Reconnecting Asia

Mapping continental ambitions

By Dr. Georg Inderst

This essay is part of our Big Questions series.

Since the 1980s, infrastructure investment has been trending down in the Western developed world to a level of about 2.5 percent of GDP while rising to 5.5 percent in emerging markets. East Asia is often seen as leading in building infrastructure. But the picture is rather mixed across the continent. Japan and China have the highest capital expenditure in infrastructure at 5 percent and over 8 percent of GDP respectively, while South Asia (4 percent) and South-East Asia (2-3 percent) are well below the required levels of 6-7 percent of GDP.

Dominance of state spending and finance

Is there an “Asian model”? It is worth taking a closer look before jumping to conclusions. Asia is, of course, not a homogeneous continent, but there are some interesting features in relation to infrastructure investment and finance:

• Asia’s infrastructure is mainly driven by the state. The ratio of public to private finance is 2:1 to 3:1 or higher, compared to a ratio of roughly 1:2 in Europe and North America.

• The private sector still plays a subdued role in Asian infrastructure, often supported by substantial government subsidies and guarantees. Both privatizations and public-private partnerships (PPPs) are below the global average.

• Private participation in infrastructure investment is still only 0.1-0.2 percent of GDP in most of Asia, and much lower than the global emerging markets average of 0.6-0.8 percent. Asia’s project finance is very dependent on bank loans, especially from state-owned banks and development institutions. Non-traditional and foreign lenders are frequently deterred by low credit standards and excessively cheap funds from public banks.

Ratio of Public to Private Infrastructure Spending source: Inderst (2016)

Scope for more private market development

There is scope for more securitization in this field, even in countries with relatively advanced capital markets such as Korea, Taiwan or Thailand that provide, for example, stocks and corporate bonds of utility companies. The use of project bonds or U.S.-style revenue bonds is still tiny overall, although interest is rising in some places.

Faced with budgetary and banking problems, many Asian governments are now trying to find new sources of infrastructure finance, especially from institutional investors. However, the local scene is rather concentrated, with a predominance of public or semi-public institutions.

The Asian private pension systems are very small while there are very sizeable public pension reserve and social security plans in the region with total assets of about $2.5 trillion. Asia also has a significant share of 40 percent of global sovereign wealth funds, and there is massive capital with other public institutions, including central banks.

Conservative investment policies and regulation

Most Asian investors traditionally run very conservative investment policies with a high allocation to domestic government bonds and deposits. Investor regulation tends to keep insurers and pension funds away from riskier and less liquid assets such as infrastructure debt and equity. Some change is underway. For example, the world’s largest pension scheme, Japan’s Government Pension Investment Fund, started to move into infrastructure in 2015. But higher commitments to real assets do not necessarily mean more finance for Asian infrastructure. Singaporean and Chinese Sovereign Wealth Funds, for example, have been very active in European real estate and infrastructure markets in recent years, and so has the Korean National Pensions Service.

What about international investors? Asia’s attractiveness has so far been sub-par. There are widespread restrictions on foreign direct investment in infrastructure sectors, not only in China but also in most ASEAN and South Asian countries. Other factors that make life difficult for potential foreign investors include cryptic regulations and land laws, bureaucracy, and judicial processes.

An “East Asian model”?

In a nutshell, there are certain commonalities across Asia but is there an “Asian model”? If any, it would apply to East Asia’s massive public expenditure programs from abundant state budgets on the back of strong export revenues. This also drives the construction, engineering, and related industries to the extent they can be exported worldwide. It is also remarkable that, at the same time, China has managed to become the largest producer of renewable energies with many highly competitive companies. But not many countries are in such a position.

Nor should other countries follow such models, at least not fully, despite the visible successes. Japan ended up with expensive overcapacities and a massive debt burden. Even China is changing its reliance on heavy state spending at all levels and on easy credit from domestic public banks and local government financing vehicles.

What other lessons from Asia? Most of them are not dissimilar to other regions.

Diversity of “infrastructure cultures”

Different approaches work in different places. Korea, Taiwan, and Hong Kong, for example, are following a more open model with capital markets that attract private and international investors. India has seen substantial domestic private activity in project finance and private equity funds. Malaysia has developed the world’s biggest market for sukuk, including Islamic infrastructure bonds. Other countries are following these footsteps. More generally, peoples’ views on “ownership and funding of infrastructure vary considerably across the globe.” Many emerging countries find it easier to divest in telecommunication than in transportation. Water, sewage, and even electricity are often taken as “free goods.” Western societies, too, disagree a lot on issues such as road prizing, privatization of water or railways, nuclear energy projects, climate change policies, or “strategic infrastructure” assets.

Public-Private Partnerships (PPPs), in particular, take good time and trust to develop. They also tend to be cyclical, even in developed markets such as the UK. PPPs were booming in the last decade in Indian energy when bank loans were easily available, but volumes have fallen back.

Investor governance and regulation

Private finance of infrastructure requires weighty long-term savings institutions with good governance and adequate investment policies. They can help rebalance the wide maturity mismatch between short-term bank deposits and long-term project financing. A few things can be learned from the Pacific examples of Australia, New Zealand, and Canada.

Long-term investing requires continuity and predictability of the legal and institutional environment. Co-investment of domestic and international institutions is often a good idea in order to combine local knowledge with external discipline.

Policy stability, consistency, and implementation

Infrastructure investment is inherently political. There is certainly merit in having dedicated infrastructure plans and institutions, as many Asian countries have set up. However, even with the best intentions at the top, they can be frustratingly slow, as Indonesia and the Philippines have experienced, for example.

When the state is trying to facilitate private involvement, it is typically standing in its own way. Infrastructure investment is hindered by policy reversals, regulatory changes, poor implementation, and inconsistencies across government departments. The classic case in infrastructure finance is that fiscal incentives are counteracted by restrictive sectoral and financial regulation.

Politicians of all colors favor flashy new projects while more investment should go into maintenance, efficiency improvements and renewal of existing infrastructure, certainly in more developed places. Commonly, the long-term funding of mega-projects is opaque, and the social and ecological cost-benefit analysis is inadequate or ignored.

Conclusion

So, what can be learned from Asia? There is probably more to learn about political determination than about infrastructure finance or setting the framework for private investment. Political leadership and consensus-building are most needed for cross-border projects such as intercontinental railways or large distribution networks for energy, water, and communication.

With the “Belt and Road” initiative, the fast establishment of the Asian Infrastructure Investment Bank, the construction of ports and railways in Africa and elsewhere, and by pushing green energy, China is demonstrating what has been lost in the West in recent times.

Georg Inderst is an independent advisor and the principal of Inderst Advisory.