Indonesia Project Finance Roundtable: Part 2
For the second part of Asiamoney's Indonesia project finance roundtable, Ray Tay of Moody's chaired a discussion on the potential for PPPs and the best way to attract the private sector.
Dr Mohamed Ishthiaq Akbar, operations portfolio manager, country gateway office, Indonesia, Islamic Development Bank
Boon Khim Tay, senior vice president, investment banking, Asia,
Sumitomo Mitsui Banking Corporation
Boo Hock Khoo, vice president, operations, Credit Guarantee &
Edwin Syahruzad, director, Sarana Multi Infrastruktur (SMI)
Richard Michael, executive vice president, Indonesia Infrastructure Finance (IIF)
Salyadi Saputra, president director, Permerinkat Efek Indonesia (PEFINDO)
Jun Tamura, chief representative, representative office, Mitsui & Co Ltd
Moderator: Ray Tay, senior analyst, public infrastructure finance group, Moody’s Investors Service
The participants (left to right): Richard Michael, executive vice president, Indonesia Infrastructure Finance (IIF); Salyadi Saputra, president director, Permerinkat Efek Indonesia (PEFINDO); Jun Tamura, chief representative, representative office, Mitsui & Co Ltd; Edwin Syahruzad, director, Sarana Multi Infrastruktur (SMI); Ray Tay, senior analyst, public infrastructure finance group, Moody’s Investors Service; Boo Hock Khoo, vice president, operations, Credit Guarantee & Investment Facility; Boon Khim Tay, senior vice president, investment banking, Asia, Sumitomo Mitsui Banking Corporation; Dr Mohamed Ishthiaq Akbar, operations portfolio manager, country gateway office, Indonesia, Islamic Development Bank
Ray Tay, Moody's: Indonesia has come a long way over the past few years in attracting long-term private capital. There are macro and micro factors coming together and influencing how long term capital is to be deployed. We will briefly discuss some of the recent initiatives but also look forward and see from the perspectives of the panelists that I have here with me: how can Indonesia do more for the sector?
From a credit rating perspective, we are encouraged by the recent initiatives, such as the reform of the land acquisition law. But we also need to see a track record of initiatives gaining traction and working as intended. Consistent implementation of PPPs, the openness of regulations to foreign capital, and the predictability of legal and regulatory frameworks are key ingredients to a vibrant infrastructure financing marketplace, which is what Indonesia desperately needs to realise its awesome potential.
But other than addressing the supply of financing, we need to also look at the demand for funding. President Jokowi has big plans for infrastructure and earlier this week pledged more money for the sector in the next budget with an 8% increase. He also indicated greater openness for more private sector involvement. However, Indonesia seems to face formidable challenges in implementation.
A key aspect of attracting capital into the infrastructure sector is building a good pipeline. The key investors in this market are patient, and they want to see a pipeline of well-structured, financeable deals before they can commit resources to the sector. How big is the potential for PPPs in Indonesia, and what can be done to unleash that potential?
Edwin Syahruzad, SMI: Infrastructure is very unique in the sense that it has to be a concession asset; a concession agreement is essential for the success of PPP finance. From my experience, if we are talking about electricity and toll roads, those sectors have benefited particularly from pretty standard concession agreements. The risks have been well understood by investors.
The government is going to encourage private participation in the electricity sector through PPPs. This could be through introducing PPP contracts in US dollars, for example. That would be one way to attract foreign banks and investors into the electricity sector. Toll roads are much more likely to be directed at local investors rather than foreign banks and sponsors, because it is rupiah-based financing and many local investors seem to know quite a lot about the toll road business, including the land acquisition and long-term financing issues.
But other than these two sectors, I think the major way of ensuring infrastructure investment in this country is going to be assigning the role to various state-owned enterprises. There has already been reform in the port sector, for example, but the stipulation of the concession agreement is still unclear. It is still far away from PPP under the law. It is going to be, instead, the B2B approach. The investors that would be brave enough to enter into these sectors would likely be SOEs that are being given long-term contracts.
