Today, Asia stands at an interesting crossroad. The power engine of global economic growth is clearly coming from South East Asia, China and India. Standards of living across Asia vary dramatically. Many parts of Asia remain home to the poorest in the world, yet the fastest growth in high net worth individuals is from Asia. Demographically, Asia holds both, the world's fastest ageing and youngest populations. Intra regional trade in Asia is growing rapidly, though many trade barriers still exist. There are several such paradoxes. However, one unstoppable trend across Asia is rapid urbanisation. Pivotal to this is how infrastructure funding will be made available to keep pace with urban growth.
Projections for global infrastructure spending is mind-boggling, estimated at US$ 60 to 70 trillion over the next 20 years. Close to a quarter of this amount will be needed in Asia itself. Countries like Singapore and China have managed a smoother urban transition and upgradation of infrastructure. On the other hand, India's infrastructure has not kept pace with the growing demand.
Currently, 31 percent of the Indians live in urban areas and by 2030, this will swell to 40 percent. Despite increased investment in infrastructure and rapidly growing cities, the demand remains unsatiated. When infrastructure lags, it results in backlogs, inefficiencies and increases the overall cost of doing business. It has been rightly said that one unit increase in infrastructure will fuel far more consumption than a unit increase in income.
China, for instance, spends 8.5 percent of its GDP on infrastructure, while India barely manages 4.7 percent. During the 5-year period ending 2017, it was envisaged that India would require US$ 1 trillion of investment in infrastructure. However, various constraints slowed the pace of investments and as a result, infrastructure financing too was severely impacted. What is clearly evident is that the policy environment and investor confidence is as crucial as the timely availability of finance to fund infrastructure.
Need for broad based funding
India continues to run fairly large fiscal deficits which constrains the government's ability to fund infrastructure. Given a more conducive investment environment, the role of the private sector in funding infrastructure will increasingly become more dominant.
As has been the case with many countries in Asia, the Indian banking sector has played a major role in funding infrastructure. In terms of deployment of bank credit, infrastructure accounts for one-third, mainly in power, roads and telecom. However, when infrastructure lending requirements are so large, it is imperative to have a diverse set of players -- banks, pension funds, insurance companies, private equity players with deep pockets and multilateral institutions -- who can provide long-term funding. A deep bond market goes a long way in enhancing funding for infrastructure.
The Indian government has laid strong emphasis on increasing affordable housing, creating 100 new smart cities and upgrading existing urban infrastructure. This opens up new avenues for investing in infrastructure.
Scope for Further Regional Co-Operation
Within Asia, there is scope for further collaboration between countries that have surplus funds to invest and those that are capital starved. Asia is home to 7 of the top 20 pension funds of the world. In terms of asset size, 40 percent of the world's sovereign wealth funds are in Asia. These are ideal funds to deploy for infrastructure. Bilateral funding lines are also helpful because they are generally long-term with softer terms. India, for instance, has been able to tap funding from Japan for the Delhi-Mumbai Industrial Corridor. China is also expected to collaborate with India for the development of high speed railways.
Retail Japanese investors crave for safe, higher yielding investments. In India, there is an acute shortage of housing. Funding retail mortgages is a relatively safe business and historically, non-performing loans have been extremely low. Thus, an ideal financial instrument would be using Japanese retail funds to fund a pool of home loans in India. There is tangible security in terms of the mortgaged properties. This can be mutually beneficial to both countries. However, regulators need to be more open to cross border transactions.
New Institutions for Funding Infrastructure
Though existing multilateral institutions have played a meaningful role in funding development, with the growing requirements of infrastructure, particularly in emerging economies, there has been a recognition that new institutions are needed to supplement this effort. The Chinese-initiated Asian Infrastructure Investment Bank (AIIB) has made a significant headway in garnering 57 prospective founding members. The founding members will initially contribute one-fifth of AIIB's capital of US$ 50 billion, and this would subsequently be increased to US$ 100 billion. The shareholding is proposed to be linked to the gross domestic product and purchasing power parity of the member countries, with the condition that Asian countries must own 75% of the shareholding.
The other initiative has been the New Development Bank comprising five countries ? Brazil, Russia, India, China and South Africa. The key focus is funding infrastructure projects amongst member countries and other developing countries. While there are apprehensions that the BRICS group is not cohesive given the disparities in terms of their economies, the framework and governance structure of the New Development Bank is very democratic. One understands that the capital contributions to the bank would be equal amongst members, thereby negating the problems that have arisen with the World Bank or the International Monetary Fund. Further, Mr. K. V. Kamath, the first President of the bank, is an extremely dynamic and seasoned finance professional. His experience is rich and varied, having worked in a multilateral institution, development bank and also led a very successful private sector commercial bank for many years.
While these are very early days in the life of these two new institutions, one hopes that they will imbibe highest governance standards and best practices in lending. There are lessons to learn from the shortcomings of existing multilaterals. Lending processes need to be simplified and timelines compressed. The focus should be risk-based lending rather than a legal and compliance based orientation. For instance, the one practice that must be completely desisted is the insistence of a sovereign guarantee of the host government because this completely restricts flexibility in structuring the funding.
To my mind, it is important that these two new institutions evolve their own work culture, rather than attempt to replicate existing multilateral institutions. They should seek to create their own infrastructure lending models, suitable to the evolving needs of developing economies. Infrastructure financing requires specialised skills and they should seek advice of practitioners who have the experience of setting up or financing infrastructure projects. The talent pool must be based entirely on meritocracy.
On the funding side, these institutions can help deepen the bond markets by issuing long-term bonds. There are a number of Asian pension and insurance companies that would readily buy these bonds as they need long-term investment avenues with low risk levels. Further, several Asian economies have a large pool of foreign exchange reserves which could earn better yields by investing in these bonds.
Lastly, these institutions must be insulated from diplomatic and political obligations, whilst keeping the focus solely on being professionally run. The infrastructure funding requirements are so vast that one can confidently say that there is sufficient room for more players. No doubt, there will be challenges ahead, but these can be overcome. Clearly, success can only be assured if there is a shared vision and genuine willingness to collaborate towards a better future.
Deepak Parekh is the Chairman of HDFC Ltd.