Unedited Event Transcript Conference on Multilateral Development Banks and Asian Investment: Introduction and Panel I Introduction

Adam Posen, Peterson Institute for International Economics Domenico Lombardi, Centre for International Governance Innovation Anne Van Praagh, Moody's Investors Service

Panel I: Infrastructure Needs and the New Silk Road Andrew Davison, Moody's Investors Service Simeon Djankov, Peterson Institute for International Economics

Peterson Institute for International Economics, Washington, DC September 30, 2015 Adam Posen: Good morning everyone. Welcome back to the Peterson Institute for

International Economics and welcome to all our friends watching the webcast live. I am Adam Posen, President of the Peterson Institute. It’s my great pleasure to be bringing you here for this joint event we do with Moody’s on sovereign debt issues and related concepts.

We’ve had a series of rich discussions in today’s multilateral development banks and particularly the need for them and for infrastructure, spending in Asia I think is particularly topical for a variety of perspectives. Very grateful to have this partnership with Moody’s on substance. Anne Van Praagh, who’s my main partner in this, and all our colleagues were delighted to move that forward, but I also want to recognize my friend Domenico Lombardi and our colleagues from Centre for International Governance Innovation.

We do a number of partnerships with them, including on central banking and governance issues and Anne and I felt that on this occasion, it was great to broaden out our audience to bring in the CIGI network and some of the CIGI scholarship. So, we are reaching out to our core economists, to Moody’s market people to CIGI’s international governance and NGO community, all of which, of course, overlap, but which, I hope, will provide us with a very fruitful discussion today.

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I look forward in particular at lunch to having my dear colleague and noted independent thinker Simon Johnson give us a keynote on the rules for the international economy in the 21st century, but we’re also featuring a very important new study from Moody’s from Steve Hess, basically where do MDBs spend their money. And, I think, that this is a key place for us to take off from. And, again, I’m glad we’re able to bring together multiple perspectives on these critical issues. I will turn it over to Anne in a moment.

First, I just want to make two announcements. First is just to say we traditionally do this and we also do activities with CIGI around the IMF World Bank meeting. This year they decided to take the IMF World Bank meetings on the road. That’s their problem, not ours. But we are going ahead and, in addition to this event, tomorrow will be our semiannual global economic prospects meeting led by David Stockton on the US and the global policy outlook featuring Nicholas Lardy, who, of course has an independent—and not to be contrarian for contrarian’s sake but at this point, contrarian to the panic view on China, as well as some issues of long-term fiscal and income developed by our new fellow, Paolo Mauro and these are things that I think will be in dialogue with Moody’s and others in the time to come.

Second announcement is just to say that we are in the midst of a very busy season here. There’s a lot of intention on think tanks and their behavior. We are very proud of our supporters and our partners, but we are also so proud of them we disclose everything. If anybody would like to know where our funding comes from or how we decide and how we quality control our publications, I refer you to www.piie.com and it’s all there. Just because of some reports in the press, I thought I’d remind people about that. But I hope it goes without saying. Anyway, not about us, by the way, just to be clear.

If I could just for a moment ask Domenico Lombardi from CIGI, who leads our Global Economy program to say a few words and then, turn it over to Anne to lead the first panel.

Domenico Lombardi: Thank you, Adam, for your kind words. I just want to reiterate that we at CIGI are very happy about our work partnership with the Peterson Institute and we are delighted to partner today with Moody’s Investors Service.

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Just as a way of introduction, I would like to make just four quick points in terms of the issues that we are going to discuss today and issues that we closely follow at CIGI, the Centre for International Governance Innovation.

So, when we talk about Asian investment especially investment in infrastructure, essentially we talk about four fundamental things. The first is how to create better regional markets and how to integrate these better regional markets in Asia with the rest of the world economy. But this is an endogenous regional dynamic that we have seen at play in other regions as well.

However, when we talk about Asian investment, we also talk about the size. And you might recall a study by the Asian Development Bank a few years ago, they were essentially estimating the need for Asian infrastructures in this decade at some 8 trillion essentially a little bit short than 1 trillion a year.

This compares and contrasts with the investments that so far have been put forward by, you know, the Bretton Woods institutions, the multilateral development banks and in fact, we are going to talk about these issues at length today. But this also speculatively also reflects, you know, huge opportunities for investors and these however, will also depend on how open the initiatives, the regional initiatives that are currently shaping up in Asia will be. And I think this is also one of the reasons why we are here today. So, I am looking forward to a very rich discussion and thanks Adam for setting this up.

Anne Van Praagh: Great. Thank you everybody and thanks to Adam and the Peterson Institute for hosting what I hope will be a very interesting and engaging event. I’d like to acknowledge my colleagues from Moody’s that are here today. Steve Hess will be presenting later today and we have Matt Kulakovskyi, who’s the contributor to the report. And hopefully, we’ll have an interesting dialogue as the day goes along.

I think that this particular topic is very interesting for a couple of reasons. So we know that the number of world leaders met this week. They have adopted what is a sustainable development agenda for 2030, outlined a plan for meeting basically society’s needs and the planet’s needs over the next decade and a half. This is a pretty groundbreaking culmination of what has been a two-year process and I think that outlines not only what

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the world’s needs are, but also the role of multilateral development banks in meeting those needs.

So, it is a very interesting topic. It’s one that we’re very focused on at Moody’s. We have about 35 ratings on MDBs and we’re going to tell you a little bit more about those, the characteristics of those multilateral development banks and some interesting findings that we’ve been looking at.

