Driving emerging markets growth through infrastructure investment

Infrastructure investing in emerging markets often has a bad name. A 2017 study by the Inter-American Development Bank, for example, found that of 200 infrastructure projects researched by the authors, 36 had been cancelled because of social conflict, another 162 had faced significant delays, and 116 had cost overruns^[1]. Seemingly inherent political instability in many parts of the developing world discourage much needed private investment^[2] and undermine the efficiency of public spending.

This helps create a huge infrastructure gap in emerging markets. According to McKinsey, “developing countries will need to invest more than $2 trillion a year in infrastructure just to keep pace with projected GDP growth over the next 15 years”^[3], and that was before the COVID-19 crisis. As the pandemic continues to impact the world, public spending and investment is likely to be directed to address critical short-term challenges on healthcare and poverty alleviation. Focus has switched away from long-term strategic infrastructure initiatives – a challenge that governments in many developed markets are also finding.

This represents an opportunity for the private infrastructure sector, including investors, to step up their interest in emerging markets. Major infrastructure projects in emerging markets with private sector involvement have often garnered bad press in recent years yet the good news stories are easily forgotten. Wind power production in Brazil, for example, was 22 times higher in 2018 compared with 2010^[4]; the industry’s growth has been driven in large part by the involvement of an array of private investors and developers, both from Brazil and overseas^[5]. Other countries in Latin America, such as Chile and Mexico, have similar stories to tell.

The different dimensions of ESG in emerging markets infrastructure

Strong ESG practice has a critical role to play here, particularly given that the debate around investing (or not) in infrastructure in emerging markets often follows two opposing paths. The first, that such investments are inherently positive because of the economic and developmental rewards for the host country and communities. The second, that such investments carry too much risk, particularly socio-political, regulatory or currency risks.

The reality on both counts lies somewhere in the middle. Infrastructure projects developed with management of ESG factors at their core can help ensure that positive outcomes are achieved and negative outcomes are minimised^[6], but this only make sense in the first instance, if they are the right type of investments in line with key climate or development goals^[7]. Similarly, good ESG practice won’t help investors overcome currency risks, but a good understanding and effective management of social and governance issues can certainly play a part in mitigating political and/or regulatory risks. National governments are less inclined to interfere in projects with strong local community buy-in, for example.

The emphasis on social and governance issues above is deliberate. ESG integration by investors in developed markets is often heavily skewed towards environmental factors. In emerging markets, successful project development and operations is much more about social and governance factors. That is not to say that environmental factors are not important – protection of biodiversity and the climate is as much as an emerging market issue, if not more, as it is for developed markets. This reflects that many stakeholders in emerging markets look at the issue through a different prism. Take renewable energy as an example: for countries with low rates of electrification or expensive grid connections, the growth of the industry can be a social and economic issue first – with the aim of providing more access to more affordable energy – and a climate issue second.

Successful management of social and governance issues requires real commitment and attention to detail on the part of infrastructure investors. Thorough stakeholder engagement is critical to obtaining and retaining a social licence to operate^[8], and the COVID-19 crisis has placed this into ever sharper focus. Many PRI signatories with infrastructure investments in emerging markets have told us how social issues have dominated their asset management work in recent months. In part, this has been operational, to ensure the resilience of projects in the face of new business conditions. But investors have also had to be proactive in supporting local communities where food security or access to healthcare may have been put under strain by the impact of the pandemic.

Bringing investors and governments together

The burden of managing ESG issues should not fall on investors alone. However, in all markets, but perhaps even more so in emerging markets given their fundamental socioeconomic challenges, it is critical that investors and governments align their interests more effectively to achieve desired sustainability outcomes. The COVID-19 crisis is a special situation that has required creative solutions on the part of investors and governments alike, but in the long term, it is clearly not an investor’s role to replace the state in ensuring the wellbeing of its population. Moving forward, it is critical that emerging markets policy makers draw lessons from the crisis to ensure that sustainability and good governance are at the heart of their recovery and long-term development plans. Green taxonomies and sustainable finance roadmaps, such as those in development in a range of countries from Mongolia^[9] to Georgia^[10] and Malaysia, point one way forward on this.

Inevitably, this faces short-term challenges. Infrastructure spending is a powerful tool for governments; all too often the temptation is to channel spending towards projects that may boost an incumbent’s political position or result in short-term economic boosts without thought for the longer-term sustainability consequences, whether financial, or ESG-related. Already, we are seeing infrastructure investors based in different parts of Latin America and Africa coming under pressure to commit capital to such projects, at the risk of undermining their own ESG commitments. However, if they don’t commit to these projects, they face pressure (whether legal or reputational) from governments and other parties. Investors have engaged directly with the Brazilian government on deforestation^[11], which may be an opportunity for infrastructure investors with interests in emerging markets to support their local peers by engaging with governments as a means of ensuring that sustainability is built into their strategic infrastructure planning.

Building for the future

The right infrastructure projects in emerging markets can derive real benefits – whether on gender inequality, climate change, worker and community health and wellbeing, and more^[12]. That points to ways in which the conflicts that major infrastructure projects have resulted in over the years can be avoided with careful and creative management of ESG factors and long-term goals in mind. Moreover, without private capital, the annual $2tn infrastructure gap in emerging markets projects will only grow and climate and sustainability goals will remain unachieved. Emerging markets’ governments must have the vision to build back better; emerging markets infrastructure investors should be ready to play their part.

This blog is written by PRI staff members and guest contributors. Our goal is to contribute to the broader debate around topical issues and to help showcase some of our research and other work that we undertake in support of our signatories.Please note that although you can expect to find some posts here that broadly accord with the PRI’s official views, the blog authors write in their individual capacity and there is no “house view”. Nor do the views and opinions expressed on this blog constitute financial or other professional advice.If you have any questions, please contact us at [email protected].