Thank you very much for the warm welcome and for your kind introduction. I am delighted to be here today. Having managed a $100 billion portfolio as chief strategist and head of Brazil’s second largest private asset management firm, I feel very much at home in this setting. Now, as the Managing Director and CFO of the World Bank Group, I left the buy side and have become a broker between the buy and sell side, guided by the mission of eradicating poverty and promoting shared prosperity around the globe. This places emerging markets’ prospects and policy efforts at the center of our action. It is indeed very special to address such a distinguished audience in a time of so much uncertainty.
I see many familiar faces, which suggests to me that there is still some stability in this very uncertain world. And it could also suggest that the current nervousness in markets might be overdone, since you have been able to take the time to be here today. Or, perhaps you see the situation more as the “calm before the storm”, and you have come to hear some uplifting words as you ponder how to best negotiate the challenges affecting your business over the near term.
Either way, since things are the way they are, they will not stay the way they are−and all of us need to be ready to consider and embrace change. In this spirit, let me share with you a few of my thoughts on the challenges and prospects of emerging markets, and how the World Bank Group is engaged in fostering new investment opportunities across the globe.
Let me first look at the current macro situation regarding emerging markets. Emerging economies already make up almost 60 percent of global GDP, although they account for a much lower share of the world’s total physical and financial capital. Developing economies have accounted for more than 80 percent of global growth since the start of the global financial crisis. But the growth of emerging markets has tapered off as global growth looks set to soften, largely reflecting stalling global trade, weak investment, and rising policy uncertainty.
According to the World Bank’s June projections, global growth for 2016 is estimated at 2.4 percent, broadly unchanged from last year, but subject to potential downward revision based on information to mid-September. Growth across emerging market and developing economies remains just above last year’s post-crisis low. We project 3.5 percent for 2016.
Commodity exporters continue to struggle to adjust to low commodity prices and headwinds to domestic demand, with growth near zero again this year ─and recession in some countries; however, there are tentative signs of stabilization in Brazil and Russia, which have somewhat reduced tail risks over the short term.
Larger commodity-importing emerging economies have proven more resilient.
- In India, growth has remained robust, with consumption bolstered by low commodity prices and consumer sentiment lifted by the government’s structural reform efforts, including in the equity market. In particular, having recently visited India, I can testify to the government’s strong desire to work with the private sector to build new or modify existing infrastructure. The World Bank is indeed supporting the scale-up of the government’s solar strategy.
- In China, growth continues to slow gradually, as private investment decelerates and the rebalancing towards more domestically-oriented sectors continues. The internationalization of the RMB makes important strides and we are moving towards its inclusion in the SDR basket by the end of this month.
- Also other emerging market countries in East and South Asia and the Pacific have shown resilience, and central Europe will continue to benefit from the dynamics of the German economy; but Latin America, the Caribbean and Sub-Saharan Africa do show some weakness. The latter countries are adjusting, but challenges are obvious in places like Nigeria, where oil revenues used to make up more than two thirds of fiscal revenues and have now declined. Finding new sources of growth ought to be the focus of policy in these places and has to be done in a way that is compatible with attracting private investment.
Hence, while the outlook remains broadly balanced, medium-term risks to the global economy are rising. The side effects of prolonged monetary accommodation in advanced economies are increasing. Policy uncertainty, including on trade, is also increasing. In this environment, emerging markets with large financing needs but unfavorable debt dynamics are, of course, the most vulnerable.
So after what I just told you, why would anyone invest in emerging markets?
There are a few reasons to respond positively to this question. First, valuations have improved vis-à-vis five years ago. Second, low growth and low interest rates reflect structural gaps in advanced economies, notably declining productivity, low business investment, and the effects of ageing populations. And the political will to implement pressing structural reforms is often constrained by a risk averse electorate, especially when you have to deal with issues related to ageing. Hence, the scenario of low returns (but rising savings and continued slack) in advanced economies may persist and it will continue to create challenges for investors and asset managers.
