By: Miriam L. Campanella

The China-led Asian Infrastructure Investment Bank will serve to ease the looming liquidity drought in infrastructure financing. As the World Bank and the Asian Development Bank move toward concessional lending and knowledge sharing with low income countries, the AIIB is left with an important niche to fill.

Developing necessary infrastructure is a vital strategy if we are to realize global growth potential. From the early 2000s up to 2030, the world will have to invest US$57–67 trillion in infrastructure such as roads, ports, power plants and water facilities. Infrastructure finance requirements in emerging market economies (EMEs) account for 37 per cent of this value.

But Otaviano Canuto of the World Bank argues that this share should be considered a lower bound. The figure does not include ‘development goals’ and EMEs would need an additional US$1 trillion per year until 2020 just to keep pace with the demands of urbanisation, growth, climate change and global integration.

Investment in infrastructure is the most appropriate development policy for EMEs. The IMF found that the long-term fiscal multiplier for government investment in infrastructure is around US$1.6 for every US$1 of investment in developing countries, much higher than the multiplier that such investments generate in developed economies. This means that for developing countries investment in infrastructure is particularly effective in increasing national income.

Infrastructure also represents a class of assets that can play a stabilizing role in the current volatile economic environment, which has been triggered by unconventional monetary policies in developed countries. Central banks’ current use of ultra-expansionary policies, such as low interest rates and quantitative easing, are unsustainable and are creating large risks. They have also proved unable to affect real-sector expenditure to the extent required.

Infrastructure investments are intrinsically defensive. Investments in infrastructure are less volatile than equities over the long term. This should appeal to pension funds, insurance companies and other long-term financial institutions.

But EMEs are still not using infrastructure investment as a financial tool. Even during economic boom periods, investments in capital were not sufficient to fill the infrastructure finance gap. Foreign direct investment into EMEs is still strong and can play a significant role in funding infrastructure investments. But long-term debt finance — fundamental to many projects — has not performed as well as it needs to.

The financial crisis and the ensuing global financial regulatory reform have caused banks to cut back from the infrastructure sector, reducing the availability of long-term financing. European banks used to play a significant role in financing infrastructure in EMEs. But the gap left by their withdrawal after the global financial crisis has not been filled by pension funds, insurers and mutual funds. The allocation of infrastructure debt in those portfolios is less than 1 per cent — far less than the 12 per cent previously supplied by banks.

In 2011 and 2012, net commercial lending by multilateral development banks was negative. The solution to the resulting liquidity drought in EMEs would be to allow the AIIB to serve as a financial outlet.

The main feature of the AIIB is private investment in infrastructure. The AIIB will handle project selection and preparation problems, and implementation risks. But if the AIIB wants to gain traction in markets, it will need sound economic rates of return and solutions to the challenges of financial intermediation.

The AIIB has the advantage of global scope. It will invest in projects that upgrade connectivity among all Asia-Pacific economies. The time is right. APEC leaders are now committed to improving connectivity in the region and China needs far better, and more strategic, links to the region’s network.

The AIIB will give a new focus to the need to address the requirements of EME infrastructure investment. It will introduce a level of sustainability and stability in the future growth of the Asia Pacific, and will lower volatility in the global economy.

Miriam L. Campanella is Associate Professor at the University of Turin and ECIPE, Brussels. This article originally appeared in the East Asia Forum, a platform for analysis and research at the Crawford School of Public Policy at the Australian National University