A case for greater infrastructure spending
Developing Asia ramps up infrastructure investment to keep growth momentum
To cope with its infrastructure requirements, developing Asia currently invests an estimated US$881 billion annually in infrastructure projects. The amount, though, is just half of the US$1.7 trillion a year that the region needs to spend from 2016 to 2030 –a total of US$26 trillion – if it is to maintain its growth momentum, eradicate poverty and respond to climate change, according to the Asian Development Bank (ADB).
The latest estimate is more than double the US$750 billion figure that the ADB projected in 2009. The inclusion of climate-related investments is a major contributing factor to the new figure, not to mention the continued rapid growth forecast for the region, which generates new demand for infrastructure.
Indeed, several countries across the region are ramping up their investments in infrastructure projects to meet the rising demand for power, transport, telecommunication services, and access to safe drinking water. Of the total climate-adjusted investment requirements during 2016-2030, the ADB says US$14.7 trillion will be for power, US$8.4 trillion for transport, US$2.3 trillion for telecommunications and US$800 billion for water and sanitation.
“There have been significant improvements in terms of infrastructure spending in India during the past 12 months,” says Manish Kothary, vice-president for project advisory and structured finance at SBI Capital Markets. “There is visible progress in the execution of stalled projects, which was made possible due to the renewed focus of the government to improve infrastructure, mainly roads, airports, railways, metros and power transmission. The same can be corroborated with India’s economic growth and is expected to give further impetus to growth with increased spending on infrastructure, which has also driven the higher consumption of steel and cement.”
Across the region, there is clearly an acceleration in activity in the energy market, both in the conventional and renewable energy space, as Daniel Mallo, managing director, head of energy, infrastructure, metals and mining finance for Asia-Pacific at Societe Generale points out. This is driven by a number of factors, including government policy, particularly for renewables. One driving factor is the desire by developed countries to go green, such as Australia, where there is a lot of activity in the wind and solar energy segments.
There are a number of state-level governments that have set ambitious targets, such as the Australian Capital Territory, which is looking to source 100% of its energy from green sources by 2020. The state of Queensland is also looking to generate 50% of its power requirements from renewables by 2025 – clearly fuelling the investment in renewable energy in Australia.
Taiwan is doing two things – exiting from nuclear power and shutting down coal power plants – which are boosting investments in renewables. They have an ambitious programme for offshore wind since Taiwan benefits from the shallow waters in the Straits of Taiwan, which is a good source for wind power. Japan and South Korea are also looking to develop a successful offshore wind energy sector to supplement the reduction in their power generation from coal and nuclear energy.
A number of emerging markets in Asia are also developing their renewable energy sector, although the implementation policies are taking longer. “We are starting to see investment in renewables in Indonesia, where the first wind farm was funded in 2016,” notes Mallo. “Project sponsors are likewise starting to look at solar, but it is very much in its infancy.”
Vietnam has a relatively ambitious programme to develop renewables as well. The government, Mallo adds, is working on a feed-in tariff framework, but not much progress has been achieved at the end of the day.
In the transport sector, the states of Victoria and New South Wales are driving ambitious plans in Australia with a fair amount of activity involving rail projects, says Gavin Munro, managing director, head of infrastructure finance for Asia-Pacific at Societe Generale. Japan is moving ahead with its airport privatization, while the speed rail project between Kuala Lumpur and Singapore is finally gathering momentum following the signing of a memorandum of understanding between the two parties in July 2016.
ADB says infrastructure investment in developing Asia is still primarily undertaken by the public sector, providing over 90% of the region’s overall investments. This amounts to 5.1% of the GDP annually, way above the 0.4% of the GDP contributed by the private sector.
Funding is available for infrastructure projects, as bankers point out, as the region is flushed with liquidity. “We are still in a positive environment with banks, including regional and domestic banks, looking to deploy their excess capital,” says Mallo. “And while the interest rates have gone up, they are still at historically low levels and so it is still cheaper to borrow to fund the projects.”
On the equity side, there is likewise a lot of capital available from infrastructure funds, pension funds and private equity funds. It is complicated and lengthy to get the projects going in emerging markets but the environment is still conducive enough to attract financing. “We are in a credit cycle where capital is readily available – there are a large number of investors who are very liquid and are actively looking for opportunities to deploy their capital,” adds Mallo.
Kothary says India is expected to spend US$1 trillion over the next five years to improve and modernize the country’s infrastructure projects. “India is definitely ramping up its infrastructure spending at a much faster pace, with the average road construction speed at around 25 km per day,” he says. “India has changed its bidding model from build-operate-transfer to a hybrid annuity model, which is a win-win for all the stakeholders as it has resulted in an increased participation from the private sector. The government is determined to double the pace of construction within the next five years.”
In addition, Kothary says the present government has tried to resolve stalled projects and has allowed funds to be released where the arbitration has been awarded in favour of the concessionaire, which in turn is attracting more private sector participation in road projects. The aviation sector is also attracting more private sector interest with the opening-up of regional routes and airports, as well as the modernization of the Goa and Mumbai airports. Foreign investors have likewise pumped billions of dollars into solar energy projects in India, participating in joint ventures with Indian partners in the modernization and development of greenfield projects.
In the Philippines, the market is also awash with liquidity to fund infrastructure projects. “We easily raised around US$4 billion in roughly two weeks for three capital markets transactions,” says Eduardo Francisco, president of BDO Capital and Investment Corporation. “The banks are ready to finance infrastructure projects and have strengthened their balance sheet to do so. While it is good the multilaterals and the government are looking at official development assistance (ODA) financing, we can fund most of the projects in the near term. We can even bridge the financing requirements, which can then be refinanced through ODA.”
