Sharper Focus

Takehiko Nakao, Japan’s nominee for the ADB presidency, highlights private-sector initiatives as an area where the bank needs to enhance its operations. Rolling out public-private partnerships across the region, however, remains a daunting undertaking.

Japan’s candidate for the top job at the Asian Development Bank gave little away in his first vision statement. Aside from committing himself to follow the same five priorities as his predecessor under the ADB’s Strategy 2020 initiative, however, Takehiko Nakao singled out one area of the bank’s operations for special attention.

“The importance of enhancing private-sector development, which is the source of growth, goes without saying. In this regard, the ADB should enhance operations for the private-sector development,” he wrote.

“Public-private partnerships should be promoted through helping countries provide appropriate institutional settings.”

For those inside the bank, the mention of PPP came as little surprise. The bank produced a PPP Operational Plan last year, and is working to roll out the partnership structure across all of the 40 member countries where it operates.

Insiders caution that it is too early to predict the course the new president will favour, and that any significant change will take years to come into effect in an institution as big and as bureaucratic as the ADB.

Nakao’s statement, however, highlights a growing awareness that the key to Asia’s ongoing development rests not with public funds or with multilateral development banks, but with the private sector.

“We have seen a fundamental change in long-term bank lending as a result of increased funding costs for banks”

The challenge that poses is enormous, and it may even be growing as private-sector investors and financiers react to an uncertain global growth outlook. The World Bank’s Private Participation in Infrastructure database recorded just US$10.4bn of private investments in the East Asia and Pacific region infrastructure in 2011, the latest data available, down 39% on the previous year and the lowest annual total since 1998.

Bank lending, in particular, has become an obstacle. The arrival of Basel III rules on capital adequacy has crimped international appetite for long-term project loans. The problem is more acute in Asia, where higher risk weightings on emerging-market exposure have left many financings looking uneconomical.

At the same time, the need for investment remains constant, and any shortfall in private sector involvement risks widening the infrastructure deficit in a region that already needs to spend US$800bn on the sector to keep up with its economic growth, according to ADB estimates for 2010–20.

Against that backdrop, the ADB’s private-sector operations take on an added significance, and the range of initiatives already in progress shows that the bank is changing the way it approaches its mandate.

In Mongolia, the ADB is advising the government on a PPP for a combined heat-and-power project that requires an investment of around US$1.3bn, representing about 16% of the country’s GDP.

The ADB is structuring the project and running the bidding, taking the financial advisory role for the first time in a PPP. Progress has been encouraging because, after two earlier failed tenders, the plant attracted 34 expressions of interest from 14 consortia, with four groups making it to the final bidding stage. The preferred bidder is a consortium comprising International Power GDF Suez, Sojitz Corp and Posco Energy, each taking a 30% stake alongside Mongolia’s NewCom (10%). Credit Agricole is financial adviser.

When completed in 2016, the 450MW plant will supply around half of Ulan Bator’s electricity under a 25-year concession with the Mongolian Government.

The participants are also looking into obtaining support for the financing from the Japan Bank for International Cooperation and the Export-Import Bank of Korea. The debt portion will cover 75% of the project cost.

Srinivas Sampath, the ADB’s senior investment specialist for PPP, is hopeful that the arrangement will become a template for other countries, which are at similar, early stages of rolling out a PPP framework.

“We have seen a fundamental change in long-term bank lending as a result of increased funding costs for banks. It is especially a big problem for smaller countries,” Sampath said.

”By catalysing direct lending, we are not looking to crowd out the private sector, but rather crowd in. We don’t want to snatch opportunities away from the banks, but complement bank lending,” he added.

There are many signs that this catalysing approach can help attract private-sector participants to projects that would otherwise be out of reach.

In the Solomon Islands, Australia & New Zealand Banking Group has come in as a lender on a US$61m ADB-backed communications project that will link the Solomon Islands to an existing submarine fibre-optic communication cable that runs between Guam and Sydney. Senior debt is US$33m and US$18m will be a soft loan. Tenors are 10 years and 20 years, respectively.

The four pillars

Typically, private-sector sponsors and financiers shy away from Asia’s smaller nations, where the pipeline of potential projects may be too minor to justify the costs involved in setting up operations or conducting the necessary due diligence. Political risk adds to the hurdles in many markets, while a lack of liquidity means an exit strategy is rarely available.

