Local Currency Financing: A Game-Changer for Sustainable Infrastructure in Emerging Markets

The World Bank report highlights the crucial role of Local Currency Financing (LCF) in addressing the infrastructure financing gap in emerging markets, emphasizing its potential to reduce reliance on volatile foreign capital. By promoting LCF, countries can mobilize domestic savings, enhance financial stability, and support sustainable development goals.

A recent report from the World Bank, produced with the support of various teams, including the Public-Private Infrastructure Advisory Facility (PPIAF), the Infrastructure Finance Practice Group (IFP), and the Finance, Competitiveness, and Innovation (FCI) Global Practice, explores the substantial challenges faced by emerging markets and developing economies (EMDEs) in financing infrastructure and climate projects. As of 2020, global investments in these areas reached 2.7 trillion dollars annually, yet there remained a shortfall of 0.7 trillion dollars. This gap is expected to grow as countries commit to achieving net-zero emissions by 2050, with the energy and transport sectors contributing around 60% of global emissions. The strain on EMDEs has been further exacerbated by the fiscal impacts of the COVID-19 pandemic and ongoing geopolitical tensions. This makes the involvement of the private sector increasingly vital in bridging the financing gap for infrastructure projects. The report highlights that with the proper frameworks in place, Local Currency Financing (LCF) can play a transformative role in unlocking funding for sustainable infrastructure projects.

Local Currency Financing as a Game-Changer

LCF is seen as a potential game-changer in enabling Green, Resilient, Inclusive Development (GRID) in EMDEs. It allows countries to rely more on domestic financial markets rather than volatile foreign capital, reducing the burden of hard currency repayments and avoiding excessive foreign debt accumulation. By mobilizing domestic savings into critical sectors like climate and infrastructure, LCF can help bridge the significant financing gaps faced by many countries. The report stresses that well-developed LCF markets offer additional benefits, such as protecting economies from unpredictable foreign capital flows. However, the successful implementation of LCF depends on a variety of factors, including a country’s macroeconomic stability, the depth of its financial markets, and the institutional ability to provide long-term financing.

Lessons from Malaysia and South Africa

The study draws on lessons from two benchmark countries, Malaysia and South Africa, which have developed more advanced LCF credit markets. Malaysia, for example, saw a transition from short-term bank financing to the issuance of long-term corporate bonds, driven by its high domestic savings rate, mandatory public pension plans, and a robust banking market. Its deep institutional investor base comprising pension funds, insurance companies, and asset management firms has been critical in providing liquidity for capital-intensive infrastructure projects. South Africa, despite lower domestic savings, also demonstrates the power of LCF, particularly in its renewable energy sector. The Renewable Energy Independent Power Producer Programme (REIPPP) created a significant demand for local currency loans by setting tariffs in the local currency, which facilitated project financing through South African banks. Both cases underscore the importance of macroeconomic stability, well-regulated financial markets, and institutional support in driving the development of LCF markets.

Challenges Facing Developing Economies

The report emphasizes that while the development of LCF markets in EMDEs is promising, challenges remain. For example, the financial markets in countries like Egypt, Indonesia, Kenya, the Philippines, and Uzbekistan are at different stages of development. The banking sector in these countries, often the primary source of debt financing, faces limitations due to short-term deposits and a lack of long-term credit options. Kenya, for instance, has relied heavily on foreign currency financing for major infrastructure projects because its local financial markets are not sufficiently developed to offer long-term local currency loans. Similarly, in Indonesia, most infrastructure lending is to state-owned entities rather than private projects, which limits the availability of LCF for sustainable infrastructure initiatives. In Egypt, the banking sector dominates financial activities, but most of the financing remains short-term and denominated in foreign currencies.

Recommendations for Strengthening LCF Markets

The World Bank’s report provides recommendations for EMDEs to strengthen their LCF markets and overcome these challenges. It suggests promoting macro-financial stability by developing domestic money and capital markets and improving governance frameworks for institutional savings. Additionally, it advocates for creating more diversified sources of financing for infrastructure projects by encouraging pension funds and insurance companies to invest in sustainable infrastructure assets. The report also calls for governments and financial institutions to support the development of credit enhancement products to increase local banks' participation in financing large-scale infrastructure projects. A key component of this strategy involves reducing reliance on foreign currency loans by shifting to local currency tariffs for infrastructure services, where cost-effective. Such a move would not only enhance financial stability but also protect consumers from fluctuations in exchange rates.

Next Steps in Operationalizing LCF

Finally, the report stresses the importance of operationalizing LCF through practical measures, such as incorporating LCF considerations into national financial planning and engaging with local banks to optimize project designs for local financing. Governments and financial institutions should also explore partnerships with development finance institutions (DFIs) to provide risk mitigation tools and technical support for infrastructure projects. By following these recommendations, EMDEs can better position themselves to address the infrastructure financing gap while promoting sustainable and resilient development. As LCF markets mature, they can become a reliable source of funding for climate and infrastructure projects, reducing the reliance on volatile foreign capital and supporting long-term economic growth in developing economies.