The private sector can provide expertise as well as funding for Asian infrastructure projects but attracting institutional investors is still a challenge in the region. Nick Ferguson reveals why bond markets need to develop if governments are to tap into investors’ savings and drive forward infrastructure development
Protesters outside the Financing for Development conference in Addis Ababa in July argued that delegates were ignoring an obvious tool in the funding arsenal: taxation.
Even Ban Ki-moon, the UN Secretary-General, seemed to agree in his opening remarks at the conference, telling delegates that domestic resource mobilisation is “crucial”, while complaining that attempts to raise such resources through taxation are frequently hampered by loopholes, tax avoidance and tax evasion.
This is a genuine problem, not least because official development assistance and other private international capital flows are in decline. The protesters are rightly upset that taxation is not being taken more seriously as part of the solution.
“Tax policies and systems should be aimed at raising resources for people’s basic and development needs,” says Lidy Nacpil, Coordinator of the Asian Peoples’ Movement on Debt and Development.
Few would disagree with such a statement, yet the international community made little progress in Ethiopia on its plan to create a global tax body that could help developing countries become more self-sufficient.
The protesters complain that cash-strapped governments have little choice but to let private interests take over the provision of public services. Reality is more complex.
Not (just) about the money
While it is certainly true that budgetary constraints are a real issue for many governments, money is not the only reason for turning to the private sector as a way to finance development, especially infrastructure.
During the past few years it has become common in Asia, for example, for local business groups to bring much-needed professionalism and discipline to project management and cost control, which has typically been more important than the financing they contribute.
“Governments believe they do infrastructure very well, but if you look at the record that’s often not the case,” says Michael Barrow, Deputy Director General of Private-Sector Financing at the ADB. “Across Asia, development has been driven to a very large extent by unleashing the private sector–or at least bringing private sector rigour to state-owned companies.”
Where the capabilities of successful private sector firms outweigh those of their governments, harnessing this reservoir of competence and efficiency can be extremely productive.
When India’s Reliance group built a nationwide digital network more than a decade ago the government couldn’t provide accurate maps for large swathes of the country, so the conglomerate used its experience in petroleum exploration to make its own. It took more than 50,000 workers and 65,000 kilometres of fibre-optic cables to achieve something the government could not: making basic communication accessible and affordable for hundreds of millions of people.
“What you’re seeing in Asia, unlike in the west, is a lot of horizontal expansion by conglomerates,” says Stephen CuUnjieng, Asia chairman at investment bank Evercore. “Many of these groups have already reached a dominant position in their core business and have capacity to spare.”
Construction firm CH Karnchang in Thailand has helped to finance and build toll roads, the Bangkok Metro, waterworks and power projects. Indonesian carmaker Astra has led the development of toll roads, seaports, industrial complexes and water projects and the Aboitiz Group in the Philippines is a significant backer of power generation and distribution.
The attraction for these groups is clear. “Properly managed and structured infrastructure provides very predictable returns,” says CuUnjieng. “It might not have the margins of a consumer retail business, but if you buy or build the right toll road or infrastructure asset, you have real stability. Nobody is going to build a rival toll road. That’s the beauty of infrastructure: once you get in, it’s an annuity.”
Ultra-low interest rates have also made it much cheaper to service debt, allowing sponsors to leverage the low nominal returns by up to five or six times to achieve very respectable rates.
Even in China, with its vast public sector, private companies have been active in developing infrastructure and are now taking their experience into the rest of the region through the US$40 billion Silk Road programme–a soft-power initiative unveiled by President Xi Jinping in November 2014 that will help build an infrastructure network of highways, railways, ports, pipelines and logistics hubs across the region.
China’s biggest private investment group, China Minsheng Investment, is part of a consortium that plans to invest US$10 billion in South-East Asian infrastructure under the initiative, starting with a US$5 billion industrial park in Indonesia.
Paying the bill
So far so good, but part of the problem is the sheer amount of finance needed. Developing Asian economies face an infrastructure bill of US$730 billion a year during the next decade, according to ADB estimates, and Barrow says that the general sentiment is that the private sector will fund roughly one-third of that.