“If there are only one or two deals in a country, it is often too expensive for the private sector to get involved. The PPP Operational Plan aims to develop a bankable shelf of projects that will open new markets,” said Sampath.

The ADB’s PPP plan is divided into four pillars: advocacy and capacity development, enabling environment, project development, and project financing. The roadmap is designed to apply to any of the bank’s member countries, recognising that some are further along the road than others. In practice, the bank will need to concentrate its efforts on the first two pillars for countries that have yet to tender their first PPP, educating government officials and ensuring the legal framework is up to scratch.

For other member countries with longer track records in project financing, such as India, work will be focused on the second two pillars, identifying bankable projects and helping structure successful financings.

While earlier initiatives have underlined the importance of PPP as a means to an end, the 2012 operational plan leaves no doubt that the introduction of such a framework is a goal in itself. The ADB’s governors are now signing off on technical assistance grants designed to improve the quality of projects that come to market in countries like the Philippines, where the US$13m Project Development and Monitoring Facility has already been expanded to handle feasibility studies and facilitate more projects.

“The internal change has been to create a community of practice that asks everyone in the bank to think about PPP opportunities. It raises the profile for everyone,” said Sampath.

Creative thinking

The ADB has also committed to a number of initiatives as an equity partner, in an attempt to stimulate investment and also leverage its own limited resources.

The Asean Infrastructure Fund brings together all members of ASEAN, except Myanmar, as well as China, South Korea and Japan in a US$485m vehicle that will support key projects in the ASEAN region. Besides providing US$150m to the fund as equity, the ADB will co-finance every project the fund selects. Initial contributions were agreed last year, and discussions are already under way to increase its capital.

The ADB is also an equity investor in the US$625m Philippines Investment Alliance for Infrastructure Fund, dubbed Pinai, with a far smaller commitment of around US$25m. The bulk of the capital is coming from the Government Service Insurance System, the local pension fund, while Dutch pension manager Algemene Pension Groep and a unit of Australia’s Macquarie are also investing.

Pinai is the Philippines’ biggest infrastructure fund. It will invest directly in equity and equity-like instruments in infrastructure projects and businesses, supporting both new projects and brownfield developments.

“It is still possible to use development funds in a creative way to boost private-sector support”

While economists welcome the additional interest in PPP, more projects coming online risks increasing the burden on Asia’s banking sector at a time when many lenders are already facing rising funding costs from the switch to Basel III rules.

The AIF, which has yet to invest in a single project, is studying the idea of issuing bonds to boost its firepower. The fund’s shareholders have a target to issue bonds by 2017, but need to structure its finances to ensure that the debt comes with an investment-grade rating, seen as crucial to attracting private-sector investors in Asia.

The concept of project bonds is gaining traction among Asian policymakers as a solution to a long-held desire to channel more of the region’s savings towards Asian development. ASEAN+3 finance ministers pledged to study the idea at a meeting in Brunei in April.

Project bonds

To a similar end, the ADB is emerging as a provider of credit enhancement, offering full or partial guarantees to encourage capital markets investors to support the infrastructure sector.

It is to guarantee a portion of up to five Indian project financings in a US$128m bid to kick start the country’s infrastructure bond market.

The supranational lender approved its first commitment at a board meeting in September. Alongside state-run India Infrastructure Finance, its first guarantee was destined to cover repayment of 24% of a 12.5-year bond of up to Rs3.2bn (US$59m) from a unit of GMR.

“We believe project bonds can be a solution,” said Sampath. “In India, a higher credit rating will mobilise infrastructure financing from institutional investors and pension funds, thus becoming a long-term enabler of PPP.”

The ADB and the ASEAN+3 countries are also partners in the Credit Guarantee and Investment Facility, a credit enhancement fund set up to promote more cross-border financings in Asia’s local bond markets.

Progress, however, has been slow. The IIFCL-ADB venture in India has yet to close its first deal, almost eight months after the ADB approved its commitment. Also, the CGIF initiative took a step backwards in 2012 when efforts to launch the first bond issue fell flat. (See Box.)

There are more positive signs, however, that Asian infrastructure remains an attractive investment. The project finance market may be constrained, but 27% of last year’s global volumes came from Asia, according to Sampath.

“The challenges are still huge, but there are many good initiatives,” he said. “It is still possible to use development funds in a creative way to boost private-sector support.”

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