Asia is in the ascendency. By 2030 two thirds of the world’s middle-class will live in the region. Of the next one billion individuals to hit this coveted bracket, 730 million will be from either India or China.
Add another 20 years and four Asian economies will be in the world’s top five by GDP, with China leading and 150% of the size of the USA, PwC, a consultancy, estimates. The UK will have dropped to ten and fallen into relative insignificance.
There are huge barriers to this rise, however. For a nation to push past the middle-income trap, its people must believe they can take entrepreneurial risks.
Political stability, easy access to clean water, clean air, fresh food, good education, and decent healthcare are essential. To be productive, they mustn’t spend their best years stuck in traffic jams. To part with their money, they must have a pension waiting when they retire.
Better infrastructure is critical. Asia must invest $1.7 trillion annually in ports, roads, railways, energy and telecommunications until 2030 simply to maintain its economic course. The Asian Development Bank (ADB) has warned only half that amount is being pumped in.
Government Gamble
To focus the world’s mind on this problem, China played a clever hand. In 2013, President Xi Jingping announced the launch of the Belt and Road Initiative. Unprecedented in its scale and ambition, it is aimed at stimulating economic activity and trade relations along historical trade routes.
It is not an altruistic move but a necessary one. China needs to export its capital and surplus capacity (especially in the state-owned enterprise, or SOE, sector), and internationalise its currency to get its economy back on a sure footing. It’s betting on a quid pro quo with nations who cannot finance their infrastructure needs. You scratch my back economics.
To its credit, China has provided the back scratcher, its institutions having pumped around $500 billion on the plan, according to Bloomberg reports. Pay close attention to where the money goes – China will point it where it can more easily sell its services and gain geo-political advantage.
Outside of Pakistan and Sri Lanka, the Philippines is a perfect example. The government doesn’t have the money to fully support its ramped up infrastructure programme and the existing public private partnership (PPP) model has lost favour with the government for failing to deliver quickly on previous commitments.
As such, President Rodrigo Duterte continues to court Xi for investment. The two have signed some $15 billion worth of deals since mid-2017 and some 150 infrastructure-related projects are under way (or signed) in the country.
However, some former Philippine government officials told FinanceAsia of concerns such vast commitments will mean they end up in China’s pocket. There is a precedent. Roll back 40 years and the nation was so debt ridden it was forced to submit to the dictats of the IMF to get itself out of trouble. This precipitated years of very low growth.
Other countries such as Vietnam share similar concerns. China is conscious of this, but courtesy of its previous cross-border infrastructure exploits, trust is thin on the ground. China must work hard to prove it has learnt from its past, and that of others.
In Africa, for example, it has been accused of undercutting the market, delivering poorly made infrastructure builds, damaging the environment, and flooding the host country with Chinese employees.
But even if trust is gained and equitable deals are brokered, it still cannot bankroll this initiative alone. The region’s governments combined also do not have the cash to do so. The political will is there, but that will only bridge 40% of the gap at best, according to ADB estimates. The private sector must fill in the remainder and this equates to a minimum of $510 billion a year.
The timing is good. A sustained low-growth and low-rate environment has given riskier assets classes a chance to show their credentials. Private investment in infrastructure globally hit a record $413 billion in 2016, with Asia absorbing $131 billion spread over 552 deals, according to Prequin data. However, most demand lies with existing assets in mature markets.
And there lies the rub. What’s in it for the private sector to get involved in emerging markets at the earliest stages of a project?
Belt and Road covers some of the lowest rated sovereign credits in the world. The myriad risks – political, contractual, financial to name a few – are such very few institutions have the capacity, expertise and desire to directly invest into greenfield projects. (Even brownfield, where a project is based on prior work or existing assets, are not for the faint of heart.)
Bankable BRI
To bridge the gap between the public and the private sector, governments, policy banks, institutional and private investors, must find a way to make infrastructure investment in Southeast Asia bankable.
This a real challenge. It’s not just about finding capital, it’s about how very different business philosophies and economic systems work together.
Western capitalism is driven by the concept of market forces and the power of contract. Capital will flow where it most makes immediate economic sense and rule of law will protect the interests of those entering into
a deal.
China’s form of capitalism is more constrained. Commercial activity is for profit, but the state has leverage over industries and financial institutions to influence its own agenda. China’s judiciary is subordinate to the Communist Party, not independent.
