India’s ballooning NPA and banking crisis is a testimony to the reality whereby infrastructure projects have not only failed to bring in private capital, but have instead managed to siphon off small savers’ money from public sector banks

AIIB has released a report on ‘Asian Infrastructure Finance’ in March 2019. The report is first in a series of reports that AIIB plans to bring out on infrastructure in the future. In the foreword, AIIB President Jin Liqun writes that investment has fallen in many Asian economies in the years after the economic crisis, contributing to the infrastructure gap.

It refers to the Asian financial crisis in 1998, but does not mention the US sub-prime mortgage crisis in 2008 which led to widespread financial turmoil and crisis in many countries, including in several Asian economies.

It says that AIIB was created in 2016 with an aim to foster greater regional and global integration through connectivity. It makes a case for Asia’s sustained development which can only be achieved through greater connectivity with the rest of the world.

This first report has been brought out by AIIB in partnership with the ‘Economist Intelligence Unit’ which has collated data and analyzed developments in the infrastructure market in Asia, with inputs from industry experts. The main data sets used for the study come from IJGlobal and Thomson Reuters.

The IJGlobal data is focused on private sector transactions, including public-private partnerships (PPPs) and infrastructure development through State-owned enterprises that have some market participation. For Thomson Reuters, the data covers bank financing in the syndicated loan market.

Infrastructure in this report covers sectors such as power, transport, renewables, water and telecommunications. Other sectors, which are not the key focus of this report but represented as part of data source, include oil and gas, mining, social and defense, and multiple sectors.

The focus is on ‘project-financing’ in the market rather than ‘infrastructure –spending’ from purely fiscal resources (which still provide for the majority of infrastructure investments). This focus on the relatively small segment of market project finance is in line with AIIB’s priority of mobilizing private capital into infrastructure.

‘Animal Spirits’ of Private Sector Investors

There is recognition that while public spending still provides the bulk of needed infrastructure investments, fiscal constraints and debt sustainability considerations limit the extension of public finance. The key is to ignite the “animal spirits” of private sector investors into infrastructure development, argues the report. For that, the need is to build and sustain the set of supportive conditions.

Therefore, AIIB’s strategy for infrastructure finance, is transparent — to mobilize private capital.

In this first report, eight markets have been given specific focus given their large economic sizes and infrastructure needs — Bangladesh, China, India, Indonesia, Pakistan, Philippines Russia and Turkey. The geographic regions that the report covers include the Asia-Pacific region (covering Australasia, Turkey, Russia), and the method is consistent with AIIB’s regional membership.

The report identifies projected risk factors for infrastructure investments with a slowing global economy, higher borrowing costs and geopolitical tensions conflating, leading to greater uncertainty. There has been no significant breakthrough in the mobilization of private capital for infrastructure. However, structural issues around bankability, coupled with macro-economic uncertainty, could further hold back private sector participation.

Mobilizing private capital is not a new concept. The report thereby refers to the ‘Development Committee Discussion Note’, prepared in 2015 jointly by various multilateral institutions that set out the ‘From Billions to Trillions’ agenda of mobilizing private capital for development. It notes that various MDBs have also made mobilizing private capital a priority, including the Asian Development Bank (ADB) that emphasizes private participation in infrastructure and capital market development in its private sector operations framework and the World Bank that has taken an approach of ‘Maximizing Finance for Development’ to leverage all sources of finance. The bank has adopted the ‘cascade framework’ that prioritizes private solutions (including finance) wherever possible, before public financing is considered.

Hence, it makes clear that AIIB is not unique in its priority to mobilize private capital. However, unlike other MDBs, AIIB has a focused mandate on infrastructure project-financing and does not offer concessionary financing. AIIB will try to develop a high degree of flexibility in financing through various instruments. Its strategy on mobilizing private capital for infrastructure (2018) spells out its vision as a bank that will help develop emerging market infrastructure as an asset.

Slow Economy, Currency Volatility, Geopolitical Tensions

The report is divided in two parts. The first part provides an assessment of the near-to-medium-term state of the project-financing market, with focus on identifying the implications arising from the global economy. The assessment takes into consideration global economic developments and data trends from various sources.

The key take-away is that infrastructure project-financing is at an inflection point. A slowing global economy, higher cost of capital, currency volatility and geopolitical tensions will mean that governments have to balance between macroeconomic stability and sustaining a high level of infrastructure investment to meet growing needs. Trade frictions and rising nationalism is also highlighted as a risk factor that could affect infrastructure investments.

Indeed, notwithstanding the fact that discussions around near-term prospects would center on global macroeconomic development and trade frictions, it is clear that in the medium to long-term, technology, economic growth and finance will reshape the way infrastructure is funded and developed.

The second part includes six articles that explore structural and long-term issues. Special focus is given to cross-border connectivity which is not a new agenda.