Capital may have to travel in a world where people and goods may face higher restrictions to movement. Investors are adjusting to lower expected returns from traditional investments, resulting in more savings or cash being set aside awaiting more attractive opportunities. Therefore, creating long-term income flows, backed by assets that respond to real demand, even in far away and challenging geographies, can be a good way to stimulate aggregate demand and an effective allocation of the savings of ageing advanced economies. In this sense, public sector support to this investment and to the time consistency of its flows may be a way to promote shared prosperity.
This is why it is worthwhile to take a fresh look at broader investment strategies and at what multilateral development institutions can do to expand the frontiers and scope of markets−despite our own modest balance sheet. I submit to you that investing in long-term projects where you find young populations and potential for higher productivity rates may be an effective medium-term strategy and can help bring the world back to a healthier “normal”. Similarly, there is room to take advantage of changing market perceptions about the expected returns of investment in climate-friendly activities.
At the World Bank Group, we believe in the potential for great and shared gains from closing the gap between capital and investment opportunities. We have developed policies and instruments that facilitate the flow of capital to infrastructure projects and actions against climate change, especially in emerging markets. This way we can help address the current investment gap−and even more so in an environment where funding is cheap but business investment in advanced economies remains weak.
What then would be special about infrastructure investment or the fight against climate change that would lead one to believe they might help an entire industry?
Infrastructure development may help address macroeconomic problems ─ a result of its potential to raise confidence and boost productivity. I just mentioned the limits of monetary policy -- we have also come to realize that expansionary fiscal policies that do not support productive investment to create rewarding assets may fail to boost consumption because people will expect higher taxes in the future to compensate for today’s additional spending. This is Milton Friedman’s permanent income hypothesis that consumers are forward-looking; they do not spend just because they are given money today─they spend according to their belief about their average long-term income. By raising potential output, infrastructure investment does raise these income expectations.
Infrastructure also creates larger capital flows to new markets if investment is affordable and protected against political risk.We all know that high consumer spending, especially in emerging markets, is often hindered by inadequate infrastructure. People may be able to afford an air ticket, and fuel may be cheap, but if you lack good airports, air travel will not “take off”, and many services will not demand labor.
Infrastructure investment also raises productivity if it responds to well-identified demand, including investment in clean energy [to forestall the costs of climate change] and in support of new technologies. For example, 4G and 5G mobile technologies continued to have a significant impact on the productivity of several sectors in developing economies, including in Africa, and help create new sources of growth through financial inclusion and many other ways. This is particularly important given that global trade has slowed down, with repercussions that are not restricted to commodity exporters.
And of course, infrastructure is big. This helps asset managers justify the investment in research required before actively jumping into new strategies, especially if we work to reduce the informational hurdle that still confronts the sector.
Indeed, the risks associated with infrastructure investment may not be what people think they are. A recent study by Moody’s based on the performance of over 53-hundred projects, representing more than 60 percent of all project finance transactions worldwide in the last 30 years suggests that:
- Default rates are noticeably lower than in other sectors (and default rates for PPPs are even lower);
- Project finance transactions in emerging markets demonstrate resilient credit strength, with average ultimate recovery rates high, at 80 percent across the studied projects.
So, given all these factors, why are global investment flows not higher, even if institutional investors hold more than $100 trillion? Why does engagement in emerging markets, especially low-income countries, remain low? Indeed, according to a 2014 OECD survey of 71 large pension funds, only slightly more than one percent of aggregate investments were held in infrastructure financing, and almost none was in emerging markets. Does it not pay to be active?
There are very concrete reasons for this low appetite, although they need not to be permanent. There is work to be done before we see a surge in flows in this risk-averse world of ours. In particular, if new sources of financing are to be mobilized, public-private partnerships are needed. Infrastructure requires vision and coordination, therefore it requires an effective engagement of the public sector to address certain risks and to provide a framework under which the private sector can prospect adequate investment opportunities. Such an approach requires countries to:
- Develop solid investment plans and partnerships with multilateral institutions to accelerate structural reforms, including the development of domestic capital markets;
- Provide risk management instruments where risks cannot be eliminated (or substantially mitigated) over the near term;
- Enhance financial regulation affecting risk-taking over different time horizons, geographies and sectors.
Our task, at the World Bank, together with markets, is therefore to help bridge these gaps. In partnership with governments and other institutions, we are supporting regulatory reforms to reduce restrictions on cross-border risk-taking and to promote the mobilization of financial domestic resources in emerging markets. We are expanding the range of our risk-mitigation instruments, including to the poorest countries, with the help of the International Development Association (or IDA in short)—our financing arm dedicated to these countries. And we are also working with market players to populate the infrastructure space with benchmarks and other mechanisms that asset managers need to increase their allocations to these markets.
Let me be clear: I understand the very real concerns investors may have about investing in emerging markets and in infrastructure. Concerns about political instability, corruption, regulatory hurdles, foreign exchange fluctuations, lack of transparency and information about project opportunities. These are some of the most common concerns, and I’ve heard many more.
This is why the World Bank has stepped up efforts at all stages of a project’s lifecycle, including:
- UPSTREAM, at the level of project preparation, identification and operation, we are developing tools to help governments prioritize Public Private Partnership (PPP) projects, manage fiscal costs, and make decisions more transparent and efficient, for instance, by simplifying and harmonizing contracting and procurement.
- Many of you are familiar with our Doing Business Report, which provides objective measures of business regulations and their enforcement across 189 economies – this week the PPP unit at the Bank is launching a report entitled Benchmarking PPP Procurement 2017, where we assess the environment for developing projects as well as the quality of regulation and procurement.
- Also the World Bank-hosted Global Infrastructure Facility (GIF), which benefits from the support of several of our shareholders and the advice of managers of $13 trillion in assets, is gearing up its pipeline of high-quality, well-prepared projects. This also provides more comparable data on government infrastructure programs around the globe—so that asset managers can get a better sense of the magnitude of the infrastructure space and the work required to create actual investment opportunities.
- MIDSTREAM, we are making a wide range of guarantee instruments more understandable and understood. Many of our guarantees can be issued in different currencies, for any sector, and in a variety of structures to match the needs of individual transactions. Over the past three years, we have offered up to $3.5 billion in guarantees, which are expected to mobilize or support co-financing of $17 billion in commercial capital. We are strengthening this line of business to serve our clients and the financial community, helping de-risk projects to adequate levels. This work may also help develop more standard structures and documentation that could turn infrastructure debt into an asset class.
- DOWNSTREAM, we aim to foster a workable environment for financial players in a world driven by significant changes to banking and insurance regulation, which have put new bounds for the appetite of traditional sources of long-term finance. And also to deal with tax regimes in emerging markets that may have had similar impacts. The World Bank Finance and Markets team works closely with many countries, such as Colombia and Peru to develop domestic markets and enhance regulatory frameworks for issuers.
We also have developed a number of investment grade instruments to support demand for infrastructure investment. These instruments include the IFC Asset Management Company (AMC)’s Global Infrastructure Fund, geared towards giving institutional investors access to existing IFC portfolio, as well as IFCs Managed Co-lending Portfolio Program (MCPP) that offers institutional investors the ability to participate in IFC’s future senior loan portfolio. And we are working with market players to develop meaningful infrastructure fixed-income indexes to facilitate the management of larger allocations in this space.
In sum, we have mapped several gaps and are working to bridge them, as we believe infrastructure investment can help raise both the level and trend of potential growth in emerging markets, and address the challenges of climate change.
Getting back to India, their plan for renewable energy, aims at building, over the next six years, capacity equivalent to all electricity generation capacity currently existing in the UK. These hundred plus GW of capacity are an investment opportunity not to be missed and may provide long-term allocation opportunities to capital earning very low returns elsewhere. It can also help diversify currency exposure for many institutional investors. I think this is an inspiring example of a broader approach that could make many of us active managers again.
By now, you realize that our approach at the World Bank vis-a-vis emerging markets includes helping governments and the financial community with as many tools, information and insights as we can to ensure that we all work together to reduce the mismatch between capital and investment opportunities, thus helping reduce extreme poverty and addressing some of the causes of low returns and high uncertainty in our world on a clear strategy towards our goal of shared prosperity.
I look forward to hearing from you with your ideas on how best we can achieve this objective.