GLOBAL INVESTMENT IN INFRASTRUCTURE: THE ROLE OF OIL EXPORTERS Shahrokh Fardoust, Ph.D. Research Professor, College of William and Mary President, International Economic Consultants, LLC SFardoust@InternationalEconConsult.com Building Bridges: Engaging the Institutional Investor in Global Infrastructure Symposium K&L Gates and SovereigNET of the Fletcher School Washington DC, October 7, 2014
2 Outline* *Based on ongoing research with Dr. Eliot Kalter Context: Global Economic Situation 2014 Key megatrends that Underpin the Dynamics of the Global Economy in the Next Two Decades Faster and more sustainable global growth requires more and better quality infrastructure But infrastructure financing by banks has been curtailed as part of a deleveraging process Oil Exporters continue to have massive current account surpluses and need to continue to recycle their petrodollars to avoid a global recession Oil & Gas-based Sovereign Wealth Funds allocations to infrastructure investments have been modest so far, but could grow in future Oil exporters are vulnerable to sharp declines in oil prices Concluding remarks
3 1. Context: Global Economic Situation in 2014 Global economic growth remains in low gear, and an uneven and moderate recovery continues. Only a modest pick up is foreseen in 2015. Advanced economies are growing again, though their recovery remains fragile. Emerging market & developing countries are likely to continue to have relatively strong growth in the latter half of 2014 and 2015, though still lower than before the 2008-09 crisis due to tighter global financial conditions. Overall, world growth is expected to accelerate in 2014 to about 3.5% compared with 3% in 2013, with some acceleration in world trade growth expected to around 4.5%. But there are downside risks due to sudden corrections in financial markets, and to rising geopolitical tensions (Ukraine, Middle East, East Asia). At current levels, growth is too weak to significantly improve the situation of workers worldwide. In many economies, unemployment remains high. Almost 202 million people were unemployed in 2013 worldwide, an increase of 5 million compared with 2012. Youth continue to be particularly affected by the weak growth. Yet, there is ample evidence G20, IMF, World Bank - that growth in advanced economies, as well as in emerging and developing economies, could be accelerated through increases in infrastructure investments. Inadequate long-term financing and weak business climate, including inadequate policy & regulatory frameworks, continue to be the main obstacles to more infrastructure outlays.
2. Key megatrends and the dynamics of the global economy in the medium-term The pace of global economic growth is likely to be slower and unemployment higher in the next decade than in the previous two, due to demographic, structural, and technological changes that render manufacturing more capital and skill intensive. The rapid convergence phase in the world economy during the last two decades was associated with a surge in world trade in goods and services, ushering in an era of hyper-globalization. After the global crisis, globalization-reversing forces have set in. The rapid globalization led to substantial increases in financial interdependence and the monetization of national economies over the last two decades. Financial development has had a positive impact on economic growth at adequate levels of financial depth, but this effect has vanished since the crisis. Population growth rates have plummeted in most world regions. But due to population momentum, Asia s share of the world population will rise, and Africa s share will rise even more, as a result of its late demographic transition. The world population will increase by about 2.2 billion people, to about 8.3 billion by 2030. Continuing rapid urbanization, particularly in Asia and Africa, will mean that urban population will rise from about half of the world population to two-thirds by 2030 - - there will be a massive increase for infrastructure service. 4
2. Key megatrends continued 5 Current patterns of energy and resource use, agricultural practices, and urbanization will lead to risks of increased costs and decreased productivity that will reduce growth, with sharp unpredictable threshold effects possible, with much of the costs of resource depletion falling on the bottom half of the income distribution. Massive infrastructure deficits are increasingly affecting productivity and thus firms ability to compete in domestic and international markets. The unreliability of existing infrastructure also reduces firms profitability and ability to invest and expand in both advanced and developing economies. The rapid expansion of the middle class in most emerging economies from about 800 million in 2010 to more than 1.9 billion in 2030, with concomitant increases in demands on infrastructure and natural resources. The official governance of the global market is increasing inadequate in representing and protecting the bottom half of the world s population, who live on just $3 a day in the developing world. It is inadequate to manage collective action to deal with climate change or further liberalization of international trade to reduce protection against exports of poorer developing countries. Source: Towards a Better Global Economy Allen, Behrman, Birdsall, Fardoust, Rodrik, Steer, and Subramanian (Oxford University Press 2014)
3. Faster and more sustainable global growth requires more and better quality infrastructure Estimates of the world s overall infrastructure investment needs for energy, road and rail transport, telecommunications and water are in the range of $50-70 trillion through to 2030 compared with the $38 trillion spent globally on such investments over the past two decades. The global infrastructure investment gap is currently in the region of $1 trillion per year. Current outlays on infrastructure in developing countries is about $0.7 trillion per year; nearly 65% is financed by domestic budget, with the rest provided by private sector, ODA, World Bank and Regional Development Banks and to a limited extent by other sources, including SWFs. Yet, there is substantial infrastructure deficit. Infrastructure outlays in emerging and developing countries needs to be doubled to $1.5 -$1.8 trillion per year (to 6.5% of GDP); annual infrastructure spending in advanced economies needs to be raised by 1% of GDP (to 4%) to about $1.6 trillion. An additional $200-$250 billion annual capex is required by developing countries to make their infrastructure investments environmentally sustainable. 6
3. Status of Infrastructure Needs and Financing Varies Across Developing Regions Source: World Bank and IFC (2012) 7
3. Reaching Infrastructure and other Sustainable Development Goals in developing countries requires an additional $2.5 trillion a year in investments (Trillions of US dollar) Source: UNCTAD, 2014. 8
4. Infrastructure investments can be transformational in developing countries and growth could be boosted 9
4. But infrastructure financing by banks has been curtailed as part of a deleveraging process Source: Canuto (2014), Infrastructure Journal 10
4. Current and Potential Allocation of EM Institutional Investors to EM Infrastructure build up over time Source: Based on World Bank Group Staff paper for the G20 Investment and Infrastructure Working Group 11 OECD Institutional Investors Emerging Market Institutional Investors Sovereign Wealth Funds (Sept. 2014) EM pension reserve and social security funds AUM USD $ Current Investment in EMDE Infrastructure 79 trillion + <1% = total leading investors c10% most in domestic markets 4.5 trillion NB growth potential e.g. EM pension funds currently $2.5 trillion AUM estimated to rise to $17.4 trillion by 2050 Even more limited than leading OECD investors Chilean pension funds 1.5% Potential Investment in EMDE Infrastructure 1% assets = $750 billion 1% assets = c$50 billion 6.8 trillion 0-5% c5% assets = c%250-$340 billion 1 trillion Limited ad hoc examples (up to 10%) 10% assets = c$100 billion
5. Oil exporters [and Europe (Germany)] continue to have massive current account surpluses (percent of world GDP) 12
5. Key channels for recycling petrodollars have worked so far (billions of US dollar) 13 Source: Fardoust (2012) 2,250 2,000 Value in Billions of U.S. Dollars 1,750 1,500 1,250 1,000 750 500 250 0-100 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 imports of goods and services change in reserves gross investment outflows workers' remittance outflows
5. Oil and Gas based SWFs account for 60% of all SWFs, and GCC SWFs account for 36% of all SWFs 14 Sovereign Wealth Funds of Oil Exporting Countries*in Middle East (GCC) (US $ Billions, as of September 2014) UAE: Abu-Dhabi Investment Authority $773 Saudi Arabia; SAMA Foreign Holdings $757 Total GCC SWFs:= $2438.4 billion Kuwait Investment Authority $410 Total oil and gas related SWFs= $4064.4 billion Qatar Investment Authority $170 Total SWFs= $6831 Billion UAE-Abu Dhabi: Investment Council $90 GCC SWFs/Total oil and gas SWFs=60 % UAE Dubai Investment Cooperation of $70 Total oil and gas SWFs/Total SWFs=60% UAE-Abu Dhabi International Petroleum Investment Co. UAE Abu Dhabi Mubadala Development Community $60.9 68 Source: Sovereign Wealth Fund Institute, 2014 All figures rounded to the nearest whole number except in those cases where the amount was less than $1 billion.
5. GCC s large CA surplus and rising foreign assets could contribute to the global and regional infrastructure financing needs? Source for data and chart: IIF (2013) 15
6. SWFs Are Making Some Investments in Infrastructure Source: B20 Panel of Six International Accounting Networks June 2014 16
6. Diverse investment objectives, but there is little information about the exact investment vehicle used 17 Source: OECD, World Bank
6. Oil & Gas exporters SWFs Asset Allocations Tend to Deal with Dual Risks of Currency and Oil Price Volatility Public disclosure of investment management strategy varies widely between SWFs, but overall is limited and lacks full transparency. Oil and gas- based SWFs have typically a long term approach to investment decisions and a preference for equity and alternative investments, but may tend to diversify risk by investing in financial assets with low correlation with their revenue stream from energy exports and hedge the risks of currency and oil/gas price volatility with increased investment allocations to financial assets. Based on what is known, around four-fifths of oil & gas-exporting countries funds are invested in overseas assets, as a part of strategy to boost yields while remaining diversified. Equity investments account for nearly a half of their overseas investments, followed by fixed income with a quarter, bank deposits 15% and the rest in alternative assets. Investments in infrastructure projects has up to now averaged less than 8-10%, but the percentage may vary significantly across funds. Recent trends indicate some funds by oil exporters SWFs are being invested in emerging economies and in their domestic markets. 18
7. But the global slowdown in growth could adversely affect oil exporters bop buffers, as well as fiscal balances and domestic social programs 19
7. Although GCC countries have strong fiscal and balance of payments positions, they are vulnerable to sharp declines in oil prices Source: IMF Article IV report for Saudi Arabia (2014) 20
8. Concluding Remarks 21 Global economy needs a significant stimulus to regain its dynamism, generate jobs and reduce poverty. A number of recent studies (including by G20 and IMF) indicate that an increase in physical infrastructure stocks raises GDP growth over the short- and medium-term. Moreover, increases in environmentally sustainable infrastructure investments would make countries economies more resilient to climate change and natural disasters. Oil exporter can make a meaningful contributions by gradually increasing their participation in the financing of infrastructure projects at the regional and global level. By finding innovative ways to finance the massive infrastructure needs at both global and regional levels, oil exporting countries with SWFs might be able to become more effective in recycling their excess reserves, and also contribute to global growth and employment generation, and ultimately to social and political stability in their region. However, this requires improved investment climates in the recipient countries, as well as strengthening of their policy & regulatory frameworks.