This article was written by Susan Hilliard (Partner, Sydney) and John Sullivan (Partner, Singapore)
The combination of the two largest developing economies (China and India) in the world with other developing countries, as well as other established developed countries, makes Asia one of the leading areas for infrastructure investment over the next decade (2015 to 2025).
The Asian Development Bank estimates the demand at USD730 billion each year for the next decade. In South East Asia alone an estimated $2.5 trillion in investment will be needed over the next ten years, with one third to be spent on transport, one third on electricity, and the remainder on water supply and sanitation, solid waste management, telecommunications and irrigation. The appetite for infrastructure makes Asia a key region for infrastructure investors – offering significant opportunities for growth over the short, long and medium terms.
Growth in demand for private investment… but challenges remain
Historically, infrastructure investment in Asia (outside of Australia and New Zealand) has been undertaken almost exclusively by large central governments with little private sector involvement. In turn, this has meant that, historically, a number of developing Asian jurisdictions have not seen a growth in private infrastructure funds and therefore there has not been the associated need to create investment regimes (that is, applicable asset, tax and securities regulation) to accommodate them.
However, we are seeing a gradual opening up of most Asian infrastructure markets and public private partnerships (PPPs) are increasingly seen as effective means for providing infrastructure.
This has led to recent significant growth in specialist infrastructure funds. In 2013, the Asia Development Bank observed that there were approximately 90 unlisted infrastructure funds investing in Asia with a total of US$22 billion of funds committed. The number and value of funds committed is expected to grow exponentially as large institutional clients overseas become more prepared to invest in Asian infrastructure. Developing Asian jurisdictions have, accordingly, been forced to implement investment regimes and continue to do so.
However, a number of regulatory, political and institutional challenges remain for investors wishing to take advantage of the strong demand in the developing economies of Asia. Although there is now greater political stability in most Asian countries, and this has reduced business risk to an extent, private sector investment still requires appropriate legal and institutional systems as well as clear and well-informed government decision-making processes. A number of the developing economies in Asia do not have clearly defined PPP policies, have capital controls that impede withdrawal, and/or have weak regulatory and legal regimes that increase risk. This in turn necessitates caution in drafting legal documentation for investment in the region – with agreements needing to take account of the possible political and regulatory changes that may occur during the long periods in which capital is locked during the timeframe of infrastructure investments.
The regulatory issues mentioned above do not, however, apply to developed economies in Asia such as Hong Kong, Singapore and Australia. In those economies, infrastructure investment is relatively commonplace and supported by developed and fully functioning regulatory regimes – including asset, securities and tax laws.
Region not homogenous
In this section, we look at the regulatory and political challenges in four of the key markets in Asia for infrastructure investment: China, India, Australia and South East Asia. What is clear, even from a cursory overview of these markets, is that the challenges and opportunities are by no means homogenous. This reflects the fact that Asia is, itself, not homogenous. Each sub-region and country is situated in its own historic and cultural milieu, which has a significant impact on the scope and nature of regulation.
China has traditionally had tight foreign investment restrictions and approximately 85 percent of infrastructure investment in China is undertaken by the State. However, faced with slowing growth, it has recently ushered in foreign money and has announced reforms to its regulatory regime. In 2013, China attracted US$118 billion in foreign direct investment. And in 2014, the government opened up a number of planned infrastructure projects to foreign investment, including railways, gas pipelines, telecommunications and clean energy.
China’s regulatory regime allows the government much discretion in selecting investment in industries or projects of its choosing, and in restricting foreign investment that it considers not to be in its interest or which competes with state-owned enterprises or favoured domestic companies. Industrial policies that protect and promote state-owned and other domestic firms have been reported by foreign investors to be a challenge in investing in China. In addition, foreign investors have also reported equity caps and other restrictions on foreign ownership in many industries as being a significant disincentive to infrastructure investment.
In early 2015, the Chinese government announced major reforms to foreign investment laws which, when implemented, will remove case-by-case approval for foreign investment for each project and allow foreign investment in any industry sector, provided the investment is not on a preclusion list and that there is regular reporting to government. This should increase investment opportunities, reduce approval delays and place foreign investors on a more equal playing field with domestic Chinese businesses. The proposal is currently in draft and will likely take a year or two to come into operation.
The government also issued a new guideline, set to take effect in April 2015, which reduces the number of industries in which foreign investment is restricted, down from 79 in the previous guideline.
India has enjoyed rapid economic growth over the last decade, but it has a massive shortage in infrastructure, particularly in electricity and transport.Approximately USD1 trillion is needed to meet demand. India is attractive for foreign investors not only because of its large and growing market, but also the prevalence of English-speakers and its stable democracy.
The business environment, however, has traditionally not been attractive. Foreign investors face unpredictable regulations, caps on foreign investment, long delays in project approvals and difficulty in obtaining land rights. Navigating government decision-making can result in delay and costs overruns. Further, the resolution of disputes in the legal system is notoriously slow and enforcement of arbitration agreements can be difficult. Corruption is also a concern. Transparency International ranked the country 85th of 175 countries in its 2014 Corruption Perceptions Index.
