Financing the Future: Leveraging the Power of Investment

Projected growth rates for emerging economies are slowing down. The International Monetary Fund (IMF) expects their convergence with more advanced economies to take place at less than two-thirds of the pace predicted ten years ago. Thus, millions of poor people will continue to struggle while the nascent middle class is unlikely to see its expectations fulfilled.

In a recent speech at the University of Maryland, IMF Managing Director Christine Lagarde said: “This is bad not only for emerging markets, but also for the advanced world which has come to rely on them as destinations for investment and as customers for its goods and services. It also carries the risk of rising inequality, protectionism, and populism.”

Emerging and developing economies now account for almost 60% of global GDP, up from just 47% under half a decade ago. Together, these countries have contributed more than three-quarters of global growth since the 2008 financial crisis. However, emerging markets are about to confront a harsh new reality. Growth rates are down, capital flows have reversed, and medium-term prospects have deteriorated sharply. In 2015, emerging markets saw an estimated $531 billion in net capital outflows compared with $48 billion in net inflows the year before.

The history of multilateral organisations in financing economic development dates back to the end of World War 2. The World Bank (WB) was set up in 1944 with post-war reconstruction and development as its mission. Today, its focus is on poverty reduction through providing financial and technical assistance to developing countries. It provides low-interest loans, credits, and grants to support sustainable investments in education, health, public administration, infrastructure, agriculture, and environmental management. Projects may be co-financed with governments, other institutions, or private sector investors. The International Finance Corporation (IFC, founded 1956 and part of the World Bank Group) works with the private sector in developing countries offering investment, advice, and asset management services.

Regional development banks such as the African Development Bank (founded 1964), the Asian Development Bank (founded 1966), the European Bank for Reconstruction and Development (founded 1991), and the Inter-American Development Bank (founded 1959) provide financial assistance to developing countries to promote economic and social development.

Such multilateral development banks (MDBs) primarily fund large infrastructure and other development projects, and provide loans tied to government reforms. Policies tied to loans may include commitment by the borrower government to privatise state-owned industries or reform agriculture or electricity sector policies.

However, there is a widespread belief within developing countries that the major regional multilateral banks are inflexible, bureaucratic and dominated by the political interests of wealthy shareholder countries.

China Takes the Initiative

Development_1

Regional MDBs such as the Corporación Andina de Fomento, (Development Bank of Latin America, founded 1970) and the Central American Bank for Economic Integration (founded 1960) have been in existence for years. Recently, China has taken the lead in the launch of two new MDBs: The Asian Infrastructure Investment Bank (AIIB) and the New Development Bank – aka BRICS Bank whose members include Brazil, Russia, India, China, and South Africa – are the first new MDBs created in decades.

China played the leading role in the creation of the AIIB. Despite pressure from the US not to join, the other 56 founding members include the UK, Germany, France, and Switzerland. China retains 26% of AIIB’s voting power. This gives the country a veto on major issues such as capital structure. However, China relinquished veto power on policy and lending decisions in order to attract broad membership.

The new institutions’ objectives are to address the financing needs of developing countries and increase the representation of emerging markets in the global economy. However, established agencies are worried that they could be undermined by the newcomers. Concerns are couched in terms of whether the new MDBs will adopt internationally-recognised best practices on governance, procurement, and environmental and social safeguards.

Insatiable Demand

The United Nations recently launched the biggest aid appeal on record. The UN Office for the Coordination of Humanitarian Affairs says that the number of people in need of aid has more than doubled in just over a decade. The escalating number of conflicts, disasters, and refugees beg the question as to whether the current approaches to aid and development are the most effective ways to prevent the suffering of millions of people. It can be argued that decisions about development aid should be taken at a local rather than global level.

Moves to improve the way the richer donor countries collaborate on development have accompanied an increase in the amount of official development assistance (ODA). Between 2000 and 2014, ODA increased by two-thirds in real terms and hit a record high of $134.8bn (£80.3bn) in 2013.

