Policy makers across Asia realize poor infrastructure is increasingly constraining the region’s growth prospects.
Investment in infrastructure is often viewed as a key to avoiding the so-called middle-income trap, but there is no consensus on how to best secure the financing.
According to a study by the Asian Development Bank, the region needs to invest about $8 trillion in national infrastructure and $290 billion in regional infrastructure between 2010 and 2020 to sustain its growth trajectory.
The study, “Infrastructure for a Seamless Asia,” also estimated a potential real income of more than $13 trillion associated with this development, a strong return on investment by any measure.
Currently, the private sector accounts for a mere 20 percent of Asia’s infrastructure investment, while public resources fund 70 percent and official development assistance covers the remaining 10 percent.
In most Asian countries, it will be difficult to further increase public funding or official development assistance, so the private sector’s share will need to expand. For example, India’s five-year plan for 2012 to 2017 anticipates a doubling of infrastructure spending, from $500 billion to $1 trillion, with at least 50 percent of that expected to come from the private sector.
Most countries in the region recognize the importance of private sector participation in infrastructure development, and many are promoting public-private partnerships, among other models. However, two key challenges loom.
The first is relatively scarce private financing for infrastructure in many parts of Asia. As funding prospects tighten for principal international project finance banks, yields have risen and spreads have widened.
Credit channels are also being impaired as pressure on some European banks causes a pullback in cross-border lending. International banks are becoming more risk averse, increasingly wedding themselves to familiar core sectors and major clients with established relationships. They are also feeling the effects of the looming Basel III regulation, which means long-term financing beyond 7 to 10 years looks less appealing from a “use of capital” perspective.
Against this backdrop, are any institutions prepared to fill the gap in infrastructure finance caused by the scaling back of principal international project finance banks? Some regional banks are becoming more active, including Japanese, Australian and Chinese banks. Yet the general appetite for political risk has been reduced, signaling a greater need for political risk insurance and guarantees.
The local financial markets in various Asian countries are playing a bigger role in the provision of project finance. Yet even in those countries, if local banks are active in infrastructure finance, their operations are still largely domestic. In addition, liquidity and tenors in the local banking system are typically insufficient to cover the enormous and growing financing needs for infrastructure, and this constraint becomes even more acute when banks reach sector and client exposure limits.
Furthermore, the local bond markets remain underdeveloped and have yet to pick up the infrastructure financing slack. Bond market financing of greenfield projects is almost nonexistent in Asia, other than in South Korea and Malaysia. Although financing by local markets will certainly be welcome, it is unlikely to resolve the growing constraints in the near term.
The second challenge is an environment that fails to enable robust private infrastructure, coupled with confusion about how to make investment attractive across all sectors. Governments often believe the private sector can assume all responsibility and risk once it enters the market. This notion, however, is generally misplaced and can have unintended consequences.
While public-private partnerships are frequently mentioned in Asia these days, their projects are too often unsuccessful or cannot be replicated due to insufficient upstream work. It is also unfortunate that some countries see these partnerships as a panacea for fiscal pressures or a substitute for sound public financial policies. Unfortunately, successful public-private partnerships have been few and far between.
Looking at those countries that have successfully mobilized private investment and financing in infrastructure, a robust and sound framework for policy and regulation was clearly essential. Governments must pursue reforms to strengthen the creditworthiness of core infrastructure sectors and provide the regulatory framework, institutions and incentives to ensure that projects are properly executed and monitored.
They also need to accept provisions for contingent support from the public sector, and they should understand the need to furnish risk mitigation for force majeure and regulatory changes.
In countries where domestic liquidity cannot fill infrastructure’s funding needs, foreign currency should be covered, as should currency convertibility risks, while international arbitration must be incorporated in project contracts. Countries should seek expert advice to determine the proper risk allocation between the public sector and the private sector.
The tendering process is the biggest Achilles’ heel for many of the Asian Development Bank’s developing member countries. In some cases, governments have undermined the process by making it difficult to attract quality bidders. It is essential to manage the dialogue with preferred bidders, negotiate the final documentation and maintain complete transparency and impartiality. Again, expert advice is fundamental in establishing an effective process, and the success of the first project is key to boost investor confidence in future projects.
In the short term, we will likely see more infrastructure transactions in which a significant share of debt and guarantees comes from multilateral development banks, bilateral agencies and export credit agencies.
Over the medium term, prospects for mobilizing long-dated commercial project financing will depend largely on the willingness of governments to introduce effective and balanced models for private infrastructure investment.
“Champions” for promoting private investment with a clear and long-term agenda must emerge within the central government. Governments will need to focus on priorities, define pipelines and recognize that “bigger” is not always “better” in project finance.