A new ADB publication looks at the major challenges that Asia must overcome to get more Public-Private Partnerships (PPPs) off the ground and to use them far more effectively than currently. It examines the best way of sharing risk and proposes optimal ways of financing PPPs.
Governments in developing Asia are aware of the need to expand and modernize their infrastructure. But tight fiscal conditions are preventing them from developing infrastructure at anything like the level needed to effectively reduce poverty and confront climate change. At least 400 million Asians live without electricity and 300 million have no access to clean water. For developing Asia to maintain its growth momentum and eradicate poverty, it needs to spend an estimated $1.5 trillion annually.
With most of developing Asia’s countries grappling with fiscal deficits, governments working with the private sector can offer a viable means of closing yawning infrastructure gaps. PPPs are contracts providing a public asset or service, in which the private party carries the risk and management responsibility, with remuneration linked to performance. While PPPs are being increasingly used in Asia, the level is still quite low compared with developed countries.
Despite appearing to be an easy way of getting roads, bridges power stations etc. built, successful PPPs are not easy to broker and fund. Sovereign risk regionally remains high: only 15% of developing countries in Asia lie at or above investment grade. In addition, many governments do not have the institutions and capacity to handle PPP projects. Often PPP projects in the region stall. The World Bank’s Private Participation in Infrastructure Database shows that from 1991 to 2015 more than half the cancelled projects globally were in developing Asia.
Weak governance in many developing Asian countries also discourages private sector investment in infrastructure PPPs. According to businesses in the region, investor confidence is shaken by lapses in law and order, government inefficiency, corruption, and political instability.
The key to scaling up PPPs is finding a way of mitigating the sizable risks associated with infrastructure investments in the region. This could go a long way toward attracting private capital to help get the infrastructure built. One proven way of doing this is project finance. This involves creating a distinct legal and economic entity to act as the counterparty to various contracts involved in a PPP and to secure the financial resources required to develop and manage a project.
Because of the many risks present in large PPPs, project finance is structured to match risks and returns to the parties best able to manage them. Balanced risk creates an environment in which investors can work together easily. Project finance also allows the leveraging of long-term debt, which is necessary to finance high-capital expenses.
Debt finance is the largest part of financing for PPP projects. While commercial banks are the largest source of debt finance for infrastructure projects, both in Asia and globally, but their ability to provide debt financing for developing Asia’s infrastructure needs is limited, partly because bank capital requirements under Basel III have tightened requirements for project finance lending by banks. The underdeveloped capital markets of Asia’s emerging economies are also making it harder for PPP projects to tap debt finance (BIS 2016).
An alternative are project bonds. Bond financing is normally more attractive than bank financing because bond investors can lend at fixed rates and for longer maturities. Bond financing can also be drawn from investors with natural long-term liabilities, compared with the relatively short-term funding sources of banks. Bonds have several advantages over bank lending, but they are not widely used in developing Asia due to a reluctance in corporate bond markets to diversity in credit quality. Also, developing countries in Asia are at the lower end of investment grade or below. Credit enhancement to mitigate sovereign risk has a vital role to play here if project bond financing is to become more widely used in the region.
Multilateral Development Banks (MDBs) can play a vital role as catalysts to attract private sector investment into infrastructure assets and bring the expertise and creativity to these projects that is often lacking in the public sector. One important role for MDBs has been provision of transaction advisory services; early-stage capacity building to improve the regulatory and institutional environment, and to support project preparation.
Having a dedicated national PPP unit can promote better-performing projects. PPP activity increased significantly in the Republic of Korea after it set up such a unit in 1998. And the Philippines’ readiness to handle PPP projects improved noticeably after its Public–Private Partnership Center was reorganized and strengthened.