In 2000, UN members agreed on eight Millennium Development Goals (MDGs) to be achieved by 2015. These targeted eight key areas – poverty, education, gender equality, child mortality, maternal health, disease, environment, and global partnership. Goals included halving extreme poverty, stopping the spread of HIV/AIDS, and giving primary education to all children. The UN’s 2015 report concluded that the goals have driven “the most successful anti-poverty movement in history” and brought more than a billion people out of extreme penury. Even so, inequality remains extreme. UN Secretary General Ban Ki-moon said that while the 15-year push had yielded some astonishing results, it had left too many people behind.

As the MDG programme concludes, its successor Sustainable Development Goals (SDG) has set a development agenda for the next 15 years. The UN Third International Finance for Development Conference took place in Ethiopia in July 2015. The resulting Addis Ababa Action Agenda (AAAA) aims to provide a foundation for implementing the post-2015 SDG agenda. While acclaimed by UNICEF, other NGOs were less than impressed. The proposal to set up an intergovernmental tax body was dropped from the agenda and critics say that overall the AAAA shows a weaker commitment to financing for development than previous documents.

Lorna Gold of Trócaire, the Irish member organisation of CIDSE, the international alliance of Catholic development agencies, said: “More than five hundred civil society groups have expressed serious disappointment at the refusal of rich countries to grasp this historic moment to put in place a global tax body which will address serious issues around corporate tax avoidance and evasion. Without tackling tax issues, it is impossible to see how poorer countries can develop.”

Investors Seek Assurance

Investors – be they states, NGOs, banks or companies – are risk averse and seek assurances that their projects will operate under a stable regime with effective laws. Regrettably, some of the countries most in need of development are also the ones most affected by weak government.

The annual Fragile States Index 2015 assesses countries by key political, social, and economic indicators. Four countries – Sudan, Central African Republic, Somalia, and South Sudan – are flagged as very high alert, meaning that much as development is needed in these failed or quasi failed states, no sane investor would expect to see a return from projects.

Over the last decade, four countries – Senegal, Syria, Mali, and Libya – have experienced a critical worsening in fragility. Racked by strife, poverty, and religious fundamentalism, the prospects for these countries look grim. Each has its own conflict dynamics, political fragmentation, and humanitarian crises, yet the deepening fragility across the four states over the past year is reshaping the whole regional landscape. For all its pious hopes, the international community seems at a loss for solutions.

New Silk Road

Development_2

Traversing the deserts, steppes, and mountain ranges of Central Asia, the Silk Road historically linked the imperial dynasties of China with Europe. China is now engaged in a massive project to modernise this ancient trade route and restore its concomitant political and economic clout.

The country plans to construct roads, railways, ports, and other infrastructure across Asia and beyond. The Silk Road Economic Belt, nicknamed “One Belt, One Road,” will pass overland from China to Europe through Central Asia. The new Maritime Silk Road will traverse vital sea lanes from China’s coast through the South China Sea to the Indian Ocean and Europe in a one direction, and to the South Pacific in the other.

The project will see China’s state banks fund investment by Chinese companies on foreign soil. In December 2015, the country inaugurated a $40 billion Silk Road Fund. China’s state banks are already major lenders to countries along both new routes, bolstering Beijing’s bid to see greater international stature for its currency the renminbi.

Beijing’s foreign ventures will present the country’s companies with new overseas markets. A study by London merchant bank Grisons Peak scrutinised loans made by the two main Chinese banks used by the government to implement policy and estimates that fully 70% of their overseas loan portfolios were contingent on the purchase of Chinese goods.

Chinese state media say that to date over 900 projects are underway at a combined cost in excess of $890 billion. The American Enterprise Institute (AEI) says that about a quarter of the $246 billion in overseas investments in construction and engineering projects undertaken by Chinese companies from 2005 to 2014 have run into difficulties, which does not bode particularly well for the massive investments ahead.

Building Infrastructure

Infrastructure – transport, utilities, and telecommunications for example – are deemed essential to foster economic development. If they believe that the potential returns are good, then private investors may find such opportunities attractive.

The exploitation of mineral wealth in Africa could herald a railway renaissance on that continent. The global commodities boom is driving growth in Africa and should help rejuvenate some of its ailing rail networks. Currently, 35 African countries have railway networks.

