Paying for Asia’s foundations

Booming infrastructure growth in Asia is attracting ever greater private investment, explains construction and engineering markets analyst Karen Chan.
Labourers work at the construction site of a commercial complex in the eastern Indian city of .../ Credits: Reuters
Karen Chan, senior research analyst, RCM Asia Pacific Karen Chan, senior research analyst, RCM Asia Pacific: "In the past it was mainly the governments that paid for infrastructure spending, but now governments see it is not possible for them to pay for the entire infrastructure." As a senior research analyst for Allianz Global Investors firm RCM Asia Pacific in Hong Kong, Karen Chan has unique access to the insights of engineering and construction companies that are at the sharp end of Asia’s evolving infrastructure markets.

What are the companies that you cover saying about infrastructure markets?
The infrastructure market in ASEAN is still booming, in Malaysia they have a 20-year plan and they will spend a lot of money. Thailand similarly has longer term plans on infrastructure and is building a lot of subways. Indonesia also has some targets for spending on toll roads and building up the country’s ports. China has a five-year plan for seven trillion renminbi ($1.12 trillion) in urban infrastructure and three trillion renminbi ($481 billion) on rural infrastructure. But in China there is a slight slowdown.

What sectors are booming, where is the money going?
For the less advanced countries like Indonesia and India it is going into power plants and toll roads. In Indonesia, they have a lot of traffic jams, which impacts their competitiveness because it is very hard for them to set up manufacturing businesses if they don’t have the necessary infrastructure. For slightly more advanced countries like Thailand and Malaysia there are more railway projects. China is also constructing more railways.

Why is China slowing down?
Because China has overbuilt in the last decades there is actually not much room for further growth. And there is the government’s structural change from investment growth to consumption growth.

Is Chinese investment shifting into sectors like schools and hospitals?
Yes, there are some shifts as well. Sectors like toll roads or power plants will slow down but the municipal sector will need those hospitals and schools because of urbanization. But because those are not a big percentage of total infrastructure spending, overall there will still be a slowdown.

When talking about financing in Asia, including in China, we are seeing changes. In the past it was mainly the governments that paid for infrastructure spending, but now governments see it is not possible for them to pay for the entire infrastructure.
What are these governments doing about this?
In Indonesia, they are setting up semi-government organizations such as the Indonesia Infrastructure Guarantee Fund (IIGF), Viability Gap Fund and Project Development facility (PDF) to facilitate the implementation of PPP projects. These agencies will help to fill the gaps and oversee projects while encouraging the private sector to invest more. We see similar initiatives in the rest of ASEAN and India.

In China, there is a similar situation. A lot of companies in the past had cash construction contracts but now they have to pick up more BOT (Build Operate and Transfer) contracts. In the past, the government was the project owner so construction companies just bid for contracts. But now construction companies also have to be finance suppliers. With the BOT model they have to source their own finance and after they build it they have to own the project.

What is balance of government financing and private sector financing?
It depends on individual sectors. In China, the toll road sector in the past may have been 50-50 between the government and the private sector, but now it may be nearer to 70% private and 30% government. For railways, in the past maybe it was 90% government financed, but now they are targeting about 20-40% from the private sector. But in China, financial instruments are still very limited: only some corporate bonds and traditional sources of funding from Chinese banks. It is tightly controlled.

So there is no room for investment from overseas?

No. Other markets are more open and trying to increase the investment from the private sector. Indonesia has a government target of 35% private sector investment; Thailand gets about 45% of funds from private sources, and Malaysia 63%. In Malaysia and Thailand, projects are sometimes financed by Japanese banks, which are actually very supportive of ASEAN development. A lot of Japanese are building the auto plants in Thailand, that’s why they also want to support the infrastructure there.
In Europe, institutional investors are moving into infrastructure. Is it the same in Asia?
I think it is a bit different. In developed countries many of the infrastructure projects are 'brownfield' projects, in other words they are already up and running. When people think about investing in infrastructure they generally associate it with lower risk, and they want to have strong cash flow.

But this is not the case in Asian infrastructure projects because they are mostly 'greenfield' projects starting from scratch. The risk is higher and the cash flow may not be strong in the initial years. This is not really a very well-developed asset class in Asia. The investors are generally entrepreneurs, not institutional investors. Banks will provide the financing but will not take up the risk. The underwriter will be the project owners.

What are the main risks?
Construction risk is relatively low. The main risk is execution risk. Even if you are awarded the project you may not get the land because people living there object, so the government cannot give it to you to develop. In Indonesia, they are setting up some land acquisition laws to make it easier for projects to be implemented. In India, the government is also trying to do something similar.

Does infrastructure in Asia provide attractive returns?
In China, policy risk is high because there is not a very good legal system so there is lots of poor construction. And sometimes with toll roads even the project owners cannot raise the tariff as it depends on government approval. Other countries like Malaysia and Thailand may be better in terms of concessions.

In the end, however, because these are greenfield projects you have a very long payback period. In Indonesia, the projects IRR (internal rate of return) has to be at least 17% to attract investors because there are lots of execution risks. Even in the initial stages projects often get delayed.

There is a lot of demand and the growth prospects are very attractive. But investors have been disappointed because a lot of projects have been delayed due to environmental issues and land access issues, so in fact the infrastructure development has been quite low.

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