Endnotes

¹The Author would like to thank Russell Krueger of the International Monetary Fund for his valuable inputs and significant contributions to this paper, and Neal Detert for research assistance.

²Regional infrastructure projects are defined as: (i) projects that involve physical construction works and/or coordinated policies and procedures spanning two or more countries; and (ii) national infrastructure projects that have a significant cross-border impact including: (1) their planning and implementation involve cooperation or coordination with one or more other countries, (2) they aim to stimulate significant amounts of regional trade and income; and (3) they are designed to connect to the network of a neighboring or third country (ADB/ADBI 2009).

³For example, according to the Indian Planning Commission's Eleventh Five-Year Plan, India requires US$500 billion to US$515 billion during the years up to fiscal year 2011/12 to upgrade its infrastructure and maintain robust growth (Planning Commission 2008).

⁴On 4 March 2008, a joint Institute for Development Economics/Japan External Trade Organization conference “Creating the World's Largest Business Space” unveiled plans for a unified economic space in Asia including all major South and East Asia countries. To support this initiative, the Economic Research Institute for ASEAN and East Asia (ERIA), located in ASEAN headquarters in Jakarta is preparing a blueprint for integration of trade and infrastructure and supporting institutions and policies. Harmonization of commercial codes and adjudication of business disputes are key parts of the agenda.

⁵For in-depth discussions of these issues, please refer to works by Alburo (2010) and Wang (2010).

⁶The terms “cross-border” and “regional” are used interchangeably in this paper.

⁷For instance, India's 11th Five Year Plan (2007–2012) has total investment requirements of US$494 billion, with private contributions for infrastructure development at nearly 30%. India has adopted an open model that encourages foreign investment. India permits 100% foreign direct investments in most sectors and this has resulted in large private flows primarily through private equity placements. However, bond market financing remains very limited, and promoting bond market development is on the public agenda (Radhakrishnan 2008).

⁸A unified method of valuing projects through the region should be considered. The International Comparison Project (ICP) has shown that national exchange rates can systematically diverge for extended periods from appropriate values based on purchasing power parity. Moreover, the specific configuration of exchange rates can affect assessments in two ways: the costs of individual cross-border projects are affected by the exchange rates between countries, and the exchange rate of Asian currencies vis-à-vis the denominator currency (presumably the external currency used to fund most of the imported capital requirements for infrastructure development) also affects calculations. Moreover, changes in exchange rates over time, perhaps resulting from endogenous economic changes created by the new infrastructure, affect overall valuations.

⁹The segmentation of a financial market is likely to result in non-convergence in pricing between two markets for similar or identical products. This imperfection in the “law of one price” has been observed even for identical equities selling in two economies, even if such non-convergence is very small. This is relevant for the infrastructure project in two ways; a security to fund infrastructure in a common currency unit or basket might have somewhat different values between countries based on differing liquidity and trading practices, and returns on Islamic bonds (sukuks) and conventional bonds for the same project are unlikely to ever fully converge.

¹⁰The use of a basket of currencies to create a standard measure of value is in some way like creating a virtual currency that can be used to denominate transactions and assets. A virtual currency might ultimately evolve into a real currency, perhaps in the manner in which the European Currency Unit (ECU) morphed into the euro, but evolution into a true currency is not inevitable, especially if political interest in creating a currency is missing.

¹¹Dealing with intertemporal consistency for a basket is a major challenge.

¹²It is relevant to distinguish between technical financial issues and politico-economic issues in constructing an efficient capital market for cross-country infrastructure finance. The financial rationale for integration may be at odds with the political environment.

¹³See also Baele et al. (2004) and Hartmann et al. (2007)

¹⁴As examples, the Euro area places strong limitations on the ratios of national fiscal deficits and national debt to GDP. The Maastricht Treaty specifies that deficits and government debt cannot exceed 3% and 60% of GDP, respectively. The Growth and Stability Pact provides sanctions for countries that violate these limits. Also, the importance of a strong and stable financial system to support monetary policy operations and to contribute to strong economic growth was recognized. These factors, even though decentralized, contributed to clear lessening of national risk in the bond markets, and fostered an environment conducive to cross-border investment.

