Georg Inderst, Independent Adviser, Inderst Advisory
Since the financial crisis, infrastructure investment has moved up the political agenda in most countries – now also including the USA. Asia is often seen as the world’s infrastructure laboratory, with massive construction of transport and energy projects.
Japan and China have spent 5% and over 8% of GDP, respectively, on infrastructure over the last 20 years while the Western developed world has been trending down to about 2.5% of GDP. The impact is clearly visible, especially in East Asia. At the same time, the “old world” is struggling even to maintain existing infrastructure.
Is there an “Asian model” of infrastructure finance? It is worth taking a closer look before jumping to conclusions, as argued in our recent working paper for the ADBI[1].
The first thing to note is that the picture is not uniform across the Asian continent. South Asia (4%) and South-East Asia (2-3%) invest well below the required levels of 6-7% of GDP.
Secondly, Asia’s infrastructure investment and finance is primarily 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, often supported by substantial government subsidies and guarantees. Both privatizations and public-private partnerships (PPPs) are below the global average.
Thirdly, Asia’s project finance is very dependent on bank loans, especially from state-owned banks and development institutions. There is scope for more securitization in this field. The use of project bonds or US-style revenue bonds is still tiny overall, although interest is rising in some places.
A fourth point is of growing interest: institutional investors are traditionally not much involved in infrastructure. Faced with budgetary and banking problems, many Asian governments are now trying to find new sources of infrastructure finance. However, the local investor scene is rather concentrated, with a predominance of public reserve funds, social security funds and sovereign wealth funds (SWF). The Asian private pension systems are comparatively small.
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. However, 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 SWFs, for example, have been very active in European real estate and infrastructure markets in recent years, and so has the Korean National Pensions Service, in line with many other large Asian funds.
Finally, Asia’s attractiveness has so far been sub-par for international investors. 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.
In summary, 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. But not many countries are in such a position.
Nor should other countries necessarily follow the “East Asian model”, at least not fully. Japan ended up with expensive overcapacities and a massive debt burden. Even China is trying to change its reliance on heavy state spending at all levels and on easy credit from domestic public banks and local government financing vehicles. Public money is eventually limited everywhere.
Asia can build on the existing diversity of “infrastructure financing cultures”. Different approaches work in different places. Korea, Taiwan, Singapore 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, PPP and private equity funds. Corporate bonds have been widely used in Thailand and elsewhere. Malaysia has developed the world’s biggest market for sukuk, including Islamic infrastructure bonds. Indonesia and the Philippines have been experimenting with new PPP institutions to “crowd in” more private capital.
Furthermore, in terms of institutional investor involvement, it is worth looking across the Pacific to places like Australia, New Zealand and Canada. Good long-term savings institution can help rebalance the wide maturity mismatch between short-term bank deposits and long-term project financing.
So, what lessons 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 railway, or large distribution networks for energy, water, and communication.
With the “Belt and Road” initiative, the $40bn Silk Road Fund, 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 has marched forward in in impressive way.
Finding more private finance and attracting more long-term investors to Asian infrastructure is a new and different challenge. The focus needs to shift towards increasing efficiency and quality of infrastructure. Private and social returns need to be properly assessed. Environmental, social and health considerations will feature more prominently in the future, also in emerging markets. The OECD with other organizations can surely help in enhancing governance standards and international collaboration.
Useful links
Pension Fund Investment in Infrastructure Georg Inderst OECD Working Papers on Finance, Insurance and Private Pensions
Pension Fund Investment in Infrastructure: A Comparison Between Australia and Canada Georg Inderst, Raffaele Della Croce OECD Working Papers on Finance, Insurance and Private Pensions
OECD work on institutional investors and long-term investment
OECD Centre on Green Finance and Investment
[1] Inderst, G., Infrastructure Investment, Private Finance, and Institutional Investors: Asia from a Global Perspective, ADBI Working Paper Series, No. 555, January 2016
