Unlocking Local Finance: The Key to Sustainable Infrastructure in Developing Economies

This article explores the findings of the World Bank's report, "Unlocking Local Finance for Sustainable Infrastructure," which highlights the importance of Local Currency Financing (LCF) in closing the infrastructure financing gap in developing economies. By mobilizing domestic savings, reducing foreign debt burdens, and mitigating foreign exchange risks, LCF offers a sustainable solution for financing infrastructure projects. The article also discusses successful LCF models in Malaysia and South Africa and provides policy recommendations to help emerging markets operationalize LCF for sustainable development.

Developing countries are facing a substantial financing gap for sustainable infrastructure, estimated at $0.7 trillion annually. According to the latest World Bank report, "Unlocking Local Finance For Sustainable Infrastructure," innovative solutions like Local Currency Financing (LCF) could provide the answer to closing this gap. By harnessing local financial markets, countries can reduce their reliance on volatile foreign capital and foster long-term, stable investments that support green infrastructure and development goals.

The Infrastructure Financing Gap and the Role of LCF

The world faces a significant challenge in closing the infrastructure financing gap, especially in emerging markets and developing economies (EMDEs). In 2020 alone, infrastructure investments amounted to $2.7 trillion, with a shortfall of $0.7 trillion that must be addressed to meet global demands. As the world moves toward achieving net-zero emissions by 2050, the need for investment in the energy and transport sectors becomes even more urgent. These sectors contribute to around 60% of global emissions, underscoring their importance in the global sustainability agenda.

Local Currency Financing (LCF) offers a practical and sustainable solution to bridge this gap. The report emphasizes the potential of LCF in enabling EMDEs to finance their infrastructure needs by mobilizing domestic resources. Unlike traditional reliance on foreign currency loans, LCF can insulate countries from foreign exchange risks and reduce their debt burden. By tapping into local savings and building a strong domestic financial market, countries can unlock new sources of funding for sustainable infrastructure.

Lessons from Malaysia and South Africa

The report highlights the success stories of Malaysia and South Africa, both of which have developed advanced LCF ecosystems that support infrastructure development. Malaysia’s high domestic savings rates and strong institutional frameworks have helped build a robust local financing market. In Malaysia, nearly 80% of non-financial corporate debt is now denominated in the local currency, the Malaysian Ringgit (MYR). The government's involvement in national infrastructure projects, supported by local institutional investors, has made long-term local currency financing a reality.

Similarly, South Africa has leveraged its relatively large banking sector to create a thriving LCF market, particularly in the renewable energy sector. The country’s Renewable Energy Independent Power Producer Procurement Program (REIPPP) has been instrumental in generating demand for local currency loans. Through this program, tariffs for renewable energy projects are set in the South African Rand (ZAR), creating an attractive environment for both local and international investors.

These case studies underline that a stable macroeconomic environment, sound financial market policies, and government involvement are key enablers for developing successful LCF markets.

Policy Recommendations for EMDEs

For emerging markets, the road to a fully operational LCF system is not without its challenges. However, the World Bank report provides clear, actionable steps to overcome these obstacles. The first step is to promote macro-financial stability. By strengthening domestic money and capital markets, countries can increase their capacity to allocate capital efficiently. Stable, low-inflation environments with predictable interest rates are essential for encouraging local currency lending.

Another recommendation is to boost institutional savings. Pension funds, insurance companies, and mutual funds play a vital role in financing long-term infrastructure projects. With the right policies in place, these institutions can invest in infrastructure projects, particularly in sectors like renewable energy, water management, and public transportation.

Finally, the report calls for the development of credit enhancement products, such as risk-sharing facilities or guarantees, to encourage local banks to participate in long-term project financing. By reducing the perceived risks of lending to infrastructure projects, these products can help bridge the financing gap and crowd in private sector investment.

The Way Forward: A Roadmap for Sustainable Development

The World Bank report outlines a high-level roadmap to deepen LCF markets in developing countries. It stresses the importance of collaboration between public and private sectors to develop a pipeline of sustainable infrastructure projects. Public-Private Partnerships (PPPs) are highlighted as a critical mechanism for scaling up investments. Countries must work on building project pipelines that are fiscally sustainable and attractive to both local and international investors.

The next steps include expanding capacity-building programs to ensure that local financial institutions can effectively evaluate and structure long-term infrastructure loans. As countries deepen their LCF markets, they must also look to innovative financial structures like pooled infrastructure investment vehicles, which can attract institutional investors.

By implementing these recommendations, EMDEs can create a robust local financing ecosystem that supports their sustainable development goals. With proper policy frameworks, financial institutions, and local market involvement, these countries can unlock the resources needed to close the infrastructure financing gap and create a future that is green, resilient, and inclusive.