Between 2007 and 2012, the private sector invested $225 billion in India’s infrastructure. A number of these projects met with setbacks. In 2013, the private equity firm 3i, which had the world’s largest India-dedicated infrastructure fund, divested its holdings as a result of poor investment performance.
The Indian government is taking steps to reduce red tape.Reforms enacted in 2013 improved company incorporation, governance and regulation and new land acquisition laws should expedite the acquisition process. Earlier in 2015, Prime Minister Narendra Modi said his Government is “cutting down on multiple clearances that choke investment. Our complex tax system is crying for reform which we have initiated.”
For the many institutional investors and pension fund leaders investigating or planning investments in Indian infrastructure projects, the business-friendly reform agenda of the Modi government is a welcome sight – but it is a work in progress.
Australia has always been at the forefront of encouraging private investment in infrastructure. It has done this in two ways. First, the federal and state governments have undertaken a number of infrastructure privatisations – the most significant of which, at the federal level, was the privatisation of the government’s monopoly telecommunications business in the 1990’s and, at the state level, in power, forest and port assets. Second, Australia is also a leader in the successful use of PPPs to deliver significant infrastructure projects including in the toll road, rolling stock and social infrastructure sectors.
These two forms of infrastructure investment look set to contribute significantly to growth in the sector over the short to medium term with a number of states announcing proposals to privatise utilities and the federal government announcing a plan to invest over AUD50 billion in infrastructure investment (including through PPPs) over the medium term.
There are, however, some headwinds from a political perspective. A significant issue in recent elections in Queensland (2015), NSW (2015) and Victoria (2014) was the proposed privatisation of key State-owned infrastructure assets. In one of the cases (Queensland) it would appear that the proposed privatisation of energy infrastructure by the incumbent party was the key issue leading to a change in government.
As always, the issue is general community concerns with privatisation of public assets. This type of community opposition has always existed in the Australian market and is set to remain for the foreseeable future. However, it is still generally expected that governments will continue to look to privatisation as a key source of future revenue. This is both because of the general need for revenue and the fact that there is a long history of infrastructure investment in Australia. That being said, it is likely that, in the short term at least, governments will approach any transaction with caution given the potential political fall-out.
From a political and regulatory perspective, Australia is a deep and developed market with a AAA international credit rating and a well-developed and sophisticated financial market regulated in accordance with international norms. Australia was ranked 11th in 2013 by World Bank Doing Business and 9th in 2013 by the TI Corruptions Index.
Despite Australia’s status as a developed country with a functioning regulatory regime, there remain two key challenges for investors in Australia:
1. Australia’s foreign investment regime. Under Australia’s general foreign investment regime, the Federal Treasurer (acting on the advice of the Foreign Investment Review Board) must approve investments over certain thresholds or in certain sensitive sectors using the ‘national interest’ as the determinative test for approval. This approval regime can significantly delay foreign investors (particularly those with foreign government involvement) and disadvantage them in competitive processes against domestic bidders. More importantly, decisions of the Treasurer on key assets are often highly politicised with the suspicion that some refusals are made on political rather than national interest grounds. In addition to the general approval regime, there are specific restrictions and limits on foreign ownership of certain key infrastructure assets including in the transport, media and telecommunication sectors.
2. Red tape. Despite the relative ease of doing business noted above, as with many developed economies, businesses in Australia are often faced with significant amounts of red tape. This is particularly the case in some key infrastructure sectors such as in media and telecommunications, transportation and energy infrastructure. Added to industry-specific regulation is the issue that some infrastructure businesses have to comply with costly (and often duplicative or conflicting) state and territory regimes. Although some progress has been made to harmonise regulatory regimes and reduce red tape, further work is needed (a fact that is widely acknowledged despite the fact progress has been slow).
Notwithstanding the above challenges, Australia stands out as a jurisdiction that offers significant opportunities to invest in infrastructure given it is a politically stable and developed country with a deep history of private infrastructure investment.
That investment is supported domestically by a large funds management industry fuelled by superannuation funds, which receive contributions under Australia’s compulsory superannuation system. This has led to a number of wholesale infrastructure investment funds and joint ventures managed by Australian infrastructure managers. In recent years, those managers have been able to access offshore demand for Australian infrastructure.
South East Asia
Infrastructure demand in Indonesia is vast with spending expected to grow to approximately $165 billion by 2025, and growth in public investment expected to increase by 7 percent a year. In recent times, foreign investment has slowed due to increased restrictions on foreign investment and the country has had proportionally less foreign investment than neighbouring countries such as Malaysia, Thailand, and Vietnam.
To date, a number of challenges have permeated Indonesia’s investment climate. First, Indonesia's decentralised decision-making, sluggish land acquisition processes and lack of coordination between ministries can result in delayed approvals and sometimes even conflicting regulations.Second, there is a lack of transparency in the formulation of law and policy, such that changes can be unpredictable and difficult to navigate.Third, because of the influence of powerful domestic vested interests, there is general favouritism for domestic companies. Fourth, the legal system is often ineffective, inconsistent and unpredictable, particularly when it comes to upholding and enforcing contracts. Like other governments in a number of the developing economies of Asia, it also suffers from corruption.