It’s also an interesting topic now. It’s interesting now because China. China is at a pivotal moment. It is growing slower than people expected. There are questions about this stop-go nature of its rebalancing effort. How successful will it be in managing this transition from what was a very government-led, heavy investment led growth paradigm to a rebalanced economy, more consumption driven and at what pace that will happen, how well managed that will be?

That’s very much a focus from our perspective from a sovereign credit risk perspective. I manage the sovereign ratings team and the supranational team at Moody’s covering the Americas, the Middle East and Asia. So, China is very much on the minds of us, many of us at Moody’s these days. You put these two things together, MDBs and China and I think you have a very interesting set of topics and that’s really the basis for our discussion today.

So, our first panel, I’ll introduce our speakers in a minute here. We are going to take a slightly different format. We’re going to take a fireside chat format. So, we’re going to have some brief introductory comments with some slides and some moderated O&A and we’ll use some of our visuals to help us along the way.

But, let me introduce my co-panelists here. We have Andrew Davison. Andrew is a Senior Vice President with Moody’s. He is in the infrastructure finance team based in London and Andrew brings, in addition to his infrastructure finance experience at Moody’s, he’s also been leader ranger and financial advisor in infrastructure financing, including project finance for many years. So welcome, Andrew.

Andrew Davison: Thank you.

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Anna Van Praagh: We have Simeon Djankov. Simeon, as many of you know, was the Deputy Prime Minister as well as the Finance Minister of Bulgaria from 2009 to 2013, very pleased to have Simeon here. Simeon was one of the early thinkers on the One Belt, One Road initiative, the Silk Road initiative. That’s going to be a subject of our panel today. Simeon, some of you know also from the World Bank his role as an economist there so very pleased to have these impressive speakers with us today.

I thought I would start just by framing the issues for us a little bit and we have some prepared slides. I think it’s not a surprise to anyone in this room. You’ve heard the estimates around the infrastructure finance needs are globally. 60 trillion is the number that people have talked about. The McKinsey study showed 60 trillion by 2030. These are big numbers. No matter how you define it, no matter how you measure it, it’s big numbers and the large and growing requirement for infrastructure investment is very much high on the agenda of policymakers across the globe and the rationale is compelling. Advanced economies have big infrastructure needs. Anyone who’s been through New York recently knows the aging infrastructure issues that we face.

And at the same time, we have very low borrowing costs across many developed economies at this point, which should make infrastructure investment attractive. Emerging markets and frontier markets will benefit from infrastructure investment to address infrastructure bottlenecks.

So, it’s clear to us that there is a strong rationale at this point to use infrastructure to help alleviate some of the growth constraints that we’re facing around the world. As the chart shows, the quality of overall infrastructure is lower for low, middle-income countries. Those are the green dots. And the scale of infrastructure is vast.

So, if you think about 60 trillion, you know, how do you carve that up? Well, I think one interesting and large piece of that that we’ll be focused on for quite some time to come is the One Belt, One Road initiative. This is an ambitious, intraregional plan. It involves potentially more than 40 countries in Central and South Asia, the Middle East, Eastern and Western Europe. And the idea is to create an unbroken transport and infrastructure network. It’s made up of the Silk Road Economic Belt cross Western and Central Asia and the 21st century Maritime Silk Road. And one interesting statistic that Andrew always likes to remind me of is that this is an initiative that affects two-thirds of the world’s population and basically one-third of GDP. So, it is vast in scale.

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The plan is designed to enhance China’s trade and financial linkages. China will gain from greater energy import diversification. Energy supplies from Russia, Central Asia will be developed as alternatives to their traditional Middle East and African suppliers. Regional integration will also create demand for Chinese capital and consumer goods exports as well as services at a time when demand from traditional markets, such as Europe and the US, remains historically weak. You see the blue line there. Those are the 40 One Belt, One Road countries that I mentioned earlier and that the growth trajectory there of Chinese exports by destination is impressive particularly relative to the US and the European Union.

So from a sovereign credit perspective, we see the One Belt, One Road as credit positive for most sovereigns who will be beneficiaries of funding coming from this initiative. More than two-thirds of the countries that fall under the One Belt, One Road initiative are either unrated or they’re rated below investment grade. That’s probably a familiar group of countries to many of you who work at multilateral development banks and you know the challenges associated with bringing to bear projects and project finance and infrastructure finance to these areas.

But we do see that enhanced trade and investment will ease downside pressures on GDP growth so that we think the net credit impact will be positive. You can see in the pie chart on the left the grey slice and the blue slice. Those are the ratings that we consider, that we call below investment grade. And the One Belt, One Road countries, the 40 that I mentioned, are shown in the orange bar. And we’re forecasting that growth will be slower for those countries, but the average forecast for 2015 to 2019 among those 40 countries is quite high, among the highest in the world so some pretty interesting opportunities for those countries.

We do see South and Southeast Asia likely to benefit most from infrastructure investment. There is the potential to really transform the economies in these countries spurring investment and growth, especially for the smaller and poorer countries – Bangladesh, Cambodia, Pakistan, Vietnam. We think these are likely to be the biggest beneficiaries. A number of these countries have projects already under way with the One Belt, One Road initiative and Simeon’s going to address some of that in a little bit.

The other way that we think about the One Belt, One Road is how is this likely to affect sovereign debt profiles? We do see that loans extended by

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China, either on a concessional or on commercial basis will raise government debt burdens. We know that the Asian Infrastructure Investment Bank and the Silk Road fund will boost China’s importance as a source of external finance. China is already a very important source of finance for many countries. Commercial borrowing may raise budgetary pressures with countries that have weak fiscal policy. And government debt burdens, which are currently moderate but depend on foreign financing, will be a little bit more exposed in that respect.

