Japanese prime minister Shinzo Abe is good at taking the measure of his audience.
Addressing the New York Stock Exchange on September 25, he recalled Gordon Gekko in the 1987 film Wall Street, when “the Japanese economy was regarded as a juggernaut.” In the 2010 sequel, “the investors are Chinese and it is not Wall Street but London where Gekko amasses his wealth. Japan is conspicuous only in its absence.”
Finally, the tide has turned. “I have come to tell you that Japan will once again be a country where there is money to be made, and that just as Gordon Gekko made a comeback in the financial world after 23 years of absence, so too can we now say that “Japan is back,” Abe said.
The premier’s sales pitch for Japan included developing the world’s fastest train and the world’s biggest wind turbine. The latter is to be built off the coast of Fukushima Prefecture, where the 2011 earthquake and tsunami wrecked a nuclear plant and led to the shutdown of Japan’s entire nuclear power industry.
Abe made no mention of Japan’s colossal government debt, now over ¥1 quadrillion (US$10.1 trillion), bigger than the combined economies of Germany, France and the UK, or this summer’s bruising political battle over raising the consumption tax.
Also missing was any reference to a project that will soon test the credibility of ‘Abenomics’ by opening up part of Japan’s vast stock of public infrastructure to private investment.
The government is selling a concession to operate two airports that serve Osaka, Japan’s second-biggest city, and the surrounding Kansai region. If the auction is a success, as seems likely, other profitable airports will follow.
That’s just the beginning. Over the next decade, Tokyo intends to sign ¥12 trillion in contracts with the private sector. Sensitive discussions are already underway for the eventual privatisation of Japan’s water and sewerage industries. Ports and highways are also on the list.
There is also the well-known and much-delayed privatisation of Japan Post Group, the world’s biggest bank outside China when ranked by deposits. This plan has been brought forward one year to mid-2015, but it remains some way off.
Instead, the concessions of the Osaka airports look most likely to reveal the ability of Abe’s government to drive through new privatisation. Hence the barely suppressed excitement among bankers, institutional investors, fund managers and lawyers.
Yet there has been a dearth of news about the concession sale by publicly-owned New Kansai International Airport Company (NKIAC). Observers think the softly-softly approach indicates the overriding importance to the Abe government – and investor confidence – of getting the sale right.
“A lot of Abenomics is riding on the hopes and aspirations that they know what they are doing,” Brian Waterhouse, Japan banking analyst with CLSA, tells Asiamoney.
The successful sale of the Kansai airports concession would offer proof that Abe can deliver the structural reform he has promised, and embolden the support of investors. Any signs of delay or failure, however, and faith in Abenomics could falter.
Abe may be reluctant to discuss it, but his grand economic plan may depend on the Kansai airports concession sale helping to get a broader privatisation push aloft.
Infrastructure lifeline
Japan has now completed the legislative framework needed to foster private-sector investment in public infrastructure. The advent of the Abe government last December also brought with it a dynamic of political urgency that was previously lacking.
“The World Bank was behind PFI/PPP (private finance initiatives/public-private partnerships) in South Korea,” comments Makoto Inoue of Mizuho Bank’s structured finance division. “Even though the Japanese government is said to be in a fiscal crisis, the sense of crisis in Japan is not as severe as that of South Korea during the 1997 Asian financial crisis.”
Investors believe that Japan has all the key pieces in place for a privatisation boom.
“Japan has a huge stock of infrastructure. A lot of it is absolutely world class and is being paid for on a usage basis by citizens, so many of the ingredients for private investment participation exist already,” says Anoop Seth, head of Asian infrastructure at AMP Capital.
Waterhouse of CLSA thinks that privatisation offers a lifeline to a Japanese government urgently seeking to reduce public debts now surmounting 200% of gross domestic product.
“Japan has a high credit rating, but it can’t go on forever issuing more and more JGBs (Japanese Government Bonds). It would be ideal if we had a Thatcherisation of Japan, which is simply to take assets you don't need and privatise them,” he tells Asiamoney.
For Waterhouse, converting public assets to private will also help Japanese banks that are equally desperate for new loan customers.
“If you transfer [an infrastructure asset] from the public to the private domain, it still needs to be funded, because an asset needs a liability. The liability was the JGB. If it is replaced by a loan then the bank has got somebody to lend to. So the JGB is either retired or allowed to run off, which means the debt ratio for Japan shrinks, the sovereign rating improves, and this trickles down to corporate Japan.”