Railways are largely state owned, and rolling stock is often obsolete and poorly maintained. Operators, financiers, and rolling stock suppliers are eyeing up the opportunities for private investment. South African firms believe that their local knowledge gives them an edge over traditional European suppliers from Europe and the US, and new players from China and India. Despite the political hurdles, investments are taking place: Zambia’s Northwest Rail Company is collaborating with a South African locomotive manufacturer to build a new 590km railway from Chingola in the copper belt to the Angolan border.

Petrodollars Fuel Diversification

The bulging coffers of the oil-rich emerging economies of the Gulf enable these countries to embark on transformational infrastructure investment without recourse to MDBs. Notable examples include UAE’s Masdar City and Saudi Arabia’s King Abdullah Economic City (KAEC). However, while finance may not be a major issue, other problems loom and both these two projects are behind schedule.

In 2005, Saudi Arabia unveiled plans to construct a £67 billion mega city on the Red Sea. The aim was to build a metropolis with industrial, manufacturing, and tech capability so that the kingdom could diversify into a global logistics and manufacturing hub and provide housing and job opportunities for a young population, of which 65% are under the age of thirty. The city was being privately financed by Dubai developer Emaar. When it offered its first public offering in July 2006, more than half of the Saudi population bought stock. However, it has needed a government loan to see it through the global financial crisis.

Plans for KAEC include four main components: the port with a projected capacity of three million containers; the industrial valley, a number of coastal communities, and the Hijaz downtown district. So far, the city has around 3,000 residents but this is expected to increase tenfold by 2020 with the ambition of eventually accommodating two million residents across seventy square miles.

Attracting foreign manufacturers to the new city site is an important plank of the development. However, this is not going well: last year Jaguar Land Rover (JLR) scrapped an ambitious plan to build a KAEC factory which would use Saudi-produced aluminium in its premium lightweight vehicles. Indian-owned JLR signed a letter of intent with the Saudis in December 2012 to build a facility expected to produce about 50,000 cars annually by 2017. However, discussions foundered and JLR has subsequently switched its investment to new facilities in China, Brazil, and Slovakia.

Chile: Profiting from the Commodity Boom

South America’s rising star, Chile is often held up as a model for economic growth. Since the demise of military rule in 1990, successive governments have kept and expanded the former regime’s economic policies in order ensure the country’s success on the world stage. One of the world’s major producers of copper, the country has benefitted from the commodity boom that followed the economic awakening of China. High prices for the raw material enable Chile to fill the coffers of its sovereign wealth fund, which it is now drawing on to maintain government spending level despite copper’s recent precipitous price drop. In its 2016 draft budget, the government of President Michelle Bachelet highlighted education as the national priority. In a nod to foreign investors, the Bachelet Administration also redirected national spending to support promising economic sectors.

Although its historic current account surplus has vanished, Chile remains confident it can run a structural fiscal deficit for a few more years without unnerving the investment community. It anticipates that copper prices will rebound before the coffers are emptied.

Meanwhile, Bolivia is undergoing a striking economic transformation and, to the surprise of many, is now home to Latin America’s fastest growing economy. For almost a decade, Bolivia’s economy has expanded at a clip of more than five percent annually on average. Fuelled by gas and minerals, the country’s GDP has tripled to about $30 billion. Notably, Bolivia now maintains a balanced budget, a high level of international reserves, and low inflation rates.

Natural resources such as hydrocarbons, minerals, and lithium are vital to Bolivia’s economic well-being. Natural gas (45%) and minerals (25%) account for around 70% of the country’s exports and have been the main drivers of its rapid economic expansion.

In the eleven years that President Evo Morales has been in office, he has adopted pragmatic policies which enabled prosperity to spread via a bottom up entrepreneurial culture. This has given the marginalised and poor opportunities to create their own businesses and thrive in lightly regulated markets. His regime is characterised by a laissez-faire attitude to informal and small-to-medium enterprise, many of which are doing quite well.

President Morales declined to join the US War on Drugs and summarily rejected the helping hand of the international financial system in the guise of the IMF and World Bank. In declining their loans and interventions, President Morales has opted to turn away from multinationals and instead encourage small to medium local enterprise. By standing back and letting freedom and entrepreneurialism of the people thrive, prosperity has spread, inequality has diminished, the country transformed.