Currently, most private infrastructure spending is financed domestically by developer equity and commercial bank debt. Barrow points to a typical example from earlier this year: a public-private partnership project to expand and renovate Mactan Cebu Airport in the Philippines, financed through a US$450 million loan from a consortium of Philippines banks, with the ADB also participating.
While less developed markets such as Mongolia or Myanmar tend to rely more on offshore financing, this kind of highly liquid domestic banking system has been the norm across most of the emerging markets since before the global financial crisis.
However, it is unclear if local banks and developers will always have the appetite to provide sufficient funding–or if it is wise for governments to rely on it so heavily.
“If you look at large parts of the Asian project finance markets, you see banks willing to go long term, but they are often providing floating rates or facilities with a reset,” says Barrow. In India, for example, he says the typical model is three years at fixed interest rates and then a re-fix every three years.
This is not an optimal way to finance long-term investment, which is why international financial institutions such as HSBC are pushing Asian governments to make better use of the region’s growing pool of savings. The bank estimates that Asia ex-Japan’s aggregate financial wealth comes to more than US$50 trillion.
But despite the development which followed the 1997 financial crisis, Asia’s bond markets still lack the depth, liquidity and legal safeguards necessary to attract the level of investment required to fund the region’s infrastructure needs or to allow issuers to tap into the region’s large savings pools.
The ADB has been working to fix that. It launched the Asian Bond Markets Initiative in 2002 to develop and integrate the region’s local currency bond markets as an alternative to foreign-currency loans, which, combined with pegged exchange rates, played a big role in the Asian financial crisis.
Barrow stresses that one of the advantages of tapping growing pools of institutional money is the long-term maturity profile of life insurance and pension savings, which provide a good match for development investment.
“For project finance it’s important to have some certainty on costs,” he says. “Bonds can provide that more easily, so having an environment where people focus a little more on interest-rate risk would be good for the bond market’s potential.”
A need for credit enhancement
The key to accessing institutional capital through the bond markets is the ability to provide credit enhancement to meet the minimum rating requirements of institutional investors.
Monoline insurers disappeared with the crisis, so the triple-A rated ADB has been working to extend its credit enhancement operations beyond official development finance partners to include the private sector and private institutions, and to reinforce closer collaboration with the private sector in project cofinancing. Barrow says it is still early days for the initiative.
It remains to be seen how China’s entrance into the development finance arena will affect such efforts. The Chinese-led Asian Infrastructure Investment Bank (AIIB) is expected to launch with US$100 billion of capital earmarked for investment in infrastructure, but the initiative is controversial and seen by some as a challenge to the Japanese-led ADB, stoking fears that rivalry between the two countries is becoming an impediment to meaningful regional cooperation.
The Japanese government did little to dispel that impression when it responded to the AIIB news with its own US$110 billion commitment to infrastructure investment.
While there is a danger that tension between China and Japan will lead to conflicting goals, both are ostensibly committed to facilitating greater private-sector involvement and the extra capital is clearly welcome.
Meanwhile, other efforts at regional integration continue. Finance ministers of the Asia- Pacific Economic Cooperation (APEC) countries met in September in the Philippines to launch the Cebu Action Plan, which comprises four pillars: financial integration; fiscal reforms; financial resilience; and infrastructure development and financing.
Amid efforts to develop a consistent framework for public- private partnerships, the issue of boosting tax revenues is a key focus for APEC members, who share many of the same goals as the protesters in Addis Ababa.
“Governments are eager to address the mismatches in the international tax system that have allowed the location of economic activity and value creation to be separated from the location of taxation,” said OECD Secretary- General Angel Gurria in Cebu. “The international tax system must be updated to meet the realities of a globalised economy and the rapidly changing business models of the digital world.”
Such efforts are laudable, but governments need long-term funding solutions today–and expectations for meaningful progress on taxation are low.
“Most countries in the world are cowards when it comes to revenue,” says CuUnjieng. “It’s never popular to raise taxes, but it’s popular to provide services. That’s the dilemma.”
For now, it is a dilemma that needs to be met with greater efforts to attract private capital.