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Tuesday, 23 September 2014

Bonds are only part of the solution to Asia’s infrastructure problem

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Until local savings pools develop, the bond markets can do little to close Asia’s infrastructure gap, says IFR Asia bureau chief Nachum Kaplan.

Think of a number – a big one. Now double it, and double it again and keep doing that until you get to 8.33trn. That, in dollars, is the amount that Asia needs spend on infrastructure over the next eight years. The only thing harder than imagining that much money is working out where it is going to come from.

Asia faces two problems: its capital markets are under-developed, and the region cannot afford to pay for all the projects on its wish list. Innovation is part of the answer to the first problem, but continued economic growth is the only solution to both.

The loan market has long been the preferred option for financing infrastructure because of banks’ ability to book long maturities and accept physical assets as security. Basel III, however, is going to hinder significantly infrastructure projects’ ability to rely on long-term bank finance.

Under Basel III requirements, banks will have to have long-term funding in place to match assets with long-term maturities. As project finance loans are always long term, banks will have to secure longer-term funding themselves and put aside greater provisions for long-term debt. Both will be expensive, meaning banks will either seek to pass on those costs or simply reduce long-term lending – including infrastructure finance.

That means that other sources of project financing need to be found. 

Yes, under-developed capital markets make raising such large sums difficult, but the fact is that Asia’s infrastructure needs are greater than its ability to pay for them.

The bond market is an obvious option. However, Asian bond markets are nowhere near big or developed enough to accommodate the huge amounts and long tenors needed. That so many Asian projects are Greenfield developments is also problematic: bond investors generally require substantial sponsor support, such as completion guarantees, to invest in Greenfield financings. That makes bonds better suited to refinancing loans post-completion than to funding construction – and even then, investors take some convincing.

The groundwork is being laid, albeit with fantastical slowness, to provide guarantees for project bonds, such as the Asian Development Bank’s (ADB) new pilot guarantee facility in India (US$128m), or Indonesia’s Infrastructure Guarantee Fund (US$480m). These are clever initiatives, but the sums involved are akin to using pebbles to build the Great Wall of China. Even the US$13bn the Asean Infrastructure Fund hopes to be able to provide US$13bn by 2020 looks like pocket money against the US$1trn in project financing that India needs over the next five years and the US$450bn that Indonesia needs over the same period.

Malaysia is the only Asian country that funds much of its infrastructure through the bond market, but Malaysia uses sukuk – whose asset-backed and asset-based nature is well-suited to financing infrastructure. Indonesia has Islamic finance ambitions of its own, but most Asian nations have no desire to build Islamic capital markets and, even if they wanted to, it would take years.

QUESTION OF LIQUIDITY

The problem is better approached by looking less at financing instruments such as loans and bonds and more at sources of liquidity. Not all pools of liquidity are suited to infrastructure’s uniquely long-term financing needs.

Pension funds, which require long-term investments and steady returns, seem an obvious and highly suitable source of liquidity. Infrastructure investment trusts are the natural vehicles to bring that pension fund liquidity to these projects, and indeed they are gearing up across the region. Countries such as Australia, Malaysia and Korea have large pools of pension liquidity but many other nations – including many with big infrastructure needs – do not.

Governments seem to be the only ones left able that can come up with truly large amounts of money. China, for instance, used state-owned banks to fund much of its infrastructure spending, and this is often mooted as an option for India. China’s state-owned banks, however, have more than their fair share of bad loans – worryingly, no one is sure just how many – to show for this policy, so it is hardly a flawless model. States can fund projects directly, too, of course.

All the talk on how to finance Asian infrastructure, however, overlooks the issue of affordability. Yes, under-developed capital markets make raising such large sums difficult, but the fact is that Asia’s infrastructure needs are greater than its ability to pay for them.

If the problem is one of affordability, rather than simply financing, then economic growth is, ultimately, the only answer. What Asian governments need to ensure is that the growth of their capital markets at least matches their economic growth. If they can do that, then the both the financing and affordability challenges will become more manageable – and surprisingly quickly if Asia can maintain something close to recent growth rates. The irony, of course, is that better infrastructure would help them do that.

Follow @NachumKaplanIFR

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