So, one last comment from me before we move to our Q&A session here is that one interesting observation that we’re going to talk about later in our MDB discussion is that there is greater financing required for lower rated sovereigns.

Lower rated sovereigns typically rely more on foreign financing and there is a strong correlation between sovereign ratings and current account balances. So an interesting trend to watch will be to what extent the One Belt, One Road strategy initiative projects will affect the balance of funding sources for particularly the lower rated countries that are typically more vulnerable to periods like we’re in now where you have more volatile capital flows.

So with that as an introduction, I thought it would be interesting to turn to Simeon for a few comments about his involvement in the One Belt, One Road strategy. As finance minister, you were in some of these meetings with other government officials, conceiving this plan and I thought the audience would be interested in your personal experience.

Simeon Djankov: Thank you. In preparing for this panel we had several conversations by phone and actually, something I had forgotten as experience from my time in the Bulgarian government when I was, as I mentioned deputy prime minister and finance minister came up which actually is quite relevant for today’s discussion.

Late, I think it was October 2011, in the midst of the Eurozone crisis where most finance ministers were dealing not with their countries, but with Greece, I get a call from my prime minister and he says, “What you are doing?” You have two choices. To say nothing which means he’s going to give you more work or to say I’m extremely busy which is the right response. So, I say extremely busy. He says, “You immediately get on to a plane and go to Warsaw.” “Why?” “Tusk called—the prime

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minister then, Donald Tusk called—and he’s calling an extraordinary meeting of all heads of governments of Central and Eastern Europe, but I cannot go so, you’re going today, immediately.”

So, with this I go and I call him from the airport and say, “Well, what’s the meeting about?” And he said, “I didn’t understand. So, they were in a hurry, but they’ll brief you I’m sure when you land.” So, literally from my ministry I get on the plane, get there. And when you land you ask, “What is this about?” And the ministry officials meeting say “Well, frankly we don’t know either, but I’m sure by the evening you’d be briefed.” In the evening indeed we learned that the Chinese premier has come with a large delegation after being in some of Western European countries and has asked Donald Tusk to organize this extraordinary meeting. And it was extraordinary in the sense that it happened for the next day.

The next morning we meet and indeed, I think about 22 heads of governments from Central and Eastern Europe, including some of the caucuses like Georgia and Armenia were there. Expecting what the topic is going to be, we’re not really announced the topic other than the Chinese premier is there with a large delegation. And we learned this is the first time when I learned the term the New Belt Road.

The comment was that the Chinese government with some academics has been preparing for a year; it was said at the time. So 2010 was the genesis, this idea as a way to bring different countries economically together. So, this picture that I’m just showed was the first time shown there from Sri Lanka, Pakistan, all the way to Germany and create this New Silk Road and that they are very interested to have an annual event with the heads of states of Eastern and Central Europe basically to see how this will progress over time.

Naturally, there are lots of questions, but nobody was allowed to ask questions at this first meeting. Like, one question, Poland was not really part of the original Silk Road, but yet we are meeting in Poland. But the more interesting part of the meeting is that in the afternoon we’re again at lunch told every one of you has 45 minutes with the Chinese premier to talk specifically about his country’s plans on the new Silk Road. Imagine, we’ve just heard of this initiative, 45 minutes, one-on-one with the Chinese premier. And indeed one-by-one we went and talked about our own country’s perspective on this possible at the time initiative. None of what we know today was known then and the conversation, at least in my

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case, was, well, my first question which, I think, is a natural question is why is China interested in some of these countries?

Bulgaria is a mid-sized country in Europe, but frankly, a relatively small country, 7.5 million population. Some of our neighbors are you know, less than a million people. So, it’s not like large, large investment projects can happen there. So, I ask this question to the Chinese premier. Why are you interested in this region? And he said, basically we want to know more about these countries. We don’t know much, we haven’t been investors in the past, not just in infrastructure because the conversation from the very beginning was infrastructure. Hopefully later we’ll talk about the fact that at least the investment that is so far happening are not only in infrastructure, they are broader on that. But, he said we want to know about this region more so that economically we can develop in the future.

And in closing, just one point I want to make, so they want to know more. I thought about it then and I think increasingly about it now. At the time, Chinese companies were trying to penetrate the infrastructure market, particularly in the new EU countries, like Bulgaria, Romania, Poland and so on and they were quite unsuccessful. So, there were many projects funded by Brussels mostly. So, money was not an issue, but you’d see Chinese companies applying for such projects, having the lowest prices, but somehow objectively or subjectively, we can discuss this more, they were consistently rejected for quality reasons, for other reasons.

So, there was one, as of 2011, there was one project, one large infrastructure project in all of eastern Europe and this happened to be in Poland. So, I think that was perhaps why Donald Tusk was the host of this meeting. They had not penetrated any of the other countries. So perhaps in closing, the rationale for this initial meeting, and it has happened since, I have been to two other meetings, 2012, 2013, like that was to indeed see whether there is some room for investment opportunities for Chinese companies in the region. As we’ve learned, it’s not just investment. They since have invested in some other projects as well.

Anne Van Praagh: Yeah. So, Simeon, give us a little bit of a sit rep on what’s happened since those early days. What projects have been done, which ones are ripe for being done now?

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Simeon Djankov: So, since then as I mentioned, every year there has been this annual meeting. It’s hosted in different countries. It was in Romania, in the Czech Republic, in Serbia this year and all the heads of state by now are visiting and are showing a number of projects. So, there is certainly a lot of interest in our region, in how to work with the New Silk Road initiative.

