea: 149.8%
  • Japan: 113.8%
  • World: 162.9%

b. Infrastructure Companies in Bond Markets

• While the US and Europe have substantial outstanding corporate bond issues ($22 trillion and $18 trillion, respectively), Asia lags behind with only $3 trillion in outstanding bonds (as of 2014).
• Project bonds, issued through special purpose vehicles (SPVs), play a crucial role in financing infrastructure projects.

6. Conclusion

Financial markets, especially capital markets, are vital for sustainable infrastructure financing. Governments, investors, and institutions must collaborate to unlock the potential of these markets and ensure robust infrastructure development.

Sources:

1. Capital Markets Financing for Infrastructure Investments
2. Institute for Government: Financing Infrastructure
3. McKinsey: Unlocking Private-Sector Financing in Emerging-Markets Infrastructure
4. Role of Investment Banks in Infrastructure Projects
5. Promoting the Use of Capital Markets for Infrastructure Financing

Feel free to explore these sources for more in-depth information!