ADB says regulatory and institutional reforms are needed to make infrastructure more attractive to private investors and generate a pipeline of bankable projects for public-private partnerships (PPPs). Countries should also implement PPP-related reforms such as enacting PPP laws, streamlining PPP procurement and bidding processes, introducing dispute resolution mechanisms and establishing independent PPP government units.
Munro says PPPs offer huge benefits to emerging markets as they enable the government to expand their infrastructure base without having to maintain and operate them themselves. “They can leave that to the private sector and move on quickly to the next project,” he adds. “PPPs are well-proven structures and there is a lot of precedent out there if a government wants to launch a PPP programme.”
PPPs are picking up a lot of momentum in China as the government is trying to introduce some discipline into infrastructure investment. Munro explains: “Some local authority investment companies have borrowed money and spent it on infrastructure projects, without realizing how much the infrastructure projects are really needed. It is still relatively early days in China. What we are really seeing are the Chinese banks demonstrating an increasing interest and appetite in investing in PPP projects abroad.”
A Moody’s Investors Services report issued in March this year says PPPs in China are primarily seen as a means of broadening the financing options available to regional and local governments for infrastructure development. But, similar to the more mature PPP markets, the Chinese government is also interested in PPPs because they allow governments to transfer risks to the private sector at a fixed price that can accelerate project delivery, lower total project costs and improve cost certainty for the public sector offtaker on a whole life of asset basis. Increasing new investment instruments will also help support the development of the Chinese PPP market.
In India, a lot of the infrastructure projects are structured as PPPs, but, as Munro points out, they are different from international best practice in terms of how they manage and parcel out the risk.
Kothary says with increased government spending on healthcare, education and other social infrastructure, it is more than imperative to attract private sector investment by way of PPP in developing and funding infrastructure projects. “Any government is finding it difficult to meet the higher infrastructure funding requirement with fiscal deficit to control and improve the social infrastructure,” he says.
The deepening of the capital markets is also needed to help channel the region’s substantial savings into productive infrastructure investments, according to ADB. Much is expected from the project bond market, but as Mallo notes, it is slow to mature due to a couple of reasons. “Where we’ve seen project bonds happening are in North America and in high investment grade countries in Latin America such as Chile, Mexico and Peru. What these countries have in common is that they are solid investment grade markets,” he says.
Another reason why project bonds are developing in these countries is the fact that bank financing for infrastructure projects is a little bit limited in terms of tenor. The sweet spot is usually seven to 10 years. It is very unusual to get bank loans with tenors of 15 years or 20 years. Loans of five or seven years are more common. They get refinanced in the longer-term market.
“So when you take all these factors to Asia, a couple of things happened,” says Mallo. “The sovereign credit rating is not that strong in this region. Indonesia, for instance, is a borderline investment grade country since it is still rated non-investment grade by Standard & Poor’s. That is one limiting factor to justify the project bond market picking up.”
Also, banks in Asia do actually provide long-term financing. It is not unusual to see 15-year or 20-year money being granted to infrastructure projects in Indonesia with export credit agency cover from the likes of Japan Bank for International Cooperation. Those are customary for large-scale energy infrastructure projects in that market.
The combination of these factors makes it difficult for the project bond market to develop rapidly. “As long as we continue to have cheap liquidity and banks continue to offer long-term lending, there is less of an argument to be made for the project bond market to develop in earnest,” argues Mallo.
Kothary says the increasing funding requirements for infrastructure projects across Asia has to be met by development agencies such as the ADB, and the World Bank, as well as the local banks, the debt markets, and institutional investors like the pension funds. “The infrastructure sector cannot grow without the active participation of the private sector, which requires stable and predictable government policies,” he adds. “The risk-reward ratio has to be attractive enough to bring more investments for faster infrastructure development.”
Meanwhile, relative to climate change initiatives, a number of large project sponsors as well as banks are moving away from coal. Societe Generale has stopped project financing for the development of coal mines and coal-fuelled power plants effective January 1 2017 since some of its large clients, such as Engie and Electricite de France have exited the sector. “To some extent, that may cost us a couple of lost opportunities, but not that many, since some of our biggest clients are ahead of us in exiting the sector,” says Mallo. “And while it is true that coal remains somewhat important in Asia, it is really concentrated in a small handful of markets, such as India, Indonesia and Vietnam.”
What is also encouraging for Societe Generale is the fact that for the first time in a long time, there are broad-based opportunities in gas-fired generation projects. “We are now in an environment where there is abundant and relatively inexpensive natural gas in the world, including liquefied natural gas,” adds Mallo. “We see large-scale gas-fired projects being developed in Indonesia, such as Jawa 1, and the state-owned electricity company PLN will be tendering a handful of gas-fired projects this year.”
Moreover, there may be as many as 20 new energy import markets in the world in the next 10 years, requiring natural gas to feed their gas-fired power stations. Out of the 20-odd countries, the majority of them are likely to be in Asia, such as Bangladesh, Indonesia, Myanmar, the Philippines and Sri Lanka.
“So in as much as we have exited coal, there are new power generation markets opening up substantially in the natural gas and renewable energy segments, which are well within our strategy,” says Mallo. “When I looked back at the decision we took, I think it was the right decision because, fundamentally, society is evolving and embracing renewable energy, and coal is increasingly becoming a marginal sector with the exit of a number of large developers and energy companies.”
For now, coal is an important source of energy for countries like the Philippines. BDO’s Francisco says until the costs of other energy sources reach grid parity, coal will remain part of the country’s energy mix. He adds that the local banks, including BDO, are ready to finance coal projects as long as all the government permits, including environmental, are obtained.