It is almost impossible to generalise about the Asian infrastructure story. In a sprawling region that includes 44 economies, from the central Asia republics to the Pacific islands, it is unfeasible to compare markets such as Vietnam or Indonesia with others such as India or China in terms of levels of infrastructure development, investment or private participation. Moreover, while Asia offers a wealth of opportunities – comprising as it does of most of the world's fastest growing economies, many in desperate need of even basic infrastructure – investment in many countries is fraught with government restrictions or legal and regulatory risk.
However, one thing is certain: nobody disputes the need for huge infrastructure spending in the region. According to most development agencies, the quantum of anticipated infrastructure spending within the wider Asian market is estimated at between $250bn and $300bn a year for the foreseeable future. It is likely that a significant proportion of this expenditure will be witnessed in the four countries – China, India, Indonesia and Vietnam – that are among the most populous, with some of the fastest forecast economic growth rates in the region, but where significant current and future bottlenecks will be experienced in both economic and social infrastructure.
Running to keep up
Rising populations, economic growth and greater discretionary spending power in many Asian countries mean that demand for energy has increased. A rule of thumb is that for every 1% increase in gross domestic product, demand for power increases by 1.5%, so governments have to constantly run to keep up with demand. At the same time, although the high export focus of many Asian countries means that investment in roads, railways, ports and airports has been identified as central to improving efficiency and promoting foreign trade flows, few governments have kept pace with growth. In Vietnam, for example, double-digit growth is being achieved in spite of the dong's devaluation, high levels of foreign currency debt, and virtually no transportation logistics infrastructure.
"A period of high economic growth across the region has led infrastructure development rather than followed infrastructure development; consequently there is an infrastructure deficit in whichever country you choose to look at," says Nick van Gelder, head of Asia and Middle East infrastructure funds at Macquarie in Singapore.
Western banks pull back
But a crucial question now is: where will the money come from? Alongside investment by government and multilateral entities, and loans from major Asian banks, big Western project finance houses such as BNP Paribas, Dexia, Depfa and Royal Bank of Scotland have historically played a major role in Asian infrastructure, but there are signs that the bank universe is being drastically redrawn through a combination of capital constraints and political pressure. It has quickly become clear that banks that have received significant state support are under growing pressure to focus their core lending on domestic markets. For the other banks – particularly in Europe and America – that have overstretched their balance sheets, lending patterns will be reduced. Inevitably, they will shrink their operations faster in non-core markets than in core markets.
RBS – the biggest project finance lender globally in 2008, which inherited a sizeable Asian project finance business through its now controversial ABN AMRO acquisition – has already stated that as part of its restructuring in the wake of the UK government's part nationalisation, it will be closing its project finance business. Dexia, a major force in Asian public-private partnerships (PPP) and private finance initiatives (PFI), is reported to be closing its Australian office and selling its loan book. Others such as Depfa and DZ Bank are rumoured to be at least pulling back, if not pulling out, from the region.
"We are already seeing a number of banks retrenching project finance specialists, not because of a lack of opportunities but because of the need to refocus their business model on their home market," says Ian Mathews, executive director and head of project finance, Asia, for ANZ Bank. "As such, we expect to see either an exodus of non-Asia-Pacific banks from the region or a marked slowdown in their appetite for new projects," he says.
While the long gestation period of many infrastructure projects means that the real impact of such withdrawal is unlikely to be felt immediately, anecdotal evidence suggests that available liquidity is already falling and that it is getting more difficult to raise funds; especially the long-term funding on which project finance usually relies. For example, the PPP funding for Singapore's ITE College West was closed last August. The S$300 ($195.31) deal secured a 26.5-year financing via a fully hedged bank loan. The same deal would not close on those terms now, as transactions are lucky to attract five or seven-year money.
Less long-term money
"Liquidity constraints have inevitably led to a reduction in tenors. Banks are less willing and able to commit funding for long-dated assets. This has particular implications for large-scale infrastructure projects where debt tenors of more than 15 years were not uncommon previously," says Mr Mathews.