However, the business environment looks set to improve. Under President Joko Widodo, the Government is pursuing a reform agenda to reduce the time needed to obtain permits and to improve the investment climate. The President has made infrastructure investment a priority and is focused on streamlining the bureaucracy to enable new development. All sectors are expected to be targeted, but particularly the manufacturing industry.
Vietnam is one of Asia’s fastest growing economies with particular potential for investment in power and transportation. Infrastructure spending is expected to reach $56 billion by 2025, with a growth rate of about 9 percent a year. Despite this fact, regulatory and policy reforms are still needed to make the country more attractive to investors.
Obstacles to investment include unclear government decision-making processes, difficulties in identifying appropriate revenue streams for PPPs and the reluctance of financiers to lend to the country’s state-owned monopoly power company and its potential suppliers. There are also concerns that there is not a level-playing field between state-owned enterprises and foreign companies, and favouritism being shown to local businesses. Other problems include corruption concerns and a weak legal system. However, the country has attracted considerable foreign investment in the region of between $10 billion and $12 billion annually for the past few years.
Infrastructure spending in the Philippines is expected to grow at approximately 10 percent a year in the next decade, to $25 billion annually by 2025. The demand for infrastructure stems from a need to keep pace with the country’s rapid economic growth in recent years. Particular areas of expected growth include manufacturing, transportation and communications.
The Philippines has however been a less attractive market due to higher business risk and corruption, which has historically stifled investor involvement. Those concerns remain, but the situation is improving, with the current President actively pursuing an anti-corruption agenda. The government is also engaging with private finance proposals such as PPPs.
Infrastructure spending in Malaysia is expected to grow by approximately 9 percent a year up to 2025, with growth in the utilities sector being the most significant. Malaysia has a strong need to improve its electricity infrastructure.
In contrast with a number of other developing economies in Asia, Malaysia’s regulatory environment is generally favourable. The World Bank’s 2014 Ease of Doing Business Report ranks it sixth out of 189 economies, and it scores highly on protecting investors. It is also relatively open to foreign investment. The OECD’s Regulatory Restrictiveness Index, which measures statutory restrictions on foreign direct investment, ranked Malaysia ahead of Indonesia, India, New Zealand and China.
However, the rule of law remains inadequate and the US State Department has noted that the legal system can be “slow, bureaucratic, and is regarded by some observers as politically influenced”. Recently, the government has taken steps to address corruption, including by establishing an anti-corruption commission.
Infrastructure spending in Thailand is expected to reach $58.5 billion a year by 2025. The government also announced in August 2014that it would pursue $75 billion in infrastructure projects over the coming eight years. Part of this stems from a $32 billion high-speed rail system. Thailand welcomes foreign investment and generally has clear approval procedures. Further, legal, regulatory and accounting systems are fairly transparent. However, enforcement of regulations can be inconsistent and unpredictable with corruption common among civil servants. Additionally, the country has experienced political instability in recent times.
Singapore is an attractive market for infrastructure investment due to excellent government planning, a favourable business framework and low risks. Singapore has been ranked 1st in 2014 by World Bank Doing Business and 5th in 2013 by the TI Corruptions Index.
The Singaporean government plans to extend the nation’s mass transit system, build new airport terminals and relocate its main port. However, opportunities for investment are relatively limited compared with the developing economies of Asia due to the existing high-quality infrastructure in place and the capacity for government funding.
That being said, due to favourable tax treatment and a well-developed legal system, Singapore plays a particularly important role as a conduit for foreign investment into developing Asian countries (particularly India and those of South East Asia). It is not uncommon to see investors without any link to Singapore structure their investments into Asia through a vehicle established in Singapore.
Significant opportunities… but reform is needed
Asia presents numerous opportunities for infrastructure investors with developing economies that need infrastructure investment. However, a number of challenges remain. Particularly in the developing economies of Asia, reforms are needed to: >
- Reduce delay in creating businesses, obtaining approvals and enforcing contracts.
- Provide sufficient legal protection for investors, including strengthening private property rights and reducing corruption.
- Ensure more transparent and predictable government decision-making.
Governments throughout the developing Asian economies are taking these actions and private infrastructure investment is growing exponentially. It is to be expected that as governments continue to reform this will only encourage further private investment.
Accordingly, infrastructure investors will need to carefully monitor the political, regulatory and other exogenous risks and opportunities before making the appropriate investment decisions.
This article is extracted from the book Infrastructure Risk Management, which will be published by PEI in June 2015. For more information about the book and to register your interest, click here: https://www.infrastructureinvestor.com/risk_ryi/
The authors would like to thank, from Australia, Daniel Natale and Jennifer Zhou and, from Hong Kong, Hayden Flinn and Guo Sun Lee for their contributions to this article.
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Ding Ding et al, ‘Future of Asia’s Finance: How Can it Meet Challenges of Demographic Change and Infrastructure Needs?’, IMF Working Paper No. 14/216, July 2014, .
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