Financing the UN Sustainable Development Goals (SDG) is one of the main priorities for the international community. However, as major stakeholders agree on working together to achieve the goals by 2030, concerns are spreading that funding is insufficient to support the massive effort required. Indeed, the existence of the SDGs is evidence that funding is not flowing into the areas most needed to achieve prosperity.

The SDG infrastructure gap

Globally, there is a substantial SDG infrastructure gap. This is most pronounced with regards to SDG11 ­– “Supporting Cities and Communities” – particularly in developing countries.

First of all, the World Economic Forum estimates that $5 trillion of annual investments in infrastructure will be required on a business-as-usual scenario to achieve the SDGs, whereas the UN Intergovernmental Panel on Climate Change (IPCC) has called on developed countries to provide $100 billion annually to help developing countries mitigate climate change, as well as adapt to its impacts, such as drought, rising sea levels and floods.

The UN Environment Programme Finance Initiative indicates that in developing countries, the annual investment gap for fulfilling the SDGs is around $2.5 trillion while it is around $1.3 trillion in Africa alone. Currently, only 48% of SDG investment needs are being covered in emerging markets and developing countries – and for Africa, the figure drops to 15%.

UN-Habitat estimates that between 2020 and 2030 the total investment needed for infrastructure worldwide, including the cost of achieving the SDGs, is around $38 trillion.

The striking fact is that funding is available, but it is not flowing to where it is needed. The total investment available is approximately $98 trillion, including commercial banks, investment banks, insurance and public pensions, sovereign wealth funds, equity funds and public global funds, such as donors, foundations and endowments.

Cities: Infrastructure Investment plus SDGs (2020-2030)
Infrastructure investment required to achieve the SDGs (2020-2030).
Image: Compiled by UN-Habitat integrating institutional reports and public websites; G20 Global Infrastructure Hub; McKinsey Global Institute; Sustainable Development Solutions Network; UNCTAD, mainly World Investment Report 2014; Dag Hammarskjöld Foundation 2019; and private sector reports.

This mounting finance gap is especially profound in cities. Urban areas are already home to 50% of the world’s population, generate around 80% of global economic output and account for 70% of greenhouse gases.

Increasing urbanization leaves more and more people dependent on urban infrastructure systems. With the lack of enough finance for investment in infrastructure, especially during the Fourth Industrial Revolution, urban populations are prevented from reaching their full potential of productivity, which increases the overall costs of municipalities.

What’s encouraging is that innovation stemming from the digital economy and "smart cities" can lower both the cost and the environmental impact in urban areas.

One example is the city of Hangzhou, China, which uses an artificial intelligence transportation management system called the “City Brain” to gather traffic information through videos and GPS data. It then uses artificial intelligence to analyze the data and coordinate more than 1,000 key traffic lights and road signals to guide real-time traffic flow. Hangzhou, a megacity of 7 million people, once ranked fifth among China's most congested cities, is 57th on the list as of 2019.

However, the world cannot rely solely on productivity gains to fix the severe financing gap for infrastructure, SDGs and climate resilience. There is an urgent need to find new financing tools for countries and cities, and one crucial source will be sovereign wealth funds.

Sovereign Investment Funds as a source of funding

While there is no single definition of a sovereign investment fund (SIF), it can be thought of simply as a government-affiliated investment vehicle that manages a substantial pool of assets. This new group of sovereign investors – which includes some of the world's largest government pension funds (federal and state), traditional sovereign wealth funds, central bank reserve funds, state-owned enterprises and various policy-driven investment funds backed by government-affiliated capital – have become the most influential capital markets players and investment asset owners.

The total amount of SIF is around $40 trillion, just enough to cover the gap in infrastructure funding, including the costs of achieving the SDGs.

SIFs are commonly funded by anything: from foreign-exchange reserves or fiscal surpluses owned by central banks; to pension savings or natural resources such as oil. Lately, both the size and number of sovereign investment funds have increased – meaning they are becoming increasingly powerful players on the global financial scene.

The SIF community therefore constitutes a strong contributor to closing the current financing gap for infrastructure, the SDGs and building climate resilience. Steering only a part of the sovereign wealth funds’ investments towards infrastructure and SDG financing could make a significant impact.

One common characteristic of sovereign wealth funds is maximization of long-term returns, which results in a higher risk tolerance than traditional foreign exchange reserves. This means that investment in, for example, climate-resilient infrastructure should not only be seen as an equitable investment choice for the funds but also suitable investment projects with the fitting risk-reward profile.

Financing urban development

There are two main methods that local governments usually rely on for financing infrastructure: pay-as-you-go (pay-go) and pay-as-you-use (pay-use). Pay-go capital financing refers to using cash or other current assets rather than debt issuance to fund capital projects. It usually depends on local taxes and user charges and is most commonly used in cases when capital project sizes are small, project sponsors have limited access to debt, local governments are approaching their debt limits, or there are prohibitions on the use of debt.

Pay-use capital financing means issuing long-term debt in the form of general obligation bonds or revenue bonds to fund capital projects. Infrastructure often involves large or lumpy investments and benefit both current taxpayers and future generations. Local infrastructure projects also rely on national government transfers, as they often have cross-municipal benefits.

Cities, however, use a range of public finance instruments and leverage tools to support sustainable infrastructure. An important one is public-private partnerships for capital-intensive sustainable infrastructure. The risk-reward profile of infrastructure projects largely determines the “investability” potential and thus the attractiveness to private finance investors. A pipeline of investable projects usually allows large investors to commit a greater share of their resources to infrastructure.

In this context, mobilized private capital, from domestic and international sources (such as foreign SIF funds), will need to complement an efficient allocation of public finance. It will also require a steady pipeline of projects that help countries meet their sustainable development objectives.

Countries remain limited in their ability to move from funding to a financing approach due to capacity constraints and incomplete deployment of tools or support mechanisms. They are not fully able to field a pipeline of projects that both contribute to a country’s sustainable development objectives and are suitable for private financing.

Key policy recommendations

Around the world, all markets face an acute need for new or modernized infrastructure. The estimated shortfall in global infrastructure investment is trillions of dollars per year, and that number may multiply when considering the latest infrastructure needs from the digital revolution.

The sovereign investment funds, with their long-term capital, are best positioned to allocate more capital into investments of smart cities, which arguably are the core infrastructure for future global sustainable growth.

Meanwhile, emerging markets need to understand the perspective of investors, who assess infrastructure projects against a multitude of options in other asset classes and countries. In this context, countries with more effective regulatory environments and credible project pipelines will attract more investment at a lower cost. Recommended actions can be categorized in three aspects:

1. Infrastructure strategic vision, which includes a project pipeline, a viable role for investors and communication strategy.

2. Policy and regulatory enablers, which mitigate renegotiation risk and increase the efficiency of key processes.

3. Investor value proposition at the individual project level, which focuses on maximizing value for governments and ensuring a competitive risk-adjusted return for investors.

Linking sovereign investment capital and smart city infrastructure needs may require a lengthy process of building consensus among stakeholders. But the rewards are high: developing countries’ governments can do much to attract quality long-term financing and set the foundation for future prosperity, while sovereign investors reap the attractive returns of long-term investment projects.

This article does not imply endorsement of views by UN-Habitat, United Nations agencies, China Investment Corporation or the World Economic Forum.