China and Japan are major players throughout the region, yet private financing is still needed to meet massive infrastructure needs.
Asia’s need for infrastructure is more urgent than ever, as economies expand rapidly and the population of urban residents increases by an estimated 1.4 billion over the next two decades according to the UN World Urbanization Prospects. At the 50th meeting of economic ministers of the Association of Southeast Asian Nations in Singapore last August, it was predicted that the grouping would compose the world’s fourth-largest economy by 2030, behind the US, China and the EU. This means more roads, more homes and more physical facilities.
The condition of infrastructure continues to dampen Asia’s growth. According to a February, 2019, report in PwC’s Strategy+Business, “As of mid-2018, only 20% of roads in Myanmar were paved, and only 53% of Cambodian households had access to grid-quality electricity. … Estimates by the ADB [Asian Development Bank] indicate that a 10% increase in paved road density could result in a 1% increase in trade and a 5% improvement in economic growth across Asia.”
There are plenty of projects in the pipeline. Within Southeast Asia, upcoming developments include a high-speed railway between Kuala Lumpur and Singapore (currently postponed due to Malaysian concerns), Indonesia’s 1,152 miles of toll road President Joko Widodo has pledged to build by the end of this year, and the 14 railway projects planned in Thailand by 2022.
Japan and China Lead
China’s Belt and Road Initiative (BRI)—a landmark project that aims to connect more than 4.4 billion people across Asia, Europe and Africa—is the region’s largest and most ambitious initiative. Southeast Asia, a region with close geopolitical and trade ties with Beijing, has attracted one-third of the Chinese investments and construction commitments under the program, according to a report by Citi Economics cited on Inkstonenews.com.
For years, Japan has been Southeast Asia’s top source of infrastructure investment. With China’s BRI now in the center of the picture, the Asian economic powers are competing for regional influence. While Tokyo may not want to try to follow Beijing’s spending, the Japanese are more admired for their approach. In November, Prime Minister Shinzō Abe’s administration announced a plan to help Southeast Asian countries train 80,000 manufacturing and digital industry specialists over five years. Cambodia is to be the first landing spot for the initiative, with about 60 Japanese trading companies, banks, general contractors and other parties already aboard.
Japan “has competitive advantages in terms of safety, technology and social responsibility for local people,” says Zhao Hong, professor at the Research School of Southeast Asian Studies, Xiamen University, in a paper he authored on Sino-Japanese rivalry and cooperation in Southeast Asian infrastructure investment, published last year by the Japan External Trade Organization’s Institute of Developing Economies.
When Japanese companies and government-linked instittutions build infrastructure, whether roads, rails or ranches, Zhao says, they deliver technical training and education that is highly valued by local stakeholders. The Chinese, by contrast, are seen as more insular—many Chinese-led construction endeavors are accused of importing materials and labor from China rather than involving local companies.
As Southeast Asian nations grew wary of Beijing’s intentions, China-funded infrastructure projects in the region plunged last year. The value of newly announced commitments and construction contracts worth more than $100 million—big-ticket deals—dropped to $19.2 billion in 2018, according to data from the American Enterprise Institute.
For example, China is Myanmar’s biggest trade partner and investor. Although China continues to build pipelines with Myanmar, relations have cooled. Myanmar has trimmed its Chinese-backed Kyaukpyu port, in part due to budgetary concerns.
This highlights another the political aspect of infrastructure spending. “When we invest, we need to make sure that at some point in the future, this project will be profitable,” says Ye Tan, the founder of Yetan Financial Information Service, a fintech focusing on Asia-Pacific investment. “What’s scary is when projects are built without consideration of profitability, but rather for image or other unsustainable motives.” She points to the many massive projects constructed in China in recent decades that are hardly ever put into use or even open to the public. “No fresh capital flow will pay for the loans invested,” she says. “These projects turn directly into bad loans.”
China has endeavored to export its infrastructure products and related technology throughout Asia; while Japan is determined to maintain its regional dominant position, especially in Southeast Asia. The most visible sign of this has been in the high-speed railway competition.
After Japan lost a $5 billion contract to China to build Indonesia’s first high-speed railway, connecting Jakarta and Bandung, Tokyo leveraged its relationship with India to secure a $16 billion deal to construct a similar railway between Mumbai and Ahmedabad. Japan is also due to begin building a high-speed rail line connecting Bangkok with Chiang Mai; while Chinese companies have begun work on another rail line, from Nong Khai, on the border with Laos, to Map Ta Phut on the eastern seaboard.
Chinese projects are managed by state-owned enterprises and funded with government loans. China is seen as more flexible and able to complete infrastructure projects faster. But Zhao points out: “China’s state-backed pattern of investment also has its own malpractice and limitations, which are manifested as poor understanding of local politics and inadequate assessment of potential risks.”
In comparison, says Zhao, “Japanese projects have private backing by companies such as Mitsubishi, Toyota, Nintendo and Sumitomo Mitsui Financial Group, [as well as] government entities and multilaterals like the Japan International Cooperation Agency, the Japan Bank for International Cooperation and the ADB.” But the great regional need for future development offers more potential for cooperation than competition, he concludes.
“We need $1.7 trillion a year in addition to the current level of investment,” said ADB President Takehiko Nakao in a television interview in February. Asked about the challenge posed to ADB by China’s Asian Infrastructure Investment Bank, he said the amount needed is so big that the two multilateral lenders need to become partners to bridge the funding.
Yet there is also a limit to what public finance alone can achieve in meeting Asia’s immense infrastructure appetite. “The demand for infrastructure financing in Asia is outpacing countries’ funding capacity,” Ravi Menon, managing director of the Monetary Authority of Singapore (MAS), said at the Nomura Investment Forum Asia. More than 90% of infrastructure investment in the region is currently financed by governments, he said.
“This is clearly not sustainable if the demand for infrastructure is to be met,” Menon said, adding the challenge for governments was to make infrastructure more attractive to private capital. This will enable institutional investors, including insurers and pension funds, to invest in debt, he said.
Singapore Steps Up
As a regional financial hub, Singapore has quickly responded to the growing demand. The city-state’s most recent and important initiative, a new government agency called Infrastructure Asia, was launched last year to help “connect supply and demand” for infrastructure projects, said Minister of Law and Finance Indranee Rajah. The aim is to bring together local and international players from across the value chain—developers, institutional investors, management and professional services providers—“to develop, finance and execute infrastructure projects,” the minister said.
With 60% of project finance transactions in Southeast Asia lead-managed by Singapore-based banks, according to the Ministry of Trade and Industry, the city-state plans to spur investment in much-needed regional infrastructure by helping to structure projects and make them more “bankable,” she said. The initiative is acting as a one-stop shop for regional governments, developers and engineers seeking advice, technical assistance and financing from Singapore’s ecosystem for infrastructure development.
The “potential is vast,” ADB Vice President Bambang Susantono says in a September 2018 ADB analysis. “Pension funds alone, which hold $7.8 trillion in assets, are estimated to invest only about 1% of funds under management in infrastructure.” Citing “Closing the Financing Gap in Asian Infrastructure,” a recent ADB report, Susantono notes that “richer Asian economies, such as Japan—where savings rates top 30%—can clearly play a stronger role.” Yet, the report shows that the country already invests about $3.8 trillion in portfolio assets outside Asia.
Risks involving approvals, land acquisition, foreign currency, repatriation, payment security and force majeure are typically the key concerns. A framework that standardizes these risks, along with incorporating political and sector-specific issues, would be essential to speeding up the delivery of projects. Asia, therefore, will need to develop contracts that are “bankable” and offer a fair risk-return framework that is consistent across projects.