Emerging Market demand for infrastructure is greater than ever. Seizing the opportunities offered by a retreating West, a new class of investors is rising to power
A mammoth power plant in Vietnam, a gigantic port in Myanmar, the world’s biggest dam in Brazil: tired of seeing their economic potential limited by infrastructure bottlenecks, emerging markets are starting to open the tap on multi-billion dollar projects. But much more is still to come. The lack of viable roads, bridges or electricity grids continues to cripple many of the world’s fastest growing nations – and their leaders find themselves under mounting pressure to bridge the gap.
Some of them have shown a willingness to do so. Infrastructure is a central part of Malaysia’s Economic Transformation Program, Brazil has pledged $60bn to new roads and railways, and Philippines approved several massive toll road projects. But political good is hardly enough. Increasingly, the main question lies in how to finance the developing world’s ambitious plans – at a time when the traditional sources of funding are drying up.
The answer will not come from commercial banks. The fall-out from the mortgage crisis, a slew of new capital regulations, and deepening eurozone woes have forced Western lenders to shorten their time and geographic horizons. European banks are now repatriating their funds to cover losses on endangered assets, and American ones are still loath to invest so far from home. Canadian and Japanese lenders, whilst less affected by the seizing up of capital markets, remain unable to fill the void left by the Europeans. They would rather work in conjunction with them.
Neither are local banks ready to pick up the tab. They tend to fund in the short term, and as such are exposed to asset-liability mismatch. Few of them are able to offer the long tenors needed to finance infrastructure projects: in most cases, they’re capped at 7 to 10 years. And they will soon have to comply with Basel III ratios and other regulations too, which will raise the cost of capital and constrain lending further.
Ideally, that’s when private investors should step in. There is ample liquidity available in emerging markets: increased savings, fast growing economies, and more flexible financial systems mean that a lot of capital is looking for places to prosper. Channelling this liquidity into local infrastructure financing via long-term debt raising on capital markets, or getting investors on board through new versions of Public-Private Partnerships (PPPs), should be a priority for projects sponsors. And there is momentum behind both: in Asia, Africa, and Latin America, governments, investors and contractors are debating on the best policy frameworks to make this happen.
Unfortunately, these mechanisms will not be in place before a while. Local project bond markets have not gained great trust among investors, due to varying disclosure requirements, accounting standards, and other regulations. There is also a lack of local rating agencies that can provide potential buyers with guidance on a project’s creditworthiness. International capital markets are sometimes used in some deals – but a vast majority of sponsors, lacking strong enough supporters, remain unable to tap into them.
Despite a genuine interest in making PPPs work in emerging markets, especially Asia, similar difficulties remain. Where it has been tried, the population’s trust in them sometimes needs to be rebuilt, owing to several projects going badly wrong. In others, the concept is not fully understood. And in general, there is no standardised form of PPP: frameworks remain very different across countries, which confuses investors.
This is where Development Finance Institutions (DFI) are supposed help. There come in international form, such as the World Bank or the International Finance Corporations (IFC). And there are regional ones, such as the Asian, African or Inter-American Development Banks (ADB, AfDB, and IDB). They can help finance infrastructure projects in two main ways: by providing direct loans to their sponsors; and by providing guarantees, information and expertise that will catalyse participation from other, private investors.
In practice though, DFIs are not a panacea. First because their pockets are not bottomless: part privatised ones have reduced their investment in response to the crisis; others have not seen a sufficient increase in their members’ contributions. Second because bureaucratic inertia, and the long list of conditions attached to accessing DFI capital, often make investors reluctant to ask for their participation. As a result, headline figures for DFI lending remain rather disappointing – and unable to plug the hole left by retreating commercial lenders.
The opportunity is not lost to everyone, however. A number of state-owned institutions including sovereign wealth funds, banks and, above all, export credit agencies, are quickly gaining prominence in global finance. Some of them still stick to portfolio strategies or existing infrastructure, and shy away from the kind of greenfield project emerging markets are tendering for. For others, infrastructure financing is not a completely new thing: Korean and Japanese agencies have been active in the Gulf for more than a decade.
But North Asian agencies, among others, are about to come to the fore like never before. Institutions like Korea’s Kexim, Japan’s Bank for International Cooperation, and China’s Development and Export-Import Banks can supply cheap, long-term capital at a time when it is sorely needed. They can dive in their country’s deep reserves, or benefit from very privileged financing terms, to outbid private lenders. Their increasingly saturated domestic markets also force them to compete ever more aggressively for infrastructure projects abroad. By cutting on margins, improving on service reliability, and putting forward their country’s technological expertise, they now have the means to offer very competitive packages. While Western lenders can still add value through their knowhow and coordination skills, many feel their position as project leaders will not last more than five or so years.
Will it help the emerging world grow faster? In principle, yes: export agencies and state-owned institutions have already demonstrated sound project management skills, and only they seem able to face the emerging world infrastructure challenge. And yet, they are not the solution to every problem. First, because their help generally comes with strings attached: it is often tied to participation of contractors from their home nations, or to long-term export contracts of natural resources. While this might not preclude the success of a project, it still means that a number of less profitable, less strategic schemes might not attract enough interest. China, for example, has done a lot to boost the potential of Africa’s extractive industries, but far less to build roads, railways or electricity grids.
Second, because participation sometimes remains hostage of political considerations. South East Asian nations, such as Vietnam or Philippines, are wary of using Chinese institutions as their main financiers, because of Beijing’s assertive moves in the South China Sea. Such factors come into play even in the developed world: the UK recently bulked at the idea of using China as a leading lender for nuclear plant projects, at a time when public and private financing offers little other option.
All this means that while it makes sense to speak of the emerging world has a land of opportunity for global financiers, the situation will remain highly varied across continent and countries. In Asia, infrastructure financing is indeed taking off, and chances are that progress will be steady in the medium to long term. The region is of strategic importance to many state lenders, and also offers strong commercial incentives to contractors and shareholders. The Gulf will surely remain an attractive investment destination, for the same reasons. But in Africa financing remains selective, all too often tied to the development of extractive industries, and the infrastructure deficit will probably take far longer to plug. And Latin America remains dependent on European financing, which may not return until the markets head for a definitive recovery. There political will is sometimes missing, too.
The best models will often combine a variety of different financing. Malaysia, for example, relies on relatively developed debt capital markets, government financing, and participations from foreign-owned institutions to go forward with its ‘Economic Transformation’ program. In other cases, such as in recent projects in Vietnam and Abu Dhabi, state-owned export agencies team up with Western banks. A new class of investors may be on its path to power, but much of the emerging world’s modernisation will depend on its willingness to share it.