Bridging Asia’s infrastructure bottleneck

Governments of many of the countries concerned saw a unique opportunity to establish a new dynamic that would spur growth and prosperity among lower-class, non-skilled workers.
Unfortunately, the development of associated enabling infrastructure, such as power generation, rail and road transport networks, ports and airports, plus the means of containing air and water pollution – under the aegis of these same governments – was much more haphazard.
The gap that formed began to widen as too many of these strategic investors came into the fold too quickly. Often, they simply overwhelmed the local infrastructure’s ability to properly service and manage the impact. Although new factories did create new employment opportunities, it has became clear in recent years that the lack of parallel infrastructure upgrades and new capacity was one of the most significant deterrents to the process.

Macro snapshot today

According to Jong-wha Lee, the Asian Development Bank’s chief economist: “In response to the global financial crisis, many developing Asia governments implemented large fiscal stimulus packages aimed at infrastructure spending. Yet the region’s infrastructure requirements remain massive. It’s estimated that the needs still add up to $750 billion per year between 2010 and 2020, or a total of about $8 trillion. And with the crisis-driven slowdown in private investment, there is even more urgency for governments to fill those needs.”
Lee sees the huge pool of domestic savings around the region as being the most natural source of this necessary financing. Asian governments must, in his view, bolster their efforts to mobilize them. The subset here is that they must enhance the institutional environment supporting the viability of infrastructure financing options.
“If viable regional mprojects are identified, then private financing can be obtained,” Lee explained. “Strengthening national and regional bond markets is one of the first steps in creating a feasible source of infrastructure financing to exploit Asia’s savings.”
Meanwhile, private sector financing involving public-private partnerships (PPPs) should be increasingly tapped to address infrastructure needs. The private sector tends to bolster the efficiency of projects, while the public sector, including donor agencies (such as the World Bank and the ADB) has an important role to play in promoting PPP, especially in building capacity and systems as well as helping in project design.
“Currently, the public sector accounts for only about 20% of infrastructure spending in Asia, while public funding accounts for 70% and Official Development Assistance 10%,” Lee continued. “These ratios need to change, and additional investment from the private sector will be critical.”

A private sector perspective

Andrew Yee, Singapore-based joint CEO of Standard Chartered Bank’s IL&FS Asia Infrastructure Growth Fund, has few doubts that this will be forthcoming, and in fact sees it as being substantially underway.
However, he slices and dices the numbers a different way. Yee notes that a c. 2008 CLSA estimate of China’s needs cited about $1.2 trillion between 2008 and 2012, with India pegged in the $500 billion range over the same period.
“You have to remember that about two thirds of these totals are going to be provided by their respective governments,” he explains. “Also, these are project values, meaning debt and equity.”
For China, “About $300 billion of this total is going to be in debt. Remember all the Chinese bank lending last year? This is what it was mostly all about. And that leaves approximately $100 billion in equity as the missing piece; while using the same calculation, only $30-40 billion in India for the private sector to fund.”
This is still a significant number, of course. But he notes that there are many listed companies in both countries for whom it is also not an unsurpassable number; and there are the private equity infrastructure funds, international and domestic, as well.
Private equity is likely to have a significant role to play – but how significant? Globally, infrastructure private equity funds have raised some $100 billion over the past four to five years. Roughly three quarters is earmarked for the developed world, namely Europe, North America and Australasia. That leaves about 25% for developing economies. The vast majority of these allocations will be to Asia, with China first and India second, comprising about 80% of the emerging markets piece.
“Collectively, China and India amount to perhaps $15-20 billion from a private equity infrastructure fund investment point of view, which frankly is not a huge amount of money. We ourselves have raised about $700 million over the past few years. And there are a lot of other funds in the market, plus many more India-only dedicated funds that have already raised more than $10 billion. Also some global fund investment [that falls into] the 75% [devoted to the] developed world is indirectly Asia-linked.”

Developed-market difficulties

At the end of the day the numbers are not the issue in Asian infrastructure. The main focus should be the different investment models for infrastructure investment.
The developed-world version of lucrative private-sector infrastructure investment was dubbed ‘the Macquarie Model’ when it was introduced in the early 1990s. It went from strength to strength until it effectively hit a wall in 2008-09. The model featured investment in well-established, large infrastructure projects like roads, power plants, airports and ports that were fully operational. They were low growth, but offered long-term, steady returns similar to dividend yields in the 10% (±2%) range.
“What Macquarie invented and others copied was [the idea of ] marrying these [projects] with large pension fund obligations.” Yee avers. These “had to be positioned to pay out predictable returns each year, and this corresponded with the whole move to superannuation or compulsory pensions around the world.”
It was remarkably successful for a long time, but governments privatized or sold off many of their key infrastructure assets as leverage and fees ratcheted up, all at the expense of the LPs.
As a result, even though the underlying assets remained strong, the structures that linked the parties together made them too expensive, and as such incapable of generating the sort of longterm returns pension funds need. With the debt overhang, when the credit crunch hit and lending dried up, asset values dropped, leaving a number of developed-market private equity infrastructure funds under water.

A new trend in Chindia

Recently, a new trend in infrastructure investing in Asia – principally China and India – started to emerge. Though there had been some early movers in the space, it wasn’t until 2004-05 that large flows of capital began to come into the market. In contrast to the Western model, Asian infrastructure investment tends to be in riskier first-time build projects. This model has already begun to make a huge difference.
“As a comparison, while China and India are of comparable size, the pace of China’s infrastructure development has put it five to ten years ahead of India,” Yee claims. “China now has 800,000MW of aggregate capacity, making it the second largest power market in the world. The US has nearly 1 billionMW – but this took nearly a century… the UK has about 80,000MW, Australia about 50,000MW, Hong Kong and Singapore about 10,000MW each.”
India has just 150,000MW, making it the fifth largest power market, but still just one-fifth the size of China. “And China has been adding roughly 100,000MW of new capacity – or more that the UK’s total capacity – per year. This compares to the build-out of about 10-20,000MWof new capacity in India annually. It’s staggering,” Yee concludes.
From an investment point of view, given the Subcontinent’s rapidly growing demand for power, India has better potential as an investment precisely because of this gap. And that’s not just in the power sector.
India has a much greater capacity to generate considerably higher returns dollar-for-dollar, in a power plant or a road, or almost any kind of infrastructure, he believes.
“But on a risk-adjusted basis it might be a different story. It all depends on your risk profile as a pension fund, hedge fund or private investor.”

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• Topics
• Infrastructure
• Infrastructure
• Infrastructure
• Greater China
• South Asia
• Asian Development Bank