The contraction of liquidity and tenor will have a direct impact on the projects that get under way. With the 'go-go days' now over, the focus is back on risk, project quality, and relationships. The projects that do get out of the starting blocks will be those where there are long-term partnerships between stakeholders and strong bank-sponsor relationships. Against the backdrop of slowing economies, a number of projects that were in the pipeline have been delayed, postponed or cancelled.
"For example, there are about half a dozen coal-fired power projects currently in development in Vietnam. If these all go ahead, they would need about $6bn of long-term debt and $3bn of equity. Clearly, in the current market environment, the commercial bank market cannot support that quantum of debt financing in Vietnam. By necessity, therefore, the result will be a phasing of projects and preferential financing for those projects developed by proven sponsors with deep relationships with commercial banks, development agencies and other key stakeholders," says Mr Mathews.
Capital will target deals of the best quality, with strong off-take agreements and solid concessions. More risky greenfield projects with no proven track record for traffic flows or usage patterns, but which represent the lion's share of emerging Asia's infrastructure needs, will likely struggle the most to secure funding.
"Where capital is available, there is now a lot more scrutiny of projects and a great deal more due diligence. Capital will flow to those projects where the quality of the project and the quality of the contract surrounding concessions are assured," says Mark Rathbone, a specialist in PPP/PFI projects and a partner in PricewaterhouseCoopers' Asia practice. "Projects such as the better structured power deals that have very good concession-based financings in place and other similarly well structured deals will stand a better chance of attracting investment."
Need for multilaterals
In India and China, there is a better chance that local lenders are able to fill the funding gap. In China, which boasts the second and third largest project finance houses in Asia, direct lending by Chinese institutions jumped from $120bn in December 2008 to $237bn in January 2009 on the back of the government's pump priming packages. State Bank of India is the second largest project finance house globally and the largest in Asia, but a recent McKinsey report says India still faces a $190bn shortfall as the global crisis chokes off investment.
However, other countries have less domestic capacity and many expect that there will have to be increased equity commitment in deals. Governments such as Indonesia and Vietnam are seeking to actively re-involve the private sector in areas that they have recently regarded as the preserve of the state. (In Vietnam, for example, despite growth in electricity demand running at more than 15% a year, no new private sector power projects have been financed since 2003). Others anticipate that there will need to be greater participation by development finance institutions and export credit agencies, particularly for larger transactions.
The latter could play a particularly important role for greenfield projects that fail to attract enough investment, or where government and multilateral involvement is needed to 'credit wrap' a project. "Multilaterals will play an enormous role in the next 18 months or so," says Mr Rathbone. "The participation of institutions such as the World Bank, the Asian Development Bank and the Japan Bank for International Co-operation will be crucial in keeping Asian growth going, particularly in 'real' developing economies such as Vietnam, Laos, Indonesia, Cambodia and the Philippines. In these markets it is much more difficult to get comfortable with concession agreements and the specific territory's regulatory framework; in order to attract foreign capital these elements will have to be robust. Many investors may even require multilateral participation as a means to reduce the regulatory and credit risk inherent in a transaction."
Indonesia is one example of where multilateral involvement could go a long way towards reassuring equity investors and foreign lenders, who have historically lacked confidence in the legal and regulatory framework surrounding projects. This is particularly true with regard to issues surrounding the legitimacy of land acquisition and critical financing features such as tariff structures. The legal details relating to who owns the land and contractual issues about whether road toll rates will be allowed to rise when they are supposed to can be political hot potatoes. But lack of certainty about them ratchets up the risk and makes the environment much less attractive to private investors or bank lenders.
"The Indonesian government is putting in a lot of effort to address many of the issues surrounding projects, and the government is now looking to procure toll roads and other large-scale infrastructure projects. It is increasingly a better story but it remains predominantly a market for participants who are able to get comfortable with the risk exposure of bidding for and completing deals in the territory," says Mr Rathbone. "It is in this kind of environment where multilaterals can be hugely important in working with other market participants to help build confidence in the project finance environment; by helping to establish sound procurement guidelines, for example, or ensuring that concessions agreements are watertight and that handback procedures are in place."