¹⁵CMI was created in May 2000 by ASEAN+3 finance ministers in response to the 1997 Asian Financial Crisis, using the ASEAN+3 framework to expand the ASEAN Swap Arrangement and establish bilateral swap and repurchase agreement facilities among ASEAN+3 countries (Henning 2002).

¹⁶For details see Kawai and Lamberte (2008).

¹⁷One of the first tasks of the FSF set up by the G-10 countries was to survey the range of international standards and codes relevant for international financial stability. Twelve codes were identified as priorities for international implementation; a larger number of codes were identified as important, but less pressing.

¹⁸One option for creation of such a pool is to link contributions to the pool with redirected flows from SWFs toward inward regional investment, or other efforts to manage capital flows associated with the SWFs.

¹⁹ERIA (Economic Research Institute for ASEAN and East Asia) is a research body that conducts policy analysis and other research related to East Asian economic integration) will conduct research in this area. It was announced on March 4, 2008, in Tokyo that ERIA would work on a blueprint to make East Asia the largest business space in the world through harmonization of practices across countries, logistics improvements, and removal of impediments to cross-border trade in goods and services.

²⁰The source of funding of the RBA is a critical variable in its financing and mode of operation. If funds are taken from official reserve assets, then the RBA must hold the funds in a liquid form in which they are readily usable in case of balance of payments need of the participating countries. Also, if the national contributors have a negative carrying cost on the contributions, it is unclear why the net profit from RBA investments should accrue to the RBA and not the countries. (Conversely, if the pooling of funds by the RBA permits countries to hold lower balances of reserve assets, it could permit the countries to make more profitable use of their funds.) If contributions to the RBA come from sovereign wealth funds or other national assets, the countries may expect to participate in any higher returns.

²¹ADB has issued several local currency bonds. In October 2005, ADB launched its fifth market-opening transaction P2.5 billion (US$45.37 million) peso-denominated bonds to develop Asia's local currency bond markets. Starting in early 2004, ADB undertook five other market-opening transactions in the region's local currency bond markets in India, Malaysia, PRC, the Philippines, and Thailand. In 2007, the ADB issued local currency bonds in Hong Kong, China; Kazakhstan; Malaysia; Philippines; and Singapore. Moreover, according to Asia Bond Monitor (2008), emerging East Asia's local currency (LCY) bonds outstanding increased at a very rapid annual 21% rate in the second half of 2007. Also, LCY government bond markets expanded by 21% in 2007, primarily due to central bank sterilization and fiscal stimulus. LCY corporate bonds grew by 20% in 2007, exhibiting the limited initial impact of the global credit crisis.

²²Greater Mekong Subregion (GMS), South Asia Subregional Economic Cooperation (SASEC), Central Asia Regional Economic Cooperation (CAREC), Brunei Darussalam-Indonesia-Malaysia-The Philippines-East ASEAN Growth Area (BIMP-EAGA), Bay of Bengal Initiative for Multi-sectoral Technical and Economic Cooperation (BIMSTEC).

²³ASEAN+3 is composed of ASEAN member countries plus PRC, Korea, and Japan.

²⁴ASEAN+6 is composed of ASEAN+3 plus Australia, New Zealand, and India.

²⁵GDP-linked instruments adjust payments to the speed of growth of GDP of the borrowing country. There is a growing body of literature recommending the use of GDP-linked bonds. For borrowers, they can lower debt service payments in times of economic distress, allowing for greater fiscal policy flexibility and lowering the probability of default. For investors, GDP-linked bonds provide opportunities to diversify portfolios and can offer high returns if payments are linked to nominal GDP growth. In this latter case, the borrowers are de facto protected from real obligations to make higher payments because of the larger size of GDP and also the possibility that there is an inflationary component in the higher nominal GDP.
See, for example: Borensztein and Mauro (2002), Griffith-Jones and Sharma (2006), Miyajima (2006), Schröder et al. (2004), and Shiller (1993).