Initially, a big road block was that in order to invest in such projects, the various Chinese institutions involved were asking essentially for sovereign guarantees, but those who have done public finances know that with sovereign guarantees you’re basically increasing your [inaudible 00:24:40] debt level, but important at this time in Europe also your deficit.

So, from the very beginning 2011/2012, we started having a discussion can this be done on a project finance basis, something that perhaps Andrew will tell us about. Otherwise, as long as it is sovereign guarantees, the majority of countries would not be that interested and the countries that would be interested as Anne mentioned, are countries that are lower ranked, have lower ratings and as a result, this is a way for them essentially to get to the international markets.

So, if you look where projects now either completed or near completion, in Eastern Europe we have Serbia having basically a completed project which is a bridge over the Danube. Macedonia having a nearly completed project which is basically an extension of an idea to go from Budapest in Hungary through Serbia from Macedonia to the Greek ports and in this way basically have a transport corridor of cargo trade coming not just from China, but primarily from China and getting to the heart of Europe so several countries.

Hungary has announced that they have just signed a contract for their part of this transport corridor, but Serbia, Macedonia, there is a project that is signed in Montenegro. So, basically the smaller former Yugoslav countries have some projects.

One rationale as I have mentioned is that they have lower credit rating. So, this is a way for them to get cheaper financing and importantly by now, no sovereign guarantees. Another rationale which I think later in the discussion would come up is that individually these countries are quite small and their infrastructure projects also are quite small.

But if you combine them, something that frankly other international institutions have not been good at—I was for many, many years at the World Bank as you mentioned. We’ve tried many times to do cross

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country projects and it doesn’t quite work in the World Bank framework while the New Silk Road initiative is very good at that. So several countries basically line up, present together a project like the Budapest to Athens transport corridor and this happens.

There is a project signed by Russia—we’ll talk about Russia later—hopefully on an another part of type of rail project that basically connects Moscow to Kazan which is a city in the south and from there it would go to another section which is already built in Kazakhstan that connects Kazakhstan to the Russian border. So, this is another part of the new Silk Road to get from China towards Russia and then from there to Germany. And then there are some projects, maybe Andrew will mention that are done in Sri Lanka, that are done in Pakistan, but here and there we already have infrastructure projects. I’ll finish with this.

In the case of Russia at least, I know of projects that have nothing to do with infrastructure. Well, we can argue that everything is infrastructure, but as part of the New Silk Road initiative, for example a Russian state-owned company has gotten about $2, $2.5 billion equivalent for nanotechnology projects.

So, in closing, I’d like to say that in my view, the new Silk Road will be mostly on infrastructure, but over time, it would expand to some related industries depending not just on economic rationale, but I would say also on political rationale.

Anne Van Praagh: Great. Thanks. Okay. We’re going to shift gears a little bit. We’re going to take a look at where this funding is going to come from. And with that, I’m going to ask Andrew to give us his thoughts on exactly how this new infrastructure is contemplated, how is it going to be funded?

Andrew Davison: Anne, thank you, and pleasure to be here everybody. So, we heard from the introductory comments that the size of investment required is significant. Recently with specific reference, the One Belt, One Road initiative however, the China Development Bank has pointed out that over $1 trillion of projects are currently under development associated with the One Belt, One Road initiative.

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Now, when we compare that with the available resources by the time you look at the aggregate assets, the aggregate debt which is outstanding from multilaterals—my collage Steve Hess will comment on this later—but essentially we’re talking about a similar order of magnitude, $1 trillion plus of outstanding debt from all multilaterals today.

Yes, the Asian Infrastructure Investment Bank and policy banks will contribute significant funding resources, the Silk Road fund, a state-owned development fund seated with $40 billion, but these contributions really just start to scratch the surface and some of the themes that we’d like to develop in this panel are the need to catalyze and mobilize private sector finance to be able to deliver these very significant quantities of infrastructure assets. That’s the very simplistic answer.

However, in the infrastructure sector as ever, the issues are a little bit more complex and in fact, Simeon touched on some of these issues. What is infrastructure? What isn’t infrastructure? We might conceptualize core infrastructure. For example, roads, yes, Bridges, yes. Power transmission, power distribution, clean water, waste water, airports, sea ports. Okay, core infrastructure.

What about motorway service stations? What about shopping facilities in airports? What about the nanotechnology facilities which are related and which have or carry industrial growth potential. Now in our view, these are not core infrastructure, but some investors might look at those characteristics and say, okay, there is still resilience in revenue streams associated with these investments.

So, from a Moody’s perspective, when we look at this universe of infrastructure, what we’re looking at, in fact, within that infrastructure word it carries the connotation discrete subsectors with homogenous risk characteristics, but the uniting characteristic of infrastructure is a fundamental need or service which those assets are providing to society which then creates a resilient or inelastic revenue stream. And it is that characteristic which turns an asset into infrastructure as opposed to something else.

So, to come back to some of the other themes then well, how these infrastructure assets within the One Belt, One Road space are going to be delivered? Well, actually it gets more complex yet. There are different procurement approaches. Is it going to be procured by the public sector entity or a private sector entity and for what reason? Are those reasons

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commercial drivers, public policy drivers? What’s the business model going to be of that infrastructure service provider? And once you’ve got that business model established, what’s the funding strategy? And there are a range of different funding financial models. So, the picture becomes more nuanced, more complex.

Trying to keep it simple, there are two sources of funds. Either user pay or public sector resources contribute. And the user pay element is illustrated by the willingness of users. For example, to pay money to cross an estuarial crossing, a new bridge between two centers of population, the value of which is an economic saving in time and cost to move from A to B direct over that bridge as opposed to circumnavigate the estuary.