Inoue of Mizuho agrees: “Whereas demand for corporate borrowing is low, fiscal deficits keep building up. In addition, we expect that infrastructure projects will generate a stable cash flow.”
Soaring interest
The privatisations of the two Kansai region airports mark a good place to start.
Kansai International Airport is an engineering marvel of the 1990s. Built on an artificial island in Osaka Bay, it overcame extreme physical challenges and served as a blueprint for Hong Kong’s new airport a decade later.
It also proved one of Japan's deepest money pits, even at a time when the country often gave scant heed to the cost of public construction. NKIAC’s debt has been declining for several years, but at the end of March still amounted to ¥960 billion.
The Nikkei reported on September 7 that NKIAC hopes to sell a 40-year concession to operate the international and domestic airports for US$6 billion-US$8 billion, which would wipe out most of its debt. Requests for tender would be sent out within this year, and a selection made in January or February, according to the Nikkei.
“NKIAC has not made an announcement on these matters,” spokesman Keisuke Hamatani tells Asiamoney, adding that the company has yet to retain a financial adviser on the discussed sale.
“There are many issues still being discussed with the Japanese government,” Hamatani adds. “NKIAC is unable to discuss the potential transaction until a public announcement of the implementation outline has been made.”
While the NKIAC is playing coy over details, potential bidders are already lining up. At present, financing for Japanese PFI/PPP projects comes mainly from banks, including government policy lenders such as the Development Bank of Japan.
However the concessions are set to attract a range of investor interest. Institutional fund managers, a leading Japanese bank and a trading house all confirm to Asiamoney that they could bid for the NKIAC concessions, depending on bid parameters.
Mizuho’s Inoue says the bank expects to act as a financial adviser to a bidding consortium, “and/or as a mandated lead arranger” for financing. Sumitomo Mitsui could not comment “on individual deals” but “will seek financing opportunities in the PFI/PPP market,” says spokesman Takashi Morita.
“We are still watching the progress of the project and have not decided anything specific,” says Sachiko Matsushita of trading house Marubeni. Mitsubishi Corp., the biggest of the sogo shosha (general trading houses).
Mitsubishi UFJ Financial Group, Japan’s biggest private-sector banking conglomerate, also declined to comment. However the group’s trust bank acquired 15% of AMP Capital, an asset-management unit of AMP, Australia’s largest private pension and life insurance provider, in 2011.
“We are already working very, very closely with them on sourcing Japanese as well as international investors who would like to participate,” says Seth of AMP Capital.
Nomura Securities also declined to comment, but one of its teams is in Australia trying to drum up work for the NKIAC concession. “Nomura is on the road,” Kyle Mangini, global head of infrastructure at Melbourne-based Industry Funds Management tells Asiamoney. “They might not be taking part as principal but they are certainly looking for some advisory work.”
Macquarie, the world’s largest global infrastructure manager, is also engaged, despite the country being virgin territory. "We are interested in the privatisation of Japanese airports,” Steve Gross, a senior managing director based in Hong Kong for Macquarie Infrastructure and Real Assets, tells Asiamoney.
Using local expertise
Infrastructure assets such as the NKIAC concessions should also make ideal investments for Japan’s local pension investors. Yet while infrastructure has become an established asset class for many pension and sovereign wealth funds, Japan has been slow to follow the trend.
The country’s Government Pension Investment Fund is under mounting pressure to seek higher returns than just the wafer-thin yields of JGBs that account for 60% of its ¥120 trillion in assets. However, under current regulations the mandate of all public pension funds prevents them from buying into infrastructure projects.
“The GPIF portfolio is bound by ‘benchmark’ allocation guidelines, set by the Ministry of Health, Labour and Welfare. It specifically states that the portfolio should be ‘safe and efficient,’ and comprising only domestic bonds, domestic equities, foreign bonds, and foreign equities,” Takatoshi Ito, professor of economics and dean of public policy at the University of Tokyo, tells Asiamoney. “The GPIF does not have any independence in choosing asset classes. The ministry probably considers infrastructure investment to be unsafe.”
That could yet change. Ito is chairing a government panel reviewing the investment strategy of public funds. It suggested on September 26 that public pension funds buy into infrastructure, real estate investment trusts, commodities and private equity.
Until local pension funds get the go-ahead, foreign pension providers could be the most active in financing such privatisations. Australian asset manager IFM, which focuses on infrastructure investments on behalf of pension funds, so far has not taken the plunge into Asia, but that may soon change.
“Japan will be viewed as a market a tremendous amount of appeal for the infrastructure-investing community,” says Mangini. “It is an extremely well-developed market. It has an affluent population, and affluence is directly correlated to air travel. There is a strong legal system. There are extremely deep capital markets.”
