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20 November 2014

Infrastructure spending will drive growth in emerging markets

Urbanisation, a positive framework for private-sector participation and pro-active government policies will ensure emerging markets (EMs), from the Brics to Thailand, will boost their share of global spending on infrastructure and capital projects over the next decade.

Despite signs in America and the UK that their economies are slowly returning back to pre-crisis levels, a feeling of unease remains about the health of the global economy.

Developed markets, which for many years have been the driving force of the world economy, are now stagnating. Uncertainties remain in Europe, with its main powerhouse – Germany – heading towards potential deflation.

In recent years, developed economies have been overtaken by new EMs – especially China – as the driving force of economic growth. Since the late 1990s, 73% of developing countries outperformed the US, by an average of 3.3% (additional GDP growth) a year.

However, even these markets are now beginning to record sluggish growth. The economic numbers in almost all the Brics look disappointing, whichever way they are measured. Growth in EMs is slowing to its lowest point since the aftermath of the financial crisis.

Asia and the Asean nations remain the most robust of the large EM regions. Even here, significant growth remains elusive as China slows and some of the overheated sectors such as property, commodities and shadow banking begin to correct themselves. To reverse this trend, EMs should go back to basics – increasing investment and spending on infrastructure.

Overall, global spending on infrastructure and capital projects is forecast to reach $9 trillion by 2025, up from $4 trillion in 2012.

However, developed economies will see their share of total infrastructure and capital project spending shrink by 2025. This is despite the fact that many of these economies are in dire need of rebuilding waning infrastructure.

Key problems

One of the key problems, however, is that government budgets continue to be very strained. In the US, public infrastructure spending as a share of GDP has declined to about half the European level.

We believe that this approach is badly in need of a rethink. As the IMF recently pointed out: "In advanced economies an increase in infrastructure investment could provide a much-needed fillip to demand and it is one of the few remaining policy levers available to support growth, given already accommodative monetary policy."

Per pound, dollar or euro of capital, the best way to stimulate an economy is by investing in infrastructure, particularly transport infrastructure.

Accelerating urbanisation – especially in India and China – provides the perfect opportunity for EMs to boost their share of global spending on infrastructure and capital projects over the next decade. This method of economic growth has worked in the past and there is no reason why it shouldn’t work again.

The Brics are well aware of the importance of infrastructure spending, which is why they have established the Brics Bank to fund many future projects. For example, Brazil is in particular need of new roads and ports infrastructure, while in India, transportation and utilities will be the major areas of investment.

EMs outside of the Brics are also following suit. In countries such as Indonesia and the Philippines, governments are creating a positive framework for private-sector participation in infrastructure projects. Last year Indonesia announced plans for $35 billion in new infrastructure projects. Of the 56 planned projects, 32 are partnerships between the private and public sector (PPPs).

Furthermore, infrastructure development was at the core of recent Apec summit in China. Chinese president Xi Jinping pledged $40 billion for a Silk Road Fund to boost trade ties between Asian nations. The fund will finance infrastructure and cooperation in industry to increase connectivity across Asia.

This is in addition to last month’s launch of a $50-billion Asian Infrastructure Investment Bank, which will also finance infrastructure in the region.

Persistent weakness

During the summit, finance ministers from Pacific Rim nations also noted that the global economy still faces persistent weakness in demand and they looked to infrastructure spending to boost growth. The summit highlighted how diverse government institutions and areas of policy need to be coordinated to facilitate successful foreign direct investment in infrastructure in close cooperation with the private sector.

In Russia, PPPs are a tried and tested formula for meeting the infrastructure needs of the growing middle classes and international businesses. According to one estimate, the infrastructure sector (energy, housing and transport) in Russia will grow from $39 billion in 2011 to $110 billion in 2020.

The numbers are impressive, but the reality is that Russia needs long-term supporters to fund this tremendous growth. The country has also succeeded where others have been slow to put in place the right mechanisms and incentives for investors to want to partner in long-term ambitious infrastructure projects.

For our part, VTB Capital has been successfully financing infrastructure projects in Russia for a number of years, including the award-winning Pulkovo Airport PPP, which entailed the construction of a new passenger terminal and modernisation of the existing infrastructure at Pulkovo Airport in Saint Petersburg.

VTB Capital is also a co-investor (sponsor), lender and financial adviser to the Western High Speed Diameter, which is the world’s largest PPP toll road project. It will reduce traffic congestion on urban highways and roads by redirecting traffic to the federal highways, as well as improving connections with the downtown area and Pulkovo Airport.

This is not a silver bullet for the Russian economy, but it will put in place the long-term foundations needed to build a dynamic economy for the 21st-century economy.

VTB Capital also sees great opportunities internationally, not least in sub-Saharan Africa (SSA). The Africa Infrastructure Country Diagnostic has indicated that in the next 10 years SSA will need $93 billion per annum to finance its infrastructure.

However, currently less than 50% of this funding is available. The African Development Bank has stated this year that this lack of investment leads to a general lack of power and water supply, travel networks and communication technology, reducing productivity by 40% and slowing GDP growth by 2% each year.

This apparent underfinancing of the SSA infrastructure sector provides VTB Capital with an opportunity to apply its expertise in the region. Infrastructure financing is a core business for the bank that can be successfully developed in SSA, where growth potential and demand are high.

Infrastructure spending is essential to sustain global economic growth. With the upgrades needed in developed nations and the new builds required in the EMs, infrastructure is clearly an investment theme that will last for a long time. Globally, infrastructure is now an established asset class in its own right.

However, as governments in developed economies struggle to pay for their projects, it will be up to the EMs to drive infrastructure investment.

VTB Capital understands the importance of infrastructure spending, which is why we will continue to play an active role in global infrastructure investment across many regions.

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