Trends: Financing infrastructure development in East Asia
Infrastructure development in East Asia is priority for many development finance institutions (DFIs). Energy projects have received the majority of private finance over the past decade, however because renewable projects are 3-4 times smaller in size than traditional power infrastructure, they can be less attractive to fund due to high transaction costs, including the high cost of due diligence in East Asian markets. To identify trends and opportunities, our team has put together a two part series presenting a picture of the private participation project pipeline (projects that are not 100% funded by government, concessional loans or donors) across key East Asia and Pacific markets.
In their 2017 report on Meeting Asia’s Infrastructure Needs, the ADB identified an annual investment of US$1.7 trillion is required to maintain the growth momentum in Asia towards 2030 targets, tackle poverty and meet the Sustainable Development Goals which includes the costs of climate mitigation and adaptation (Asian Development Bank, 2017). ADB estimates the infrastructure financing gap in the region is around USD$459Bn per year. Currently private investment contributes a very small proportion of total infrastructure investment, with the East Asia and Pacific region receiving AUD$18.2 billion in 2019 (World Bank, 2019). A greater participation of private capital is required to enable Asia to deliver its infrastructure needs. Currently Asian infrastructure is predominantly driven by availability of commercial debt as capital markets are less well developed.
Prior to the COVID-19 pandemic the Asian infrastructure sector faced challenges including a forecast rise in interest rates coinciding with banks taking more risk adverse positions because of changes in the capital and regulatory environments globally and within the region. This includes rising cost of capital, and impact from Basel III and the International Financial Reporting Standards (IFRS) 9 regulations.
Global and regional trade frictions have driven shifts in supply chains across Asia and currency volatility has impacted project pipelines, as well as the uncertainty introduced by 2019 general elections in India, the Philippines, and Indonesia (Asian Infrastructure Investment Bank, 2019).
Electricity infrastructure is the predominant investment across Indonesia, Philippines, Vietnam and Cambodia. As green and blue external capital influences project selection, governments are increasingly looking at renewable energy investments. Because renewable energy is a newer sector it has needed to overcome hurdles in Asia’s conventional banking sector to achieve appropriate senior and mezzanine debt leverage. Domestic governments such as in Vietnam are creating subsidy incentives to support renewable energy projects (wind projects in the case of Vietnam). Because renewable projects are 3-4 times smaller in size than traditional power infrastructure, they can be less attractive to fund due to high transaction costs, including the high cost of due diligence in East Asia and Pacific markets.
Indonesia has a long-term plan to invest in infrastructure, however, only saw US367m investment commitments in 2019, down on previous years due to the Indonesia general elections which put several projects on hold.
Excluding small local projects, 147 private investments were made in Indonesia’s infrastructure over the 1995-2019 period as recorded in the World Bank PPI database, totalling USD$69.3 billion in nominal terms. Electricity projects have dominated the infrastructure agenda in Indonesia over the past decade with 77 projects recorded since 1995, 18 of which are renewables focused. Transportation and ICT investments have been increasing over the past five years.
Over the past five years project finance has been the dominant type of finance used across 74% of total transaction value, with public issue and corporate finance comprising only 16 and 10 percent, respectively. Corporate finance provides longer (indefinite) time horizons for equity, versus finite arrangements to meet the project timeframes offered by project finance, project finance arrangements offer highly bespoke structures tailored to each project. In terms of structure, Indonesian projects are largely funded with commercial debt, with some projects reported as up to 90% debt leverage ratios and therefore highly vulnerable to economic shocks. Over the 2017-2018 period, cost of debt for infrastructure projects in Indonesia ranged from 7-11% for long term debt in the transportation sector, 8-10% for long term debt in the water sector, while debt financing for the power sector tracked at LIBOR + 400-600 basis points (Economist Intelligence Unit, 2019).
In recent years the mode of financing in Indonesian deals has mostly been primary at 67% of announced transactions, with refinancing ranking second at 17% and asset acquisitions at 7% (IJGlobal, 2020). Primary transactions in Indonesia are typically under a PPP mechanism, although B2B mechanisms are used with a higher cost of finance of 1-2% premium due to the benefits of PPPs receiving direct or indirect guarantees from the Government of Indonesia, although the Economist Intelligence Unit notes that guarantees have decreased in recent years. Indonesian bonds are local-currency-denominated and are generally illiquid with only six companies involved in infrastructure development issuing the instruments. Government bonds are more actively traded with 10-year Indonesian government bonds are currently returning 7.845% (as of May 2020) with an S&P BBB rating.
Excluding small local projects, 156 private investments in Philippines infrastructure projects over the 1995-2019 period as recorded in the World Bank PPI database, totalling USD$41.8 billion in nominal terms. Electricity projects have dominated the infrastructure agenda in Philippines over the past decade with 102 projects recorded since 1995. Electricity projects dominated the infrastructure investment landscape between 2006-2016, however water and waste treatment, as well as ports and airports projects have been the focus over recent years, coinciding with an overall decrease in transaction volume and size across the Philippines.
Excluding small local projects, in total 14 private investments were made in Myanmar’s infrastructure over the 1995-2019 period as recorded in the World Bank PPI database, totalling USD$12.7 billion in nominal terms. Transactions significantly increased during 2016-2018 following a long period of low or no activity.
Excluding small local projects, in total 34 private investments were made in Cambodia’s infrastructure over the 1995-2019 period as recorded in the World Bank PPI database, totalling USD$69.3 billion in nominal terms. 23 out of 34 investment with private sector participation have been in the electricity sector.
Excluding small local projects, in total 82 private investments were made in Vietnam’s infrastructure over the 1995-2019 period as recorded in the World Bank PPI database, totalling USD$17.9 billion in nominal terms.
In the past year fully government or multilateral debt funded projects in Vietnam included US$4.5Bn across 12 projects in electricity generation, roads and water treatment, which do not show up in the Public Participation in Infrastructure database. The largest project in Vietnam is the 1,320 MW Coal fired power plant at US$2.7Bn. Seven out of nine energy projects were wind, which aligns with an FDI incentive from the Vietnamese Government for wind power projects.
Vulnerability to Regional Shocks
East Asian and Pacific countries have exposure to China’s economy, both on an imports and exports basis. This drives volatility in the macroeconomic context, with upstream countries such as Vietnam and Cambodia where approximately 25% of manufacturing GDP contributions have been exposed to import supply volatility and disruption over 2020. This will impact foreign exchange, interest rates, and fiscal policy, which can translate quickly into large infrastructure finance problems.
In the infrastructure sector, well-structured PPPs share risk effectively and avoid pushing government-controlled risk onto private investors, such as the risk of development approvals, as these drive up the cost of projects significantly. Governments are well placed to take on development risk and the responsibilities of chaperoning projects through approval processes. On completion governments can recycle capital through an exit to private investors – once the asset is established with a track record of revenues. Government equity (public assets) can provide a degree of stability in economically volatile environments and the development of sophisticated capital structures for East Asian infrastructure projects is important for reducing volatility for investors over the long-term asset lifecycle.
Asian Development Bank. (2017). Meeting Asia’s Infrastructure Needs. Asian Development Bank.
Asian Infrastructure Investment Bank. (2019). Bridging Borders: Infrastructure to Connect Asia and Beyond. AIIB.
Carlsson-Szlezak, R. a. (2020). Understanding the Economic Shock of Coronavirus. Harvard Business Review.
Economist Intelligence Unit. (2019). Asian Infrastructure Finance. Asian Infrastructure Investment Bank.
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