The challenge for us is how we bring the right selection of deals. It is not so much a question of project preparation, because that is important whatever deal you want to bring to the market. The most important step for us is making sure we pick the right deals to bring to the market and thereby help infrastructure development in Indonesia.
Richard Michael, IIF: People tend to assume that PPP is going to make up essentially all of the private portion of the total infrastructure plan that is being rolled out over the next five years. That's a misconception. There are many forms that private sector involvement in the infrastructure sector can take. Pak Edwin has also referred to one of them, which is the B2B approach.
We have seen some projects go ahead in the water sector, for instance, with a pure B2B arrangement between a local water authority and the private sector on the basis of quite a limited tender. It is completely within the law, but it does not have all the bells and whistles of the PPP approach. Another example, of course, in the power sector is IPPs. There have been plenty of IPPs that have contributed to power sector production whereas the first PPP, which is in Central Java, has not even closed yet.
There is also a lot of private sector involvement in toll roads, but none of those are in the form of PPPs. IIF and SMI were both involved in a toll road that connects the Trans-Java to Cirebon in West Java. That project was massive. It was funded by local banks with almost Rp9tr of 15 year financing with four or five year grace periods and a reasonable interest rate. This type of deal does not hit the headlines internationally as much as it should. People are not as aware of projects like that because they don't have the cross-border funding and they don't have the ECAs. They deserve more publicity.
Tay, Moody's: The potential for this market is clearly huge. It would be good to get the perspective of a developer to find out what more could be done to attract private sector players. Tamura-san, what you would like to see the government do to attract companies like Mitsui to this market?
Jun Tamura, Mitsui & Co: We already have lots of operations in the works in this country. Currently we are constructing a container terminal and a MRT railway system, working on power, and oil and gas field developments. There are plenty of opportunities for us in Indonesia. But also there are some hurdles that the government could certainly help with.
Private investors are not superheroes; we cannot do everything by ourselves, for example like land acquisition in large scale infrastructure or procurements containing unique local market risks. These are very challenging parts of the equation for international investors to deal with.
The other factor is the financing of deals. This is especially a hurdle with the IPP project with PLN. For the projects requiring billions dollars of financing, we believe that a government guarantee will be necessary and beneficial for PLN. In order to get competitive financing for the projects, we expect the government to show that it will support PLN for the long-haul.
There is a similar situation with port projects. We are not seeing a lot of long-term financing allocated to these developments, where we see some benefits by bringing financing which government can give more comforts.
As we believe that government-level involvement will be important for such large scale developments we encourage Japanese governmental institutions like the Japan Bank for International Cooperation, which provide a competitive and strategic loans in many cases. So we also expect appropriate supports from the local government understanding the limits of the private sector's capability.
Projects need to not only be well-structured; they need to be bankable.
Tay, Moody's: That seems to be the major issue that comes up in this sector. This would be a good time to go back to Pak Edwin and Richard, who are in some sense proxies for the government. What are you working on that is going to help address some of the problems that Tamura-san has raised?
Michael, IIF: I think I'm less a proxy for the government than Pak Edwin, since we are about 70% owned by non-government sources. But I will certainly try to tackle the question.
There is a temptation for people to ask for more policy to be put in place, but what that will lead to will be more delays. We have seen that on projects already. We were advising a client on a water project that was more or less bankable at the start but, for reasons I will not go into, it changed along the way and a lot of tinkering went on. That led to fatigue on the part of advisers and on the part of government, but also, more importantly, on the part of investors. They cannot mobilise teams to support these deals forever. At some point, they want to go and do something else.
The government has done a lot in the last few years to come up with the building blocks for PPP, with the land acquisition law, viability gap funding, the performance-based annuity scheme and the creation of KPPIP, for instance. Lots of things have happened. Now, we just need to take a breath and start to focus on implementing those projects. Too much new policy making will, I think, just give people more excuses to delay.
There are three Cs that are applicable to PPP. The first is coordination, in particular between national government, provincial government, regional and city governments. They all need to be working together because a lot of projects can cut across all of those. The second factor is consistency. Once you launch a project, just stick with it. Don't play around with the structure too much, because that just leads to further delays. The third factor is commitment. In order for this programme to work, it requires the commitment of all members of government, particularly from the top, to stick with it and get things done.