And that illustrates real value that infrastructure can provide to users, but contrast that with a social accommodation facility, might be a hospital. Would users be willing to pay for that facility and where markets have been established, typically transportation, the answer is often yes. Where markets are unlikely to be established in the public sector, for example, social accommodation, the answer is likely to be no.

So, coming back to these procurement approaches, you know, we identify within the infrastructure sector procurement directly by the sovereign, by sub-sovereign entities or indeed guarantees which allow those assets to be procured. That’s a key and very important source of procurement particularly important in the One Belt, One Road context. More generally, particularly in the developed markets, regulated utilities or businesses will also develop an infrastructure to meet their regulatory requirements.

Within the US, we’ve seen the advent of P3s, public-private partnerships more generally and a growing global sector of asset procurements. But those public-private partnerships are associated with concession or single asset project facilities. And then we can add a fourth type of procurement associated with businesses competing in open markets particularly in developed countries, perhaps less relevant to developing and emerging countries along the One Belt, One Route.

Moody’s rates some $3.3 trillion worth of debt obligations in the infrastructure space. We segment that conceptually between utilities, infrastructure corporate, so the roads, the airports, the sea ports entities. And then, project finance special purpose vehicles to which we then add municipal infrastructure entities – four different building blocks within that in aggregate representing over $3 trillion worth of debt obligations.

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Throwing some other ideas into the pot, the availability in terms of financing will reflect investment risks. That’s a very simplistic statement, but essentially investor risk appetite is also a function of exposure to country risk, exposure traffic risk, currency risk, commodity price risk and these develop from and are shaped by the different procurement approaches and delivery mechanisms that we mentioned.

So, coming back to the questions around the One Belt, One Road initiative and the key sources of funding for infrastructure so, yes, policy banks such as the China Development Bank are clearly going to be important. On-shore and off-shore corporate bonds and we know, we observed that the Chinese government is indeed encouraging Chinese financial institutions and companies such as infrastructure state-owned entities to issue bonds in renminbi and foreign currencies outside China to that end. So, we know that those corporate sources of funding are being mobilized, encouraged by China. The Asian Infrastructure Investment Bank, clearly the Silk Road fund that I mentioned earlier and then, other development finance institutions, bilateral regional development banks, et cetera.

So, those are key, but coming back to the overall message which is that scale of financing is so vast that it creates the imperative to mobilize and leverage private sector resources. These are some of the other issues that should also be on the table for policymakers to consider how to leverage public sector risk capital in such a way to catalyze private sector capital.

In that instance, multilateral banks have a key role to play in achieving that catalyzation. In particular, multilaterals have unique ability to manage risk, particularly risks associated with developing markets and sovereign entities. And that appetite and ability has the potential to provide a platform for the innovation of risk mitigants, new products in the space which will allow private sector capital both debt and equity to flow once those investable parameters are attractive for the private sector.

Anne Van Praagh: Great. Thank you.

Andrew Davison: Thank you.

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Anne Van Praagh: All right, Simeon. Back to. We’ve talked about the role of the publics, the private sector, where the sources of funding are going to come from. In your view, what’s the role of the public sector here and which governments do you see as being actively embracing these projects going forward, which ones will be taking liabilities on balance sheets, which ones will be more actively engaging the private sector? What’s the role of the public sector here?

Simeon Djankov: The two sets of governments that so far have shown quite a lot of interest are some of the Central Asian countries – Kazakhstan in particular and some of the smaller, not yet European Union member countries in East Asia or the Caucuses. Georgia is an example, Macedonia. I mentioned Montenegro, Serbia. Basically, countries that cannot yet rely on EU structural funds or at least not all of the EU structural funds which has a big infrastructure component and which for reasons of history have transport corridors that do not well serve their trade and finance.

So, what do I mean by that? So, if you imagine Macedonia or Montenegro, part of former Yugoslavia, they have good infrastructure going to Belgrade because that was the capital 20 years ago, in some cases ten years ago, but they don’t have good infrastructure capitals, good infrastructure corridors linking them either to ports as Andrew mentioned, for example, the Greek ports or towards Central and Western Europe, towards Austria, Germany and so on. To build these transport corridors they need money that is significantly more of what they can get from, at least so far, from most of the existing multinational institutions.

That’s why a new player like the New Silk Road initiative or however you can call. This is very interesting for these countries, particularly as I mentioned earlier, if they manage to avoid the sovereign guarantee issue. And the sovereign guarantee issue, I mentioned one feature which is important that it gets on your public accounts and counts as debt and deficit, but the other issue is that if you have a project that involves several countries, then it becomes a big issue which sovereign guarantee are you going to use to basically to build this project.

At the World Bank certainly, where I’ve worked on such projects, this is a big issue especially if countries are not otherwise friendly to each other for political or other reasons. At least in Eastern Europe, in the last two, two and a half years, the New Silk Road initiative has managed to get around

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the sovereign guarantee issue by basically saying this is project financing and we are fine if different parts of the projects are signed by different governments, in some cases even large municipalities. The bridge that I mentioned is essentially a municipal project, at least the way that it was done. So, there is certainly interest in it.

These countries, there is potential interest as I mentioned in Georgia; even Azerbaijan now is getting interested in this, Kazakhstan for the same reason. The infrastructure, the transport infrastructure of Kazakhstan basically goes to the extent that the [inaudible 0:41:04] goes towards Russia. They’d like to expand and have some transport corridors going to other parts of the world, including by going to the far east of Russia to get to the ports that exist there and towards China.

