Investment in emerging markets falls to historic low

Net public investment in emerging market countries has fallen below 1 per cent of GDP for the first time on record, raising fears of widening infrastructure gaps.

The share of national output developing world governments are spending on investment in assets such as schools, hospitals and transport and power infrastructure, net of depreciation of the existing capital stock, has fallen from 3.3 per cent in 1997 to a low of just 0.9 per cent last year, according to data from the IMF.

This is well below what the IMF believed was needed to meet basic needs and allow countries to close infrastructure gaps that are slowing the pace of development.

“Whether you look at [public investment] in gross or net terms you are talking about a decline,” said Paolo Mauro, deputy director of fiscal affairs at the Washington-based body.

“This is something that should be reversed. Emerging economies, as they develop, need to build infrastructure. Of course they have competing pressures and that is where the struggle is.”

The IMF’s central fear is that “spending rigidities on wage bills and transfers” by emerging market governments are “crowd[ing] out public investment”.

This adds to recent fears, expressed by the Institute of International Finance, that the rising cost of servicing public debt also risks “crowding out vital public investment”, given that the average government debt-to-GDP ratio across emerging markets is nearing 50 per cent for the first time ever.

The proportion of GDP that EM governments devote to public sector wages and social benefits has held up, even as spending on investment has fallen, while “other expenses” such as food and fuel subsidies have risen sharply, as the first chart shows.

While the share of national output eaten up by interest expenses has fallen since the late 1990s, it has started to trend up once again, from a low of 1.5 per cent in 2015 to 1.9 per cent last year.

To some extent, the collapse in public investment is distorted by the outsize influence of China. According to the IMF’s data, net government investment in China last year was -2.9 per cent of GDP, as spending has slipped in gross terms and the country has a high level of depreciation given its vast capital stock.

Despite this negative reading, Mr Mauro said, “There is no concern that China is under investing, on the contrary.”

If China is stripped out of the data, the weighted average for the rest of the emerging world is 3.9 per cent of GDP, which Mr Mauro emphasised was markedly lower than the 4.8 per cent figure seen as recently as 2010.

“Take out China and, gross or net, you get exactly the same pattern of decline,” he said.

The decline has been particularly noticeable in Brazil, where net public investment tumbled from 3.9 per cent of GDP in 2010 to 1.3 per cent last year; in Malaysia, where it is down from 6.8 per cent to 4.4 per cent; in Mexico, where it has halved from 3.1 per cent to 1.6 per cent; in Russia, down from 5.5 per cent to 3.5 per cent; and in Saudi Arabia, where it has slipped from 8.6 per cent to 7 per cent, as illustrated in the second chart, as well as in the likes of Angola, Ecuador, Iran, Libya.

Only a handful of countries, including Hungary, Indonesia, Morocco, the Philippines, Qatar and India have managed to buck the trend.

Even in a country such as India, where net investment spending has ticked up from 3.9 per cent of GDP in 2010 to 4.5 per cent last year, it is still weaker than in the early years of the century, and well below what Mr Mauro considers necessary.

“For India, or a country at its level of development, this is the time where they have to accommodate forecast demand for transport. As people become richer their spend on transport rises,” said Mr Mauro, pointing to the likelihood of much of the Indian population switching from bicycles to cars in the years ahead.

His own personal calculations suggest emerging economies need to spend an additional $2.2tn a year on transport alone up until 2035, equivalent to 2.6 per cent of global GDP a year.

The IMF’s published figures on the size of the emerging market infrastructure gap are not quite as bad as this, at least for the 72 countries it classes as “emerging” or “middle income”, as opposed to low-income developing countries.

For these, it estimates they need, on average, to allocate an additional 2.1 per cent of GDP, or $1.05tn, to public investment each year until 2030 in order to achieve “high performance” in the UN’s sustainable development goals. This analysis, however, only covers gaps in road, electricity, water and sanitation infrastructure.

Adding in a need to spend more on health and education in order to achieve high performance in the SDGs (partly on infrastructure, but mostly on salaries and medical supplies) takes the bill to 4.1 per cent of GDP a year, or $2.06tn.

The 49 low-income developing countries, mainly in Africa but also encompassing the likes of Vietnam, Bangladesh and Moldova, are much more badly placed, with the fund calculating they need to invest an additional 7.1 per cent of GDP a year until 2030 on roads, electricity and water alone. With health and education added in, this rises to a colossal 15.4 per cent of GDP, or $528bn, a year.

This raises obvious questions as to how this could possibly be paid for, both in emerging economies and their poorer peers.

As it stands, the primary fiscal balance (ie before debt servicing costs) for EMs, and particularly the LIDCs, has been trending downwards in recent years and is already around minus 2 per cent of GDP, as the third chart shows.

As a result, debt-to-GDP ratios for both groupings have risen sharply, even as they have stabilised or fallen a fraction in the developed world, and now typically stand at around 45-50 per cent of GDP, as illustrated in the fourth chart.

Moreover, for non-oil exporting emerging countries, at least, the IMF forecasts that the total fiscal deficit will spiral to its highest level since at least 2012 this year, depicted in the final chart.

Despite this, Mr Mauro argued that, for the emerging market countries at least, the public investment target was reachable.

“These require big increases in revenues, but with good policies there are reasons to think that it can be done,” he said.

One step many countries could take would be to reduce energy subsidies, which Mr Mauro labelled “a wasteful form of expenditure [that] has negative consequences for the planet”.

Another would be to tackle corruption “and the more general issue of the efficiency of public investment”.

Recent IMF analysis found that the least corrupt quartile of countries waste half as much money in procuring public investment as the most corrupt quartile.

For very low income countries, “their priority is to raise the share of [government] revenues in GDP and there are a lot of opportunities to do so,” Mr Mauro said. “Historically, as countries develop, we know they do increase their tax base.”

At present, public spending in the average LIDC is only 17.9 per cent of GDP, versus 29.4 per cent in emerging markets and 40.5 per cent in developed countries.

However, Mr Mauro was sceptical that the public investment shortfall could be solved by LIDCs increasing their tax base alone.

“With all the best practices, you can get 5 percentage points [more] through higher taxation but you cannot get to 15, so that is a challenge,” he said.

“The needs are great and we need to think about how, as an international community, we can have the right combination of revenue generation by the country itself and other forms [of financing].”

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