Syahruzad, SMI: There are a few things we can do to help this market. The first is to enhance the quality of project preparation, including the tender process, the project documentation and other factors. This is something that we have been doing already, and that we will continue to.
Secondly, we can play a catalytic role in terms of financing. Infrastructure is not necessarily built through PPP, but also through SOEs. We help SOEs figure out the right structure for a deal and the optimal way to find the financing they need to make sure a project gets completed in a sustainable way.
Third, we can introduce products that are applicable to specific projects. For instance, traffic risk is something that concerns lenders to toll road projects. We can provide cash deficiency support at the very beginning so lenders take SMI risk in the early stages. That can help accelerate the financial closing of a project.
Tay, Moody's: This raises an interesting point about the role of credit enhancement in this market, whether that comes in the form of stand-by liquidity facilities, sub-debt, mezzanine debt or other structures. How important is credit enhancement at the moment?
Salyadi Saputra, Pefindo: The corporate bond market in Indonesia is far behind our neighbouring countries, because what we have here is mainly conventional bonds. There is a small portion of residential mortgage-backed securities, but by and large, this market is dominated by senior unsecured deals from well-known borrowers. I remember going to a seminar about the project finance market as long as 12 years ago. This is a market that has generated so much discussion, but very little has actually happened.
The major challenge in this market is to convince domestic bond investors such as pension funds and insurance companies to accept project bonds. They tend to be very risk-averse and their knowledge of project finance is usually very limited. We need to make a huge effort to educate them so they have an appetite for this sort of project. It is going to help greatly if the bonds that kick-start this market are ones that best fit their appetite. That is going to mean keeping maturities to 10 years or less because, beyond that, demand will be very small.
Credit enhancements can certainly help. Any risk mitigation for a project is, of course, going to lead to a higher rating for the project. But for me, it is more important to look at the type of projects that come to this market. The projects that do well in the bond market are going to be those that are easier for investors to understand. That means greenfield projects are probably not suitable for the bond market at this point.
Tay, Moody's: Boon Khim, what do you think about regulators, sponsors, bankers and other market participants working together to unlock private sector funding for PPPs? What is going to be the best way to make that happen?
Boon Khim Tay, SMBC: From a lender's perspective, we would definitely like to see a lot of coordination between government bodies, sponsors and lenders to try to get through all of these infrastructure projects. For example, we have seen when looking at various power sector projects that the power purchase agreement is different on every single project. There are certain risks that should be commercially-negotiated, but certain risks are really beyond the sponsors; there is no real reason why power purchase agreements should not be much more standardised.
Involvement and coordination with export credit agencies and multilaterals like ADB, IFC, JBIC, KEXIM, and others would be key in providing support in terms of lending to projects in this area. Infrastructure projects of this nature require long-term type of financing. It would make sense for the sponsors to arrange a long tenor financing package to match the cashflow of the project. However, commercial banks are quite risk-adverse, and would look towards procuring some coverage from the ECAs and multilaterals in order to provide such long tenor loans. This is just one example of how different institutions can work together to help the infrastructure market.
Looking at the infrastructure projects in the pipeline, we have to start looking at the project bond space as another source of financing for these projects. We need to look at the local regulations to make it more investor friendly. The government can help to create a more conducive business environment for these investors, and banks like us could use that as a springboard to help bring new buy-side accounts to this market.
We would also like to see more coordination between various government departments. We can work around these constraints, but it takes time. For example, licenses need to be renewed on a regular basis but various departments interpret the rules differently, which creates some unnecessary re-work and strain on the parties involved in the process. It would definitely help if there was simplicity, transparency, and more certainty when it came to interpreting the regulations.
Tay, Moody's: Islamic finance has frequently been brought up as a source of growth for the bond market in Indonesia. Do you see scope for Islamic bonds to be used as a financing instrument for infrastructure in this country, and could it become one of the key funding pillars?