Japan’s megabanks and sogo shosha trading houses will also be likely players. Both groups have steadily notched up infrastructure and PFI/PPP deals overseas and are keen to put such experience to use at home.
“We have been applying our PFI/PPP experience in Europe and Korea to Japanese PFI/PPP for 10 years,” said Inoue of Mizuho. “We are interested in large economic infrastructures such as airports, toll roads and railways.”
In the UK, Sumitomo Corp. bought Sutton & East Surrey Water in February for £165 million ($265 million), while rival Itochu last year paid £43.5 million ($70 million) for 20% of Bristol Water. Mitsubishi Corp. heads a consortium that owns Australian water company Trility, while Marubeni has water businesses in Chile.
In Japan, water and sewerage companies are still largely owned and managed by local governments. “Considering the severe state of public finances in Japan, we expect rapid implementation of water privatisation to improve the level of service and reduce the public burden,” says Matsushita of Marubeni.
Impediments to overcome
For all the interest in Japan’s infrastructure, some sizeable impediments to its successful privatisation remain.
For a start, there is the country’s dismal demographics. The government recently started counting foreign residents to mask a shrinking Japanese population, which dropped for four years in a row. The percentage of Japanese aged 65 or over is now a record high 24.4%.
Abe is trying to offset this by encouraging more Japanese women to work, and prospective investors don’t appear overly concerned.
“We believe a potential NKIAC concession would have mitigating positives like scope for growth of low-cost carriers and Japan’s favourable credit rating to support long-term financial commitments,” says Seth of AMC Capital.
After all, South Korea has attracted a great deal of foreign infrastructure funds in spite of having the most rapidly ageing population.
Another potential snag of infrastructure is the relative frequency of earthquakes in Japan.
Naoki Eguchi, a partner in Tokyo with law firm Baker & MacKenzie, notes that allocating force majeure risk in the event of a natural disaster, such as the 2011 earthquake that severely damaged Sendai Airport now slated for privatisation, remains to be decided.
Seth believes this will be dealt with separately. “If there are significant specific risks that you identify, you would normally not bundle them up into force majeure, you would take them out and see how you want to price them, allocate them, and insure against them.”
Political opposition
More difficult to navigate could be the political roadblocks to privatisation in sectors outside airports.
Asiamoney asked Mizuho whether the bureaucracy or public opinion was the biggest barrier to privatisation in Japan. “We don't think public opinion is the biggest obstacle,” was the bank’s answer.
Informed sources tell Asiamoney that privatisation of water sewerage is the subject of heated argument between local governments and the Ministry of Internal Affairs on the one hand, and the Ministry of Land, Infrastructure, Transport and Tourism on the other.
Additionally, the government would need to address public concern over private-sector control of drinking water, and mollify local government employees concerned about redundancy.
The privatisation of expressways could also prove challenging. Sales in this sector were attempted in 2005, but botched due to bureaucratic interference. A government holding company still wields control.
“For highway privatisation, there is still a lot of discussion needed. There is already a consensus among the government on airport concessions, which is why it is being done first. Expressways do not seem to be at the top of the agenda,” says Ken Koizumi, a managing director of Goldman Sachs in Tokyo.
This could yet prove a misstep by the government. Last year a major road tunnel collapsed in Sasago, 80 kilometres west of Tokyo, killing nine people. The accident was blamed on ageing ceiling bolts, highlighting the need to repair the road network. Yet the government looks like it would like to defer road sales until it has little choice.
“Privatisation of expressways and water will happen when the Ministry of Finance finds it really needs to secure funding, such as for maintenance of expressways. This is most likely to become a more serious issue sometime around 2018 or 2019, when the total government debt is expected to exceed total household savings,” Koizumi adds.
Structural reform, the ‘Third Arrow’ of Abenomics, promises sweeping deregulation to quicken the animal spirits of Japanese business. But, with the striking exception of airport concessions, so far there is little of immediate substance. This is bizarre given that Japan has all the necessary ingredients to initiate an infrastructure privatisation boom that would improve the nation’s fiscal health and stimulate economic growth.
Foreign investors as well as Japanese banks and trading houses clearly recognise the opportunity. The country’s pension system is a huge potential source of funding if restrictions could be lifted. The main impediment remains a stubborn bureaucracy.
“Privatisation requires political will and determination and the Abe government has a window of four years before the next Diet elections,” says CLSA’s Waterhouse. “They need to get on with it.”
