Plenty to play for

Make no mistake: with its economy still projected to grow at 6.5 percent this year despite the global recession, China’s infrastructure demand is not going to stall in the near future.

For international infrastructure investors, the outlook is intriguing. Speaking at an infrastructure roundtable at the recent Private Equity International Forum: Asia 2009 in Hong Kong, Daniel Liew, Hong Kong-based Asia managing partner at international law firm SJ Berwin, said “the sky is the limit in most infrastructure sectors” in China. Liew qualified this bullish statement by noting two exceptions: basic telecommunications and passenger railways, where foreign ownership of infrastructure assets is limited to 49 percent. In all other sectors, no such constraints exist. 

Water, roads, renewables

China is of course one of the two largest markets in Asia for private investment in infrastruture. India is the other. Saud Siddique, joint managing director of Srei Infrastructure Finance, an Indian infrastructure finance and investment company, noted at the roundtable, the two countries will account for some 80 percent of all infrastructure investments in the Asia-Pacific region.

China has a population north of 1.3 billion and much remains to be done in terms of providing adequate basic infrastructure to its people. According to Liew, the sectors hungriest for capital in China are water, waste water, railways and toll roads.

Siddique agreed. He said that the water sector in China is one of the most developed in the region and the country plans to spend about $200 billion to $300 billion in water projects alone. Given the sector’s conducive regulatory framework, there will be opportunities for private investors to participate in build-operate-transfer projects, he said.

Another sector discussed in depth at the roundtable was renewable energy. “Renewable energy is very interesting in China as the government is actively encouraging investment,” said Andrew Yee, joint chief executive officer of Standard Chartered IL&FS Infrastructure Growth Fund (SCI Asia), an $800 million pan-Asian infrastructure private equity fund.

Standard Chartered and SCI Asia together own a 50 percent stake in Meiya Power Company, through which the firms have focused on hydro and wind power generation where “the government provides attractive tariffs and priority dispatch [meaning as long as the company operates, it will be paid irrespective of demand],” said Yee.

Yet another growth segment, arising from the country’s continuing urbanisation is the road sector, said Tony Adams, a managing director with JPMorgan Asset Management, where he co-manages a fund focused on Asian infrastructure.

Historically, it has been difficult to invest in Chinese road projects that produce a reasonable rate of return, added Yee, though with the current downturn, valuations are coming down. Adams said that his firm does not assume tariff rates will increase when it enters a deal. It looks for returns that come from organic growth rather than tariff increases. “You’re making a bet on [traffic growth] rather than higher tariffs,” he said.

Everyone at the roundtable agreed that the infrastructure requirement in China is so huge that the state cannot fund it on its own. So while there are several state-controlled companies dominant in certain sectors such as energy and transport, there are substantial opportunities on offer for private players as well.

Neverthless, the government will continue to play a key role in addressing the infrastructure need, the panelists agreed. There was consensus among the panelists that the economic stimulus package worth almost $600 billion announced by the Chinese government last year will benefit private players in infrastructure, particularly considering that about 70 percent of that capital has been marked for infrastructure.

“The government is now targeting the domestic economy”, said Yee, as opposed to export-driven industries. The focus is therefore on roads and railways as opposed to ports, he added. While it continues to promote both, “there is a subtle move inwards”, Yee remarked.

The easing of monetary policy in the country is also good for private investors in infrastructure, as liquidity is now freely available for quality projects and developers with established track records, primarily from large local banks. 

“Debt financing is available, but one should focus on local sources of financing,” Adams said. Panelists also suggested it was unlikely that “marginal” projects will be financed.

But while there seems to be plenty of infrastructure investors interested in China to work on, there is one potential pitfall. “A combination of state-owned enterprises having a very low return requirement or being more focused on growing market share than profitability, and overly tight focus on returns by the regulators [for example when determining tariffs] could restrain future private sector investment,