Despite the flood of investors into emerging Asia – and the exhortations to other emerging markets to follow Asia’s lead – the region’s competitiveness and growth are under severe threat from lagging infrastructure investment.
Ramshackle transport and decrepit communication links are increasing energy and logistical costs across the region. In India, spending on logistics is rising sharply, and in China it represents nearly 18% of GDP, compared to 10% in North America. Moreover, rapid urbanization requires greater integration with rural areas and links to ports to facilitate the region’s exports.
According to the Asian Development Bank (ADB), East Asia requires $200 billion a year, while South Asia will need $88 billion annually to sustain a growth rate of 7.5%. In total, the region covered by the ADB needs $3 trillion for the next 10 years – but at present, only half this amount is being invested. In fact, things are a lot worse than a decade ago: before the 1997 financial crisis, a third of all global infrastructure investments were funnelled into the region, but the recovery has been slow.
Even though banks and capital markets in the region are by and large flush with cash, funds have yet to be channelled meaningfully towards infrastructure. Bill Streeter, head of international public finance, Japan and Asia Pacific, at Fitch Ratings says: “The lack of investment is not due to cash problems, but to the poor credit quality of projects.”
Lack of confidence
Country risk rather than a downturn in global infrastructure investment activity is to blame, according to Bob Bestani, director-general of private-sector operations at the ADB. Foreign firms and investors are holding back, largely because of what they perceive as “lack of a solid and dependable regulatory framework in many sectors”, he says.
“They [foreign companies] have found themselves subject to the whims of host governments that failed to honour underlying contracts, or that felt free to change the regulations governing investments,” says Bestani.
This lack of confidence bears itself out through the relatively high bank lending rates. Project lending by commercial banks before the crisis came at relatively competitive rates – about 160 basis points over Libor according to the World Bank, but this had increased to 220 basis points by 2002-03.
Nevertheless, private investment is gradually increasing, and sources of financing are also diversifying, says Streeter: “Most financing has been through domestic bank loans, but now we are seeing international and local capital markets getting into the game.”
One of the more encouraging signs of foreign investor enthusiasm for Asian infrastructure came when Australian Macquarie bank replicated its well-known domestic model of listed infrastructure funds, this time in Asia. Most recently, it launched the $1 billion Macquarie Korea Infrastructure Fund – its first listed Asia dedicated fund – which was listed in Seoul in March 2006.
The funds were committed mainly to toll roads, with inflation-adjusted long-term government revenue support tied in. Nick van Gelder, head of Asian and Middle Eastern infrastructure funds at Macquarie, says: “The extent of private investment is constrained by the deal flow and the number of investment grade projects. But although it may have been difficult five years ago, there is now a better regulatory environment. For example, investors now realize Indian airports are certainly worth it.”
Private equity firm Darby Overseas Investments raised $610 million last July for its Korean fund, which will focus heavily on energy infrastructure investments through private equity and mezzanine capital, according to Simon Sham, managing director at Darby Asia Investors. The fund is Darby’s largest Asia dedicated fund. Its first managed Asia mezzanine fund was launched in 1998.
Local markets
Currency risk has long been another reason for caution. “Investors have to make an informed decision; there is no magic answer, but currency risks cannot be ignored,” says van Gelder. ADB’s Bestani points out that investors are often in effect “forced to invest using hard currencies, in economies where there is no capital market either to provide long-term local currency loans or to allow investors to hedge foreign exchange exposures.”
But this is changing as local capital markets gain momentum, in some cases using the Singapore model as a point of departure [see box]. Multilaterals such as the ADB are at the forefront of local market development, Bestani notes: “We are now in a position to provide long-term, fixed-rate local currency financing in those countries that do not, as of yet, have a functioning capital market through which to do a bond issue.”
One of the most ground-breaking examples of this came in October 2005, when the ADB and IFC both launched bonds in renminbi (so-called “panda” bonds) on the Chinese local market, with the majority of the proceeds channelled to domestic infrastructure firms. The deals marked a bold attempt to develop China’s domestic financial sector and local capital markets – one of many such moves by development banks in Asian local markets.
In the longer term, just as in Europe and North America, the growth of pension funds and insurance companies will also help spur local capital market development as more sophisticated financial tools – including the securitization of infrastructure revenues – gain currency.
As Sudhir Rajkumar, head of pension investment partnerships at the World Bank says: “Infrastructure gives pension funds the opportunity to invest in a domestic asset class in local currency, allowing them to match their long-dated liabilities to gain potentially higher returns than government bonds.” The likely adoption of mandatory pension schemes by many governments in the region would transform domestic institutional investors into major players.
Mobilizing the capital
Ideas on how to mobilize capital for infrastructure finance are now being hotly debated, not least following the suggestion by former US treasury secretary Larry Summers and others that excess foreign exchange reserves – especially in Asia – be put to use for that purpose, among others, in part to earn higher returns. The UN Economic and Social Commission for Asia and the Pacific (Unescap) has since moved to back a proposal for setting up an infrastructure investment bank or finance corporation for the region, which could draw on excess reserves.
Not everyone, though, is convinced by this approach: Bestani, for one, argues that the focus should rather be on setting up a framework for funds to be channelled effectively. “This is not about money: an institution needs to create a proper enabling environment, facilitate dialogue between the government and private sector and rebalance the risk/reward equation,” he says.
In the long term, Asia’s infrastructure watchers are putting their faith in the liquidity of local financiers – and the promise of increasing financial sector sophistication. But ultimately, only regulatory reform and stable policy regimes will ensure that the deals get done.