²⁶The IWG was set up as an ad hoc group to determine the principles of conduct for SWF and treatments in host countries. The GAPP agreement is an important step forward in understanding the nature of SWFs and making them more accountable and transparent, but the code is voluntary and adoption by all SWFs is not assured. Work is underway to build on the achievements of the IWG to create a standing body to represent SWFs. See also IMF (2008).

²⁷International reserve assets serve a special purpose to be available for exchange rate policy and to deal with balance of payments imbalances. According to the IMF definition of reserves, they must be readily available and in a readily convertible currency, SDRs, or monetary gold. The requirement that reserves have high liquidity precludes their use for long-term investments, such as those made by SWFs. Countries with reserves exceeding balance of payments needs can transfer them to SWFs to allow for their long-term investment. Also, income generated on international reserves is usually low (and sometimes negative, net, if reserves are built up by issuing high-interest rate liabilities to sterilize the monetary impacts of foreign currency assets held by the public). SWFs have the flexibility to invest in higher return assets.

²⁸By extension, regional, cross-border, or international investments by SWFs can also have macroeconomic ramifications on the host countries that need to be considered by the host country or by regional authorities.

²⁹For purposes of how SWFs could support infrastructure finance, precise definitions of the type of SWF are not needed. Various types of large state funds exist, with different legal standings and purposes. Any of them could be potential investors in infrastructure and thus it is not necessary for this purpose to draw precise distinctions between the types of funds. For other purposes, taxation or prudential supervision for example, precise definitions will be needed.

³⁰Estimates of total assets of Asian SWFs are imprecise, but 10% devoted to infrastructure would be around US$70 to US$100 billion. This portfolio adjustment would require several years, so the annual contribution, which might reasonably total less than US$20 billion per year, would clearly cover only a small portion of the annual financing gap.

³¹A 1% ODA contribution from total Asian SWF assets might yield something between US$7 billion and US$10 billion annually, which is a large amount. It could be a direct contribution, but could also be leveraged into more investment if it enhances private lending. ODA provided by SWFs could be used in many ways, but one interesting option is to use it to provide enhancements to financial instruments issued for infrastructure projects, including instruments purchased by the SWF itself. Enhancements can include exchange rate guarantees, credit guarantees, coverage for grace periods, subordinated capital contributions, traffic guarantees, etc.

³²Zakat is essentially a wealth tax. For more information, see Sulaiman (2003).

³³For example, World Bank President Zoellick said that government-sponsored funds could invest equity in development, which would allow emerging countries to join the 185-nation development lender's aid program, through the support of their SWFs. Such contributions would avoid allegations sometimes made that bilateral aid is politically motivated (Mufson 2008).

³⁴For information on the background and characteristics of Islamic finance, and prospects for its future development, please refer to ISDB/IFSB (2005).

³⁵Noibi (2008) of the Islamic Development Bank has said that Takaful instruments, which are a form of collective insurance, seem to be an appropriate means to gather funds within Islamic communities and provide financial protection for the individual contributors. Also, Ibrahim (2008) has said that injunctions to fight poverty are pressure to move Islamic finance to adopt microfinance programs.

³⁶Countries include: Afghanistan, Azerbaijan, Bangladesh, Indonesia, Kazakhstan, Kyrgyz Republic, Maldives, Pakistan, Tajikistan, Turkmenistan, and Uzbekistan.

³⁷For more details on PPP modalities, please refer to Finlayson (2008) and van der Geest and Nunez-Ferrer (2010).

³⁸Should Asian countries collaborate in the future to enhance policy coordination to make the exchange rates between countries more stable, the exchange rate risk of the AICU would be further reduced.

³⁹See Rajan (2000) for more details on this proposal.

⁴⁰See ADB (2009c) for more details.

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