Russia is a relatively a new player in this market. Until about a year ago, Russia not only was not interested in this initiative, but it was through its both economic and political levers was actively trying to undermine it in part because it has its own economic initiative in the broader region which is the Eurasian Economic Union that involves from Belarus to Armenia to the Kyrgyz Republic, Kazakhstan, potentially Turkmenistan and Tajikistan as well. So, it was not particularly happy to see China basically getting into its backyard with large infrastructure projects.

This rapidly changed last year basically when the west imposed sanctions on the financial sector primarily, but also through the financial sector on some of the large infrastructure project financing that large state-owned Russian companies have been promised to build infrastructure in the region. And suddenly about a year ago, we saw a lot of initiative from the First Deputy Prime Minister Igor Shuvalov of the Russian Federation going several times to China, inviting Chinese officials to Russia. And we have several projects, I mentioned railroad that links Moscow to Kazan which is already signed. That same project has to continue from Moscow to St. Petersburg. That part is nearly negotiated and I expect to be signed maybe early next year.

And then some projects that, at least on the face of it, like I mentioned the nanotechnology project don’t really link to the New Silk Road as an infrastructure project, but they are valuable for two reasons. One that I already mentioned, it’s a good way to substitute absent, at least now Western financing because of sanctions with basically Chinese financing. So, Russia is interested in that, but also, unlike some of the smaller countries that I’ve mentioned in Eastern Europe that are basically happy to

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find an alternative source of financing, Russia takes the view of that okay, so we’ll have this infrastructure build up and then what’s going to happen? We’re going to have even more Chinese cargo and Chinese goods. So, when we build it, we want also to be able to have exports if it can go the other way. So, it’s not a one-way road. And this is how nanotechnology links.

So, the discussions and the negotiations on some projects have been like this, okay, let’s build this, but let’s at the same time think, in this case trains when they go from Russia to China what are they going to carry? And nanotechnology seems a bit let’s say overly optimistic at this stage, but around this type of projects. There are some agricultural projects incidentally that are under consideration, both in Kazakhstan and in Russia to be financed by the New Silk Road initiative.

So, Russia’s turnaround so to speak mostly dictated by the Western sanctions as I mentioned means that suddenly the whole region is in play, not just in the infrastructure projects themselves, but to say well, this is an initiative. Andrew made this, the point where we can create markets along the way. So, we can create industry that currently either does not exist or is not linked with the rest of the world, getting financing alongside the New Silk Road initiative and in this way having a two way trade.

Anne Van Praagh: Okay. We’re going to shift gears and before we open it up to the audience for questions, I want to ask about implementation risks. Obviously, with a network of projects this vast and the ambitious nature of this kind of undertaking integrating Eurasia, constructing the belt and road will be challenging. It will be challenging from a diplomatic perspective. It will be challenging from the standpoint of recipient governments may not have the policy framework or the project implementation capacity to handle projects of this magnitude. That could lengthen project execution.

There are other political hurdles, political risk we’ve talked a little bit about, the stability of governments, the capacity of government balance sheets. So, maybe Andrew, I can ask you to share your thoughts on implementation risks and you’ve looked a lot at infrastructure projects over many years through different economic cycles, what are the ingredients that make for successful or unsuccessful projects?

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Andrew Davison: Sure. I think the fundamental ingredient is, is there a need that that asset is going to provide or meet? And you know, a rhetorical question is what is the benefit of a road that does not link meaningfully to populations or does not meaningfully create an economic story? What is the benefit of painting all buildings in a city green which could be an infrastructure investment, but actually has no value?

So, if that story really does create value, if it creates a resilient product or service which then catalyzes economic growth, then that is a key ingredient in creating a revenue stream or use of that asset which can then create the benefits which create the resilient revenue which give rise to a number of these financing strategies that I mentioned.

In terms of the ability and willingness of new sources of finance to come into market, the slide on the screen here illustrates some of the depth that currently sits within the institutional investor space which is attracting significant interest in terms of how policymakers might tap into that depth.

So, what that chart shows essentially is there’s over $93 trillion worth of assets held by institutional investors across the OECD country and that’s split into three particular sectors – pension funds, insurance companies, investment funds represent about a third each and then there is public pension reserve funds which is that little line slightly lower down so $93 trillion worth of assets of which a relatively modest proportion today is invested or associated with infrastructure.

So, the execution risks that Anne referred to, if those are managed and manageable and within the risk return appetites for this type of investor, it is possible to attract and mobilize sources of capital for those particular investment opportunities. But more specifically, what are the key risks that any infrastructure project may be exposed to? Well, the political risks and country-specific risks that Anne referred to. These are issues that would create some degree of correlation with stresses affecting host governments or public sector entities within those host governments and those could have significant and adverse impact on the ability of infrastructure project to deliver on its base case economic plan and associated revenues.

Currency mismatch risk, a mismatch, fundamental mismatch between revenues and the debt currency create headaches for projects. Projects exposed to legal and regulatory risks are a challenge within that host country. These are different aspects of sovereign and country risk.

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And then when we come back to thinking about the project itself, we can conceptualize risks that can adversely impact the revenue stream such as traffic volume risk or indeed toll price risk on new build toll roads. And then, we might also conceptualize the underlying risks, the fundamental risk associated with construction or indeed the operation of a new facility.

For example, there is very little experience today of carbon capture and storage, but that type of project might be rather more important in the future in order to meet some of the sustainable development goal ambitions in reducing and managing climate change in due course.

So, there are a range of different risks which in due course might lead a project to fail or underperform.

Anne Van Praagh: Great. Okay. Well, let’s see what questions the audience has at this point. We’ve got one here.