AIIB has been expanding regional connectivity and integration at its core, as written in its ‘Articles of Agreement’. Multilateral institutions and governments have also promoted various regional connectivity initiatives.

The report cautions that at this time of rising trade frictions and populist sentiments against globalization, it is even more important to catch sight of the many opportunities that are either present or will come along for cross-border infrastructure. This is crucial for countries to sustain trade and income growth.

Infrastructure and its impact on trade will be an exciting space for AIIB, policymakers and players in the industry for many years to come. Pursuing the positions taken by other MDBs, AIIB makes a case for infrastructure opportunities in emerging Asia, and cross-border infrastructure, in particular, can bring about trade and development.

To Connect is the Key

The report emphasizes that information and communications technology (ICT) would be a key enabler to facilitate trade and integration. Asian economies are at the risk of falling behind in basic ICT to support trade. They will require greater investment support from the international community.

There are significant opportunities to connect beyond Asia for infrastructure investment in tourism and better infrastructure for sustained trade structure between Asia and Latin America. Project-financing is at an inflection point, due to significant infrastructure needs, limits to expanding public finance, and the necessity of crowding in private sector investments.

The report suggests that geopolitical tensions, rising nationalism and macroeconomic developments are adding uncertainty to the sourcing and continuity of such infrastructure investment. It assesses that in the next few years the infrastructure sector will face different situations, namely:

• Rising interest rates due to policy normalization by central banks will drive a flight to quality. The combination of remaining liquidity in the system, higher cost of capital, and the potential impact from the implementation of Basel III and International Financial Reporting Standards (IFRS) 9, may drive banks to be more risk-averse in terms of long-term lending and is likely to drive a divergence in lending costs. There will be a widening credit spread between projects with strong contracts, government-backing and the involvement of Multilateral Development Banks (MDBs), and those without these ties.
• Trade frictions and market volatility have increased uncertainty around project pipelines. Sustained trade tensions will drive a shift in supply chains, potentially affecting long-term infrastructure and economic development plans. Currency volatility in some emerging markets is likely to increase uncertainty in the transaction pipeline, as governments put a hold on or delay projects with a view to protect their currencies or reduce government expenditure.
• Rising geopolitical tensions and a busy election cycle will increase investor caution. As major economic infrastructure is sometimes classified as a national strategic asset; sponsors and lenders are likely to be more prudent in building such assets.

Macroeconomic Uncertainty and the Risk Factor

The report summarizes that the risk is that structural issues around bankability, coupled with near-term challenges, would continue to hold back private sector participation. Despite much discussion and effort, private capital is still not playing the role as it can and should play. MDBs and governments will therefore need to address near-term concerns in the context of longer-term market improvements. In the backdrop of macroeconomic uncertainty, MDBs such as AIIB can help reinforce public infrastructure investment where it is fiscally sustainable to do so, given the ability to lend counter-cyclically and take longer-term exposures.

There is also an urgent need to redouble efforts to mobilize private capital. This would include improving project preparation, improving country policy framework, and sustaining the supporting conditions such as through better information for market players. MDBs will play a critical role in mobilising private capital not just through co-financing but also to improve project preparation and reduce project risks. Greater risk-sharing between financiers can help cushion the impact from the increase in borrowing costs.

The AIIB report on infrastructure financing clearly identifies the major hurdles facing large infrastructure financing, construction and operation envisaged in its own strategies and other multi-lateral institutions, not only within countries but also beyond the political boundaries to increase regional connectivity. These include rising populist sentiments against globalization, trade disputes, looming general elections in some large economies in Asia (India, Indonesia, Philippines), rising interest rates, higher cost of capital, banks risk-averse behavior, currency volatility, macroeconomic stability and lack of bankable infrastructure projects. These issues would pose challenges for mobilizing private capital for infrastructure financing and making infrastructure an asset class.

Conclusion: Same Old Strategies

The AIIB report on infrastructure suggests the same strategies for large infrastructure construction that have not yielded positive results in the past. The focus on private capital and private sector to build infrastructure and deliver services to the public has been promoted by other MDBs earlier with evidence showing that both, attracting private capital and the promises of private sector delivering services, have failed.

India’s ballooning NPA and banking crisis is a testimony to the reality whereby infrastructure projects have not only failed to bring in private capital, but have instead managed to siphon off small savers’ money from public sector banks. Its vision to create infrastructure market as an asset class is to ensure long-term revenue streams and profit-making for private investors from infrastructure construction and operation.

Clearly not learning lessons from the poor experiences of private sector participation and public-private-partnerships (PPP) in public infrastructure projects in several countries, the report suggests an increase in the implementation of PPPs for infrastructure projects. Indeed, AIIB looks to continue the same old strategies of improving country policies, supporting conditions, better information and greater risk-sharing between multi-lateral institutions and governments to bring in private capital for infrastructure projects.