Mohamed Ishthiaq Akbar, IDB: The IDB Group has a suite of services that we offer to beneficiary countries, including public sector financing, private sector financing, trade financing, PPP and export credit insurance. All our products are shariah-compliant. We have been functioning in Indonesia for more than 35 years, since Indonesia is a founder member of the IDB, and over this time we have invested more than $4bn in the country. The primary sectors of focus have been infrastructure, education and agriculture. This experience has shown us clearly that there are specific Islamic modes of finance that can be tailored towards infrastructure.
Islamic financial products are based around three principles: it needs to be interest-free, there needs to be no uncertainty in terms of the pricing agreement between the lender and borrower, and there needs to be no element of gambling in the project. On that basis, all of our financing is asset-backed. But once borrowers understand the principles, the substance is not very different than the process they are used to in getting conventional forms of financing.
There have been some positive signs in terms of the government's desire to expand Islamic financing here. Recently, the government announced the 'Islamic Finance Roadmap', which was supported by the IDB. There has also been talk of merging the shariah windows of some of the big conventional banks here to make one big Islamic bank. Separately, we are working with the government to establish an Islamic investment bank. Shariah financing is around 5% of the banking sector at the moment in Indonesia and the government is hoping that it will be around 20% by 2023.
There are definitely positive movements from the IDB Group as well. We are planning to extend a financial support envelopment of around $5bn to the country over the next five years, which is a major increase on what we have invested in the past and will be predominantly focused on infrastructure financing. We think that this will be just part of the growth of Islamic financing in the infrastructure sector over the next five years.
Tay, Moody's: The other part of the equation is unlocking investment from other countries within the region, something that CGIF is particularly designed for. How large is the potential to unleash intra-regional financing in the infrastructure sector?
Boo Hock Khoo, CGIF: Project bonds are sorely lacking in the ASEAN debt markets, with the exception of Malaysia. This is something we want to help change. There are some countries with surplus savings, but many have a severe shortage of long-term savings. They are trapped in deposits or short-term accounts; these savings cannot be used to help fund infrastructure projects efficiently. ASEAN investors are much better placed to understand their neighbours than European or US investors are. We need to mobilise available savings for the good of the region.
Whether this is a realistic goal in the near-term really depends on individual countries and what these countries can do to make infrastructure finance an investable asset class in the fixed income market. We know that foreign investors do come into ASEAN countries and buy sovereign debt. How do we get these investors to take the extra-step of financing infrastructure bonds in exchange for a yield pick-up? There really needs to be a coordinated and comprehensive framework that countries can embark on to achieve this. Countries often jump into the projects first and then try to get the financing in place. It would be better if they had the infrastructure bond framework in place first.
Withholding tax is a clear example. We think countries in this region should look at withholding tax waivers for infrastructure bonds. ASEAN countries are very good at getting foreign direct investments in the manufacturing sector with numerous incentives and tax holidays. But for debt investors who help finance critical infrastructure like roads and power plants , the welcome gift is a withholding tax. That is not going to encourage people who are needed to finance as much as 80% of the total cost of the infrastructure. Malaysia and Singapore do not have withholding tax on their bonds. That should be the case elsewhere.
Nationalistic policies are a bit of an issue as well. The requirement that a certain amount of shareholding needs to be domestic, for instance, is not always helpful. If I'm a foreign bondholder, a project defaults and I take over shares as part of the security package for the project finance bonds then I get tripped: I can't legally own those shares. To my mind, you can have local content requirements, but you should not have local ownership requirements to the extent that it curtails foreign savings from being deployed in the country’s project bonds – exemptions to such rules should be made. It is important to remember that foreigners can exit their investment in a toll-road, the money can leave the country, but they cannot take the road with them. The development of the infrastructure asset, not the ownership, should be the key consideration for governments, more so if the domestic long-term savings capacity is not sufficient.
Regulatory risk is another factor that presents a bit of a roadblock to infrastructure financing across the region. How do you reassure investors that they will not be penalised by regulatory changes? One way is for governments to look at the warranties they can give to lenders and bond investors. For example, they could offer termination payments that cover all lenders. That would make people a bit more comfortable that they will be paid out even if they are forced to exit a deal.
Can we bring overseas savings into this country? We certainly can. But the environment needs to be designed to meet their concerns head-on.