Ravi Vish: Thank you. Ravi Vish from the Multilateral Investment Guarantee Agency.

So, we provide political risk cover for projects in emerging markets, in particular infrastructure and Andrew, you talked about a number of risks in these projects. Obviously, we see all of them, but the biggest risk we see quite often is the traffic forecast risk as well as the amount of toll that’s provided and those obviously are not easy to quantify upfront and those are quite important just because you obviously want to also minimize the toll in the government in terms of the minimum revenue guarantee.

So, in a project like this where we have number of countries involved, I’m interested in understanding how those are being sequenced so that you have a network effect and that, you know, these risks are minimized to the extent possible. And on this point, a comment I want to add is obviously the political risk cover that we provide includes bits of contract which does not involve a government account and guarantee. So, just like OPEC, we provide the same cover, but those can be very useful in mitigating the risk for investors. But the key question is how do you sequence these different projects to have the maximum benefits? Thank you.

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Anne Van Praagh: Thank you. That’s a key challenge. Anyone want to take a stab at that? I would say that we have our own history of looking at toll roads and having fairly mixed results in terms of, you know, actually meeting forecasts. So, toll roads themselves and maybe Andrew can talk a little bit about the history of toll road debt performance relative to other asset classes, but I think the forecasting is a key issue and I don’t know if the others want to chime in there?

Simeon Djankov: Maybe I can make first a slightly more general comment and get to the toll road. I think as one of perhaps the challenges of this project going forward is so far the projects that I have seen being signed, worked on and in a few cases finalized under the New Silk Road initiative without exception have been projects that the project preparation and evaluation was started with a different either development agency or commercial bank and basically for one reason or another, they didn’t get to the end.

In the case of Russia as I mentioned, for example, the Moscow-Kazan high-speed railway was basically a project where the World Bank was involved, EBRD was involved, two large global commercial banks were involved. When sanctions hit basically, these financiers withdrew, but the project preparation and evaluation was fully done. So, it was essentially given for consideration and then signed on. Exactly the same happened with the nanotechnology project. Exactly the same happened with the idea of having Athens to Budapest highway and rail.

So, in other words another multinational or commercial global financier did a lot of the work together with the governments, municipalities and so on. And for one reason or another when it was not possible to finance it in this particular way, the Chinese investors/partners came in and took these projects.

Why is this a challenge? Because you know, there are only so many finalized evaluated and prepared projects. So, for this initiative to really get to the large numbers that had been presented today, the institution, the Asian Infrastructure Investment Bank, the New Silk Road fund, they rapidly have to build up project preparation and evaluation facilities something that they frankly don’t have now.

So I think this is a potential challenge and it goes then to the question of how do you evaluate which country or which even section within the country to build. In my mind, at this point, there isn’t a particularly

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rigorous way that this has been looked at. It really has been looked at where do we feel that the preparation and evaluation has been completed by somebody else. Thank you, we take their project and then we finance it, but you cannot really develop a serious business model based on the prior work of others.

Just in conclusion, these projects that I mentioned, Budapest to Athens, it started, perhaps not coincidentally with Belgrade and then with Macedonia because 2009 or so China invested in the Port of Piraeus. So, a Chinese state-owned company became the majority owner of the Port of Piraeus so, they already have several years of experience in that region and they have done as part of this preparation basically studies of how much cargo, which way and so on. So, that’s why they started building it that way.

The moment you go however Serbia to Belgrade to Budapest, there are no studies how much this is going to be used. There are some alternative railroads that can be used from Belgrade and not coincidentally, I think that project is behind everything else even though it was signed at the same time.

So, in conclusion I think this evaluation, preparation both on new projects in general and particularly how to stage an existing project is very much missing. We are very much at the beginning which means to me it would take some years before we can say now this is financing projects to the tune of several hundred billion dollars, not to talk about trillions. I think this is seven, ten years in the future.

Andrew Davison: I’d probably highlight three issues. Firstly, Simeon has talked about the establishment of integrated networks across the One Belt, One Road initiative countries. So potentially, we’re talking up to 40 separate sovereigns coordinating in a strategic visionary way an integrated transport network. And if there is a bottleneck at any point, it doesn’t really matter if you’ve got a six-lane highway to your border if there isn’t a road then connecting on the other side. That asset has no value. It only becomes valuable when people can actually use it.

So, I think the first point I’d make is that it comes down to the political will and vision to actually create these integrated transport and economic corridors.

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The second point I’d make is the attraction of user-paid toll roads or user-paid facilities as a procurement mechanism. So, from a country’s perspective, if aggregate resources for that country are constrained and rationed, it’s very attractive to be able to pass a concession law to grant a concession to auction a concession to the private sector and say you, private sector entity have the right to build a road and charge users. So, essentially for very little money upfront, you can leverage or a country can leverage its ability to create and develop assets.

But then the private sector response is well, okay, what is the traffic going to be on that road and I think this is where you’re question really focused. And I think this a third element which is there is a fundamental uncertainty about traffic forecasts, particularly in developing markets where those traffic routes have not been established. The science of traffic forecasting works well where there is an established traffic pattern or there is a limited opportunity for traffic to move in different ways, different pathways. Where it doesn’t work well is where there is essentially no established traffic pattern which is essentially part of the problem with where we are today in terms of the ambition of the One Belt, One Road initiative.

One way which could work is that it may be an appropriate use of public sector resources and risk appetite to establish a road and then to perhaps sell that asset once that traffic establish has been created or it might be an appropriate use of private sector risk appetite to underwrite a certain minimum level of traffic or committed revenue which then allows a private sector financing solution to evolve in a way in which you had suggested. But fundamentally these issues around traffic demand risk forecast, it’s essentially educated guess work and there are many precedents where that balance has just been completely misjudged by so-called experts.

