Financial system risk is elevated and global standards are essential in managing cross-border infrastructure investment

OECD logo 2018_

(OECD, 2018)

This article is brought to you in association with OECD.

A new OECD report, the 2018 Business and Finance Outlook, highlights a number of major risks having the potential to disrupt global economic growth. It notes that the gradual normalisation of monetary policy in an environment of growing debt will be a major test of whether the Basel III regulatory reforms have achieved their goal of ensuring safety and soundness in the financial system.

Although capital rules have been strengthened, the business models of systemically important banks have changed little since before the crisis of 2008, says the report. One gauge of interdependence, the notional value of over-the-counter derivatives, was USD 532 trillion in the second half of 2017, only slightly below its pre-crisis peak of USD 586 trillion in late 2007.

The report says the financial outlook will also be shaped by China’s ability to manage risks relating to high indebtedness and leverage in its banking, shadow banking and wealth management industries. The extent of non-performing loans in China is obscured by the lack of information about which assets are sitting in off-balance sheet vehicles. These could disrupt growth beyond China if further changes to the structure of financial markets and institutions are not considered in major advanced and emerging economies, according to the report.

The risks to financial stability in China arising from elevated corporate indebtedness make it all the more important to ensure that China’s Belt and Road Initiative (BRI) results in economically viable projects. The Outlook recognises the important contribution that the BRI can make to filling the global infrastructure gap, but emphasises that all international infrastructure efforts should be mutually reinforcing and respect global standards. The report highlights that cross-border investment projects must be viable, cost effective and appropriately selected, regardless of the source of funding.

The Outlook argues that the BRI will need to engage with other investing economies and institutions given its largely debt-funded nature and coverage of many countries with challenging business environments, and it says that significant contributions from OECD countries will be critical in the BRI’s success. This will require an increasing role for markets in resource allocation decisions. Property rights, competition, level playing fields and sound governance will need to be strengthened to make this possible.

Five areas that could benefit cross-border infrastructure investments from greater alignment with international standards stand out:

  • The growing role of state-owned enterprises (SOEs) in the global economy calls for ways to ensure a level playing field that discourages subsidies and non-transparent processes and allows recipient countries to benefit from investments based on widely accepted practices of corporate governance.
  • Open and transparent arrangements for procurement, especially for large infrastructure investments, are needed.
  • The heavy costs that bribery and corruption can impose must be avoided, both in the case of large infrastructure projects and elsewhere. Social and environmental costs need to be taken into account by ensuring responsible business conduct that minimises disruption to local communities.
  • Governments need to conduct environmental impact assessments prior to implementing proposed projects for facilities and infrastructure.
  • Open and transparent regimes for cross-border investment are needed to reduce costs and increase options regarding technology.

In all five areas, OECD provides essential guidance for both the economies where the new infrastructure projects would be located, as well as for those countries where the financing, equipment and expertise may originate, notes the report.

The OECD Business and Finance Outlook 2018 is available at http://www.oecd.org/investment/oecd-business-and-finance-outlook-26172577.htm.

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