To find common ground, good old-fashioned business, financial and legal innovation is required. This means marketing sensible projects and finding more ways for cash-rich investors to tap infrastructure assets that suit their risk tolerance.
It also means providing legal protection that works for investors used to rule of law. If China expects investors to work on more informal terms, it will be disappointed.
Take Hong Kong for example. The territory is pitching itself as the perfect legal jurisdiction for Belt and Road. With a different political system to China, Hong Kong works under the rule of law (closely following the British legal system). It is also a hub for both international and Chinese capital.
However, recent events in the territory have got legal scholars spooked about China’s true influence on Hong Kong’s judiciary. If China wants to promote a level playing field for international investment, it would do well to ensure confidence in Hong Kong’s rule of law is unshakable.
More Innovation
In terms of market access, there are two major ways to finance infrastructure through private investment: standalone infrastructure projects – such as project bonds or PPP – or via corporate balance sheet finance and other similar methods, such as corporate bonds, or real estate investment trusts [Reits].
Loans and bonds form the largest categories of infrastructure finance but are seldom used when the projects have unpredictable cash flows. Equity markets are important for infrastructure assets, especially those with a high risk-return profile.
Structures such as project bonds cannot be relied upon to boost investment into infrastructure in Asia. Complex in nature, very few investment grade deals to come to market in the region. That said, the first investment grade project bond, and the largest rated amortising international bond for an infrastructure bond since 2000, was priced in August – a $2 billion two-tranche issue from Indonesia’s Paiton Energy.
A handful of infrastructure funds are popping up that offer such opportunities also. Interesting examples include the IFC Emerging Asia Fund – a fund that allows investors to park capital in the International Finance Corporation’s [IFC] proprietary pipeline of equity investments explicitly tied to infrastructure, financial institutions, and manufacturing, agribusinesses and services. The IFC is the private sector arm of the World Bank.
Such funds are critical to the success of BRI and are predicated on investors having confidence in the credibility of respected multilateral agencies such as the IFC investing wisely. (The Asian Infrastructure Investment Bank has committed $150 million into the fund, also).
Previously shunned vehicles that mop up varying pools of debt are also coming back into vogue. Large institutional investors in Asia are lapping up new collateralised debt obligation (CLO) issuances in the US. Assuming no major mishaps, it is possible they will prove a useful source of demand for similar Asia-originated debt tied to infrastructure.
Goods news begets good news
What is also required is sustained interest in the Belt and Road story. Having successfully caught the world’s attention, investors, large multinational corporations and governments must continue to innovate and invest in the concept and its development. Successful bankable deals must be promoted and shared as case studies for the market to review. Transparency is key.
According to a recent survey by East & Partners Asia, debt investors admit they are extremely interested in the infrastructure sector, but just over half (50.9%) have yet to form a view on Belt and Road.
Of more concern is that the proportion of investors that intend to participate has also dipped from 50% a year ago to 43% today. If this trend continues, it could pull the rug from under the carpet of potentially a very positive development.
Worse still it could push China to overleverage itself in a bid to save political face (a concept very important in Asian business dealings) precipitating a fresh financial crisis or leaving many nations under the financial thumb of a very powerful neighbour.
China has earned the right to be taken seriously. Its impressive economic growth since the 1980s gives justification to the model of ‘Socialism with Chinese characteristics’ developed since Deng Xiaoping’s reign.
And as Donald Trump singlehandedly erodes the US’ international credibility, and Europe tackles an illogical and ugly divorce with the UK, Xi has positioned himself as a voice of calm on the global stage.
A check and balance to any power rise is a healthy and objective media. As FinanceAsia enters its 21st year independently covering the developments of Asia’s capital markets it will now turn its full attention to the “Asia going out” story.
We will follow closely the developments of Belt and Road, pointing out the positive and the negative developments, the key actors and actresses along the way. We will serve the world’s international investors a window into the Asia story in an effort to close the financial gap.
Ultimately we believe that will come if the East and West can find a place to meet in the middle.
To offer more Belt and Road insights, FinanceAsia is hosting its first Belt and Road Connected: Invest Philippines conference in Manila on January 30. For more information, contact Andrew Wright on +852 31751926 or via email.
