Investing In Infrastructure.

Private funding of infrastructure projects can make everybody a winner.

Great and enduring civilizations have always had great infrastructure. Take the Romans. In 312 BC, they started to pave the Via Appia from Rome to Southern Italy to improve links with Greece. Three centuries later, there was a 3,700-kilometer long highway network spanning throughout the Roman Empire. And the Romans also learned first hand that a good infrastructure at home is necessary for economic growth. When traffic in the city of Rome became too chaotic, Julius Caesar felt obliged to impose a daytime driving ban. Whole classes of economic activity--such as deliveries--had to be carried out at night because of the limited capacity of Rome's streets.

Yet despite its obvious importance throughout history, infrastructure as a concept has always given economists and social philosophers trouble because of the complex mixture between public interest and private entrepreneurship it entails. To find the line where the public interest ends and the private begins has occupied many a great mind over the centuries. No matter on which side of this debate you come down, there's one indisputable reality: The infrastructure financing needs of developing countries alone are going to run into the trillions of dollars over the next few decades--and public institutions alone simply will not be able to pick up the tab.

Today's infrastructure needs do look different than that of the Romans' time. Technological advances, such as the globe-spanning communication networks that have heralded the information revolution, mean that commerce is literally done at the speed of light, and distance is shrinking. These trends have had a dramatic impact on infrastructure. Countries must find the money to spend on the information revolution or risk being left behind on the wrong side of the "digital divide." Getting the infrastructure right is the key to full participation in global economic progress.

The IT revolution has a huge impact on traditional infrastructure. Although Internet-based businesses and the so-called "New Economy" may be virtual in many ways, they rely entirely on things that exist in the real world. Products may be ordered on-line, but have to be delivered by real airplanes, ships, trains, trucks, oil and gas pipelines or power transmission lines. Just-in-time decisions need just-in-time availability of efficient infrastructure--both real and virtual.

If millions of potential working hours are wasted by delayed commuter trains or traffic jams, whether in Los Angeles or Bangkok, London or Lagos, Leipzig or Lima, this is clearly at the expense of productivity and social welfare--just as Julius Caesar understood. And infrastructure has to be upgraded constantly to ensure sustainable, long-term economic growth. The infrastructure of the developed world was created over centuries, and even longer time horizons. Some modern European highways are even built on the old Roman roads.

In emerging markets, meanwhile, the needs are pressing. To compete, they must build a competitive infrastructure in a matter of years. All of this takes money. Yet, financing infrastructure investments has always proved to be a challenge, and not just in the developing world.

The world financial system over the past fifty years reflected a clever solution to this difficult problem. It appeared in the form of quasi-public agencies that were charged with becoming the banks for infrastructure investment in developing countries. Thus were born the various regional development banks, along with the World Bank. For many years, these institutions were the primary players in funding infrastructure projects in developing countries.

More recently, however, limitations in this system have become apparent. Whatever the reason for these limitations, the fact of the matter is that the amount of infrastructure financing these international financial institutions can provide is far below current needs, and unlikely to catch up very soon.

Developing countries simply cannot rely upon these institutions alone to help pay for the necessary investments in roads and telephone networks.

As a result, in most infrastructure projects in the developing world today, there is a shifting division of labor between the public and the private spheres toward a much greater involvement of the private sector. According to the World Bank, from 1990 through 1999, private investors carded operating and construction risks worth $580 billion in more than 1,900 infrastructure projects in developing countries. That is 3.5 times the total amount the World Bank lent to developing countries over the same period.

Exactly where do commercial banks fit into this picture? First, banks continue to be an important source of funds. For all the talk about an increasing role for bonds and equities, banks accounted for 43 percent of total financing for emerging market countries in 2000, just slightly less than the 46 percent banks provided in 1994.

Without diminishing the accomplishments of the international financial institutions, the trend towards greater private infrastructure financing suggests that it is time for a rethinking of their role. The World Bank and other multilateral institutions will still be needed to participate in infrastructure projects, primarily to promote investor confidence in many countries. Of course, this does not mean that participation of the World Bank Group is a prerequisite for a project. But its presence often serves as a catalyst that triggers the green light for private sector participation.

But even more than simple participation, the World Bank could help to increase the flow of funds for infrastructure investment by securing these loans. Securitization could be a key factor in helping to increase the flow of money to the developing world. Why?

First, the staggering volume of infrastructure investment financing needs facing the world suggests the necessity of involving global capital markets. Banks' balance sheets, impressive as they are, are simply too small to absorb those needs. Second, the key role of banks as intermediaries should not require that their own capital be permanently tied up in the project at hand. On the contrary, once banks have made their primary contribution by analyzing and structuring the risk, there is little advantage in the bank retaining the loan on its books. Holding a portfolio of infrastructure investments may not the best use of scarce bank capital. The ultimate goal should be to find a way for banks to assist in infrastructure financings without taking on permanent assets on the banks' balance sheets. If banks can sell loans via securitization, they can obtain fresh money for new infrastructure projects. This puts the bank in the role of servicer to ensure, rather than the investor, that the infrastructure project is realized. Such securitization can lead to an increased deal flow by the private banks and, consequently, increased funding for more projects.

Greater private participation in developing infrastructure financing has other very profound advantages. A shift towards private participation implies a shift towards more efficient and competitive markets. And that is good news for governance issues in developing countries.

Raising private participation in infrastructure projects is also in the self-interest of the developing countries because it can help reduce their borrowing costs. The primary responsibility of the host country to build investors' trust and confidence will, in turn, result in considerable financial savings. Private lenders currently require a margin of 3 percent on the money invested in some developing countries.

This compares to the one percent margin they expect in countries with sound legal frameworks. That differential represents a huge incentive for developing countries to create reliable frameworks because it can substantially reduce their borrowing costs. For example, on a $1 billion project, the reduced margin can save a country about $300 million over a twenty-year period.

It is a cliche to claim that the solution mapped out here is a "win-win" scenario. But there are times when the cliche is appropriate--and this is one of them. Each of the actors in this drama stands to gain from the trend of growing private financing of infrastructure investment. The developing countries need financing on a huge scale. The World Bank needs to change its role from primarily lender to catalyst. And banks are looking to provide solutions in growth markets around the world. While all three actors have made mistakes in the past, we have all learned enough to indicate that banks' participation in infrastructure financing will be a powerful force for world economic growth.

Bernd Fahrholz is Chairman of the Board of Managing Directors of Dresdner Bank.