# **The scale of this increase in debt-financed public investments by developing countries has raised three important questions:**

- _What will be the growth impact of these investments?_ The debt sustainability impact of this new borrowing to finance public infrastructure investment depends critically on its impact on growth. A number of empirical studies find a positive impact of public investment on growth both through a direct impact on economic activity and through spillover effects on private investment.<sup>6</sup> Buffie et al. (2012) find that a sustained increase in debt-financed investment by 1 percent of GDP can raise real GDP growth in developing countries with good policy implementation capacity by about 0.5 percentage points.<sup>7</sup> Gupta et al. (2011) find that the unadjusted output elasticity of public capital is only 0.25.<sup>8</sup> These findings are consistent with the results reported by Perotti (2005) and Zandi (2008), who find that fiscal multipliers for investment spending are higher than for other types of public spending and tax cuts. Also, a study by the World Bank (2007) concludes that there are positive growth effects of public spending in general, and that of infrastructure, education, and health spending in particular.

- _What are the risks entailed by this shift toward a blend of concessional and nonconcessional borrowing?_<sup>9</sup> The works by Buffie et al. (2012) and by Andrle et al. (2012) suggest that caution should be used when developing countries are considering the financing options for public investment. When an economy can borrow concessionally to cover only part of an investment surge, difficult fiscal and private sector adjustments are unavoidable in the short to medium term, especially when the investment surge is frontloaded and the structural conditions of the economy are weak. While allowing for external commercial borrowing by less developed countries may mitigate some of these adjustment costs, the presence of weak structural and policy conditions, as well as unexpected exogenous shocks, can lead to debt sustainability problems. These external debt sustainability problems are magnified when considering domestic non-concessional borrowing.  Since domestic commercial borrowing does not provide additional external resources, it requires even more drastic fiscal adjustments and worsens the crowding out

> 6 Romp, W. and J. de Haan (2007), “Public Capital and Economic Growth: A Critical Survey,” Perspektiven der Wirtschaftspolitik 8, 1–140 presents a survey on this topic.

> 7 Buffie, E., A. Berg, C. Pattillo, Portillo, and L. Zanna (2012), _“Public Investment, Growth, and Debt Sustainability: Putting Together the Pieces_ ”, IMF Working Paper No. 12/144.

> 8 The authors present an alternative measure of efficiency-adjusted capital for which the output elasticity would be around 0.25 (IMF, Working Paper No. 217, 2011).

> 9 Bilateral and multilateral agencies have traditionally been the main sources of financing for public investment projects in developing countries. With the support from its shareholders, these agencies provided debt relief to several developing counties over the last years with a view to ensure their improved debt sustainability and give them the fiscal space needed to carry-out new investments. These multilateral financing sources are increasingly strained, however. Some agencies are reaching their lending limits for individual countries, and are unable to meet all the demand from these countries to finance investments designed to close their infrastructure gaps. The increase in non-concessional financing flows to developing countries reflects this fact, as well as two other developments. The policy of induced low interest rates and quantitative easing in high income  countries that has prompted a search for yield by global investors, seeking to open or guarantee access to natural resources. The cross-border bank lending tends to be cheaper than financing from international capital markets, with information asymmetries playing an important role in terms of access and costs. These banks have a closer relationship with borrowers and therefore have an advantage in monitoring creditworthiness. High risk borrowers gain access to financing with projects backed by well-defined revenue streams, usually based on natural resource revenue flows.

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