Although some state-owned and policy banks within north Asia have redirected their attentions to domestic markets in line with proposed government stimulus packages, others have already increased investment abroad. "The quantum of lending of state-owned institutions such as JBIC [Japan Bank for International Co-operation] has actually stepped up markedly in support of their key clients investing overseas," says Mr Mathews.
Other organisations are making plans to do so. In March, the Asian Development Bank (ADB) announced that it is setting up a regional infrastructure fund that can be accessed by its members, including Indonesia. The bank has managed to bring together funding pledges amounting to about $5bn, including from the Islamic Development Bank, with other possible funding sources still being explored, including those from China and South Korea. According to the ADB, the Islamic Development Bank has committed $1bn to the scheme.
Equity investors
With commercial bank lenders often reserving balance sheets for core clients, many projects are seeking greater participation from equity investors at the same time that investors are facing funding constraints – and their risk appetites have dropped and equity costs have risen accordingly.
Yet infrastructure funds are finding that investors – including institutional players – are still attracted to Asian infrastructure. Standard Chartered and the International Lease Finance Corporation's joint SCI Asia Infrastructure Fund did a second close in January at more than $600m; the seven limited partners (LPs) include the founding partners, along with European and American institutional investors. Appetite is such that the fund is targeting a third close at about $800m or even $1bn before the end of the year, according to Andrew Yee, global head of infrastructure, principal finance at Standard Chartered.
"European and North America LP investors have shown themselves to be ahead of the curve in their understanding of infrastructure. They have gained a lot of experience in their own, more mature markets, which proved that infrastructure investments are less susceptible to downturns. They are consequently increasingly open to opportunities in less mature infrastructure markets such as Asia," says Mr Yee.
Macquarie's Mr van Gelder is also upbeat about the potential of infrastructure. He believes that the infrastructure industry will emerge from the crisis with its reputation enhanced relative to other asset classes – and that this is already being reflected in increasing allocations. "Many institutions who have had a challenging time across their entire investment spectrum are actually increasing allocations to unlisted infrastructure at this time, and to about 10% of their entire portfolio in some cases," says Mr van Gelder. "There is a growing realisation around the world that long-dated infrastructure income streams have a meaningful role in pension fund portfolios, especially if these income streams are either explicitly or implicitly linked to inflation via toll rate rises, etc."
Golden age?
In fact, the next three years could turn out to be a "golden age for private equity" in the infrastructure business, says Mr van Gelder. Government investment in new infrastructure will likely benefit existing projects simply because one infrastructure project often benefits another. And because raising equity capital via the initial public offering markets will be challenging and debt will be much tighter, it will leave a huge gap for private equity capital, either through funds or direct investment. A few years down the line, healthy exits are on the cards.
"The capital that many governments consume over the next 24 months in economic recovery packages will leave them short of funding for infrastructure development and they will have no choice but to increase levels of private participation over time. Privatisation of stimulus projects in five to 10 years may offer another level of opportunity for the industry," says Mr van Gelder.
Mr Yee also believes that, with a few caveats, 2009 and 2010 will be "good vintage years" for infrastructure investment. "There are a lot more opportunities and much less competition. The next couple of years could be very good ones for investment. That said, when assets are getting cheaper, you have to invest very carefully. Projects where sponsors are being too aggressive or where not enough due diligence has been done will fall by the wayside."
As Western banks tighten their purse strings or even withdraw from the market, there will clearly be a funding gap. It will also mean the loss of key project finance practitioners who have brought their experience of mature infrastructure markets to the region. But for local and regional banks, it is a golden opportunity to grab market share from some of the established Western players. As the global financial crisis and economic slowdown reshape the world's capital flows, the effects could help to redraw the dynamics of infrastructure investment and the competitive landscape in the Asian region.
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Mark Rathbone, specialist in PPP/PFI projects and partner in PricewaterhouseCoopers