Anne Van Praagh: Okay. Let’s see what other questions—yes.

Shahid Yusuf: Shahid Yusuf from The Growth Dialogue at George Washington.

My question is regarding growth inducing and multiplier effects of the sorts of investments you’re talking about.

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If I look at the kind of countries, Kazakhstan, Macedonia and others, most of them have very little industry. So, if there is going to be Chinese investment, there is a high probability that the Chinese would bring some of their own workers, some of their own machinery, a lot of the intermediate inputs that will be needed for the construction of this kind of infrastructure.

In which case, what would be the short- and long-term multiplier effects of this for these countries and what do you see is the likely growth effect? Will it be 0.1% to their growth, will it be 0.5%? I mean, what sort of growth effects are we looking at because in looking from the countries’ perspective that’s what really counts. It isn’t you know, that can I get some tolls out of this road; it is how much growth do I get out of this activity.

Anne Van Praagh: Yeah, that’s a great question. I’m not sure we have a good answer for that. I know I’ve heard being on the receiving end of different government meetings, ranges from 0.1% to well over one full percentage point of growth, annual growth.

And so, I think that that’s a question that we don’t have a good answer to. It probably depends on which country we’re talking about, what kinds of investments, the scale of those investments and timing of them. I don’t know if panelists want to make a brief comment on that topic.

Simeon Djankov: First, you brought an interesting point that we have not discussed so far which is that indeed, at least in the contracts that we’ve seen parts of, there is always a part that says that such and such percentage should be basically performed by Chinese companies. So in the case of Moscow-Kazan railway, I think it’s about 30%. In the case of the Athens to Budapest, it’s in some sections 25%, in some 13%, not sure exactly how the negotiations were done, but there is a component where as you mentioned Chinese workers, Chinese companies will actually execute the project which over time is one I think of China’s interest to basically bring its know-how, to increase its know-how in these new countries and regions.

I still think in this part of the world, there are a number of infrastructure projects that I can at least see that have a very high return. Basically,

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because of what Andrew said which is that—let’s take Georgia. So, it’s a small country, it doesn’t have too much exporting ability, but certainly its exporting ability will be greatly increased if there is a good transport connection between the capital Tbilisi and the port, let’s say of Poti or the Port of Batumi. Currently, it’s very difficult to get from basically the main industrialized area of the country to the port so that from there you can somehow export.

Similar is the case with as I mentioned, with some of the former Yugoslav countries. Some of them are landlocked, some of them don’t have large ports so they very much would benefit from being linked to the Greek ports and then, from there to be able to export.

And even in Russia, a country that invests very heavily in infrastructure because so much of the investment is let’s say wasted, there are many projects. You know, there isn’t for example, a good railway connection between St. Petersburg and Moscow. The return to such an investment is probably huge both in terms of the actual utilization of this road as well as improvement to the economy.

So, my guess is that if we take a specific project which is not yet financed, the Georgian government hopes to have it negotiated soon, Tbilisi to Poti let’s say highway, my guess is that this is going to add two to three percentage points to the GDP of the country for several years. Simply the need for such basic infrastructure is very high in some parts of the region.

Anne Van Praagh: Okay, let’s see if we have time for one more question then we’ll go to our break.

Sunil Sharma: Sunil Sharma from the IMF.

Given what I’ve just heard, given that we’re looking at not just country-specific investments, but multi-country investments, in terms of the funding, given the multiplicity of risks, how would the assets be created? Will these be ill-equipped investments? Are there specific issues involved in trying to securitize some of these investments? Is there a need for long-term patient investors?

And, this issue came up recently in the discussion we had with Martin Wolf at the IMF and there was a sense that maybe there’s a market failure

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and a sense that long-term patient finance is not available cross border as easily it may be available in country-specific investments. So, when I think about the framework that we have in mind, are there specific issues that arise in these sorts of multi-country investments?

Anne Van Praagh: Great question. Okay. Who wants to take a stab at that one?

Andrew Davison: Well, thanks for your question. Simeon has mentioned this concept of project financing several times now but essentially, we’re talking about asset-specific financing, the revenue stream for which is created from the use of the underlying asset. This has been a very successful technique to finance projects in emerging markets.

To give you a sense of scale of project finance industry, it didn’t really exist 30 years ago but as quantitative and analysis techniques have matured, this industry has delivered over $3 trillion worth of long-term funding over 30 years. And that’s split essentially 40% power, about 30% social and transportation infrastructure and about 15% oil and gas so three big categories of project finance. So, there’s about 70% of that $3 trillion sum has been deployed to support long-term investment in infrastructure and related assets. Most of that investment has been undertaken by banks, however and, I think, where you started from which is what are the constraints which are preventing institutional money from flowing.

Well, I think we see green shoots of interest from institutional investors who are particularly interested in infrastructure debt for three reasons. It provides an asset liability matching, long-term assets and cash flows with long-term liabilities. The risk return parameters are attractive and it provides portfolio diversification.

So, the pull factors are there, but actually, this industry has been started and really established bedded down in the banking sector and that technology hasn’t really transferred yet to the institution investor base.

So, the attraction is clear. With $93 trillion worth of institutional money and a relatively small proportion today invested in the infrastructure sector then, that is the prize, which many parties are seeking to mobilize.

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Anne Van Praagh: Okay. Thank you everyone. I’d like to ask you to join me in thanking our panelists Andrew and Simeon. Great job, everyone.