During a recent oath-taking event hosted by president Benigno Aquino at Malacanang, the Philippines presidential palace, proceedings were interrupted by a power blackout. Indeed, blackouts have become so widespread on the island of Mindanao that social-media users have taken to calling the energy secretary the secretary of darkness.
Infrastructure needs more energetic development in the region as a whole; the trouble is that investment in the sector has been the preserve of government and attempts to harness the private sector have achieved limited success. Meanwhile, as the US Federal Reserve tapers its quantitative easing programme, emerging markets are maintaining prudent reserve policies that might limit infrastructure investment. However, changes in the macroeconomic environment are forcing a rethink of financing, with innovations that might lead to greater private-sector participation. Still, the twin ogres of governance and transparency loom large.
The Asian Development Bank estimates that Asean (Association of Southeast Asian Nations) infrastructure projects will require sustained annual investments of approximately $60 billion a year to 2020, in addition to investment in projects with large cross-border impacts such as airports, seaports and roads to borders. HSBC estimates that demand in Asia as a whole might reach $11.5 trillion by 2030.
Leaders in Asia are no doubt mindful of the correlation between economic development and the quality of infrastructure, but despite strong growth in southeast Asia, the bloc continues to lag behind the Asian average in infrastructure coverage and has attained a fraction of that found in OECD economies.
Thailand is a case in point. The government has announced infrastructure projects to be executed in the period up to 2020 worth Bt2 trillion ($62 billion) – some 18% of GDP. According to Capital Economics, a London-based economic research consultancy, economic growth in Thailand averaged 4.5% in the past decade compared with 9% for the region in the decade before the Asian financial crisis. “One of the main reasons for this lacklustre performance is the poor state of the country’s infrastructure, particularly for transport,” it says.
The World Bank agrees. It places Thailand behind Malaysia and Philippines but ahead of India and Indonesia in its logistics performance index, a measure of the timeliness of shipments in reaching their destinations.
The Asian financial crisis of 1997/98 was a monetary-policy wake-up call for regional governments; their reaction has been to build substantial foreign-currency reserves as a defence against speculative capital flows and rises in interest rates. China has amassed around $3.8 trillion, according to estimates by Silk Road Associates, an economic research consultancy in Hong Kong. Southeast Asian countries have more than $700 billion in foreign-currency reserves, as well as substantial levels of private savings, according to the ADB.
Finding a way of matching financial resources to infrastructure requirements is a policy dilemma. As a way to bridge the funding gap, the ADB has structured an Asean Infrastructure Fund (AIF). Incorporated in April 2012 in Malaysia, it expects to provide loans of up to $300 million a year.
The fund made its first advance last December with a $25 million loan to fund power links in Indonesia. As well as being lender of record, ADB contributes as a shareholder, co-financier and administrator. Other shareholders include Asean member countries, the so-called Asean-9; of the $485.2 million in total shareholder equity, ADB provided $150 million. In the first five years of operations, the AIF is restricting financing to sovereign or sovereign-guaranteed projects to ensure financial prudence and creditworthiness, and to make sure it obtains an investment-grade rating.
Not surprisingly the AIF is promoting private-sector participation including public-private partnerships, although PPP is an area of uncertainty since few projects have attracted long-term yield-seeking sovereign, pension or insurance funds as participants. Most governments still rely on a combination of annual budget, state-owned enterprise revenues, borrowing and dedicated infrastructure funds.
The private sector remains a relatively untapped source, accounting for just 20% of infrastructure financing, according to the ADB.
Policymakers are hoping to change that. Last April a fund backed by Bangkok’s Skytrain raised around Bt62.5 billion in Thailand’s largest initial public offering. Effectively a securitization deal, it offers a glimpse of the project finance of the future. Krystal Tan of Capital Economics says it could alter funding dynamics: “With the Skytrain IPO and the new PPP law, the private sector’s share of the funding mix should rise in the medium term.” Given the creation of the Asean Economic Community by 2015, the implication for the private sector is that what is good for Thailand is good for everybody else. The ADB agrees. In time, it says, the AIF will provide the mechanism for long-term institutional investors such as pension or sovereign wealth funds to purchase debt instruments and hybrid capital, opening up access to the region’s private savings.
Patrick Mispagel, associate managing director at Moody’s Investors Service, thinks it is the right course. “From our perspective, facilitating institutional investment in Asian infrastructure is generally positive as it will increase availability of capital to meet large funding needs,” he says. “While banks have traditionally funded infrastructure, they alone will not have the capacity to fund multi-trillion US dollar infrastructure investments in Asia.”
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| Ronald Man, Asian economist at HSBC in Hong Kong |
For all that, Ronald Man, Asian economist at HSBC in Hong Kong, says government money can still underpin infrastructure funding. “Since 2000 emerging Asian economies have been noted for fiscal prudence,” he says. “For a few years this meant public funds available for infrastructure were limited, particularly in India and Asean economies, [but] public debt [has] declined sharply. For instance Indonesia’s government debt-to-GDP ratio fell from 95.1% in 2000 to 24% in 2012. With public debt loads more manageable, the public sector is able to provide support for infrastructure investment.”
Man says there is also likely to be an influx of cheap liquidity from Japan. “The Bank of Japan’s aggressive monetary easing under governor [Haruhiko] Kuroda will lead to a strong inflow of liquidity into emerging Asia. In 2012, Japan’s foreign direct investment into emerging Asia reached around ¥2.7 trillion ($26 billion).” That also looks like a geopolitical retort to China’s recent attempts to promote its regional infrastructure bank.
When Chinese president Xi Jinping proposed the creation of an Asian infrastructure bank during a speech to the Indonesian parliament in October, he implicitly acknowledged what many had speculated: China intends to use its massive reserves not only to boost regional economic integration but also to advance its soft power. At a time when relations with its neighbours are fractious the establishment of such a bank makes for a neat diplomatic manoeuvre to exemplify China’s desire to collaborate while downplaying accusations of economic imperialism.
Although these are early days, an infrastructure bank might shake up the dynamics of regional development, historically the domain of the ADB and to some degree the World Bank. Ben Simpfendorfer, founder of Silk Road Associates, says it remains to be seen how China’s proposal will play out. “The idea of an infrastructure bank is compelling on paper, especially as the Asean Economic Community will only increase demand for stronger land links,” he says. “But it will need to be further fleshed out in practice, particularly the issue of whether or not China will expect those benefiting from soft loans to contract Chinese construction companies.”
China is already a donor to the ADB, and there is no doubt that Asia’s appetite for infrastructure investment will be large in the next decade and beyond.
Substantial amounts have already been lavished on developing mainland China’s national infrastructure, largely funded by debt. According to Silk Road, China’s debt has risen 80 percentage points in the past decade to reach 255% of GDP when including the shadow-banking sector. Although that is lower than US debt, Silk Road says it nevertheless makes China one of Asia’s most indebted economies.
China’s total credit stimulus since 2009 is worth $11 trillion, or enough to buy the world’s entire oil supply for three consecutive years, according to Silk Road estimates.
Transparency will play an important part in easing investor concerns, as will regulatory reform. It is possible imminent Asean integration will spur regulatory harmonization and improve governance structures. Deeper regional debt capital markets would be a key part of future infrastructure financing, but diverse regulatory structures remain confusing to fixed-income investors. Some policymakers have said there is a need for a regional bond market. That is probably right as an Asean class of financial instrument, such as a regional bond market, would attract institutional investors to a standardized form of PPP.
Moody’s Mispagel agrees. “Capital markets approaches like project bonds and corporate infrastructure issuance can help to diversify available funding sources,” he says. There is also a need to build trust in PPP governance structures; countries such as the Philippines have attracted criticism for the slow implementation of PPP strategy.
Clearly reforms are needed in regional debt capital markets, including a liquid secondary market. Figures from data provider Dealogic indicate a bond market that has declined recently. In 2013, Asia issued just over $14 billion in bonds, compared with $24.6 billion in 2012.
However, Conor McCoole, head of project and export finance, Asia and Americas, at Standard Chartered, says it is only a matter of time before institutional investors assume a greater share of infrastructure financing as governments alone cannot bankroll investment. “We currently see strong appetite from institutional investors for infrastructure/PPP debt instruments and expect this to translate into transactions sooner rather than later. Once a first transaction occurs in the region we expect capital markets solutions to get adopted more widely in regional PPPs.”
It is a point echoed by Man at HSBC: “Most Asian countries will follow the lead of other countries in developing a sophisticated and deep infrastructure bond market. Malaysia already has such a market, and the rules that facilitated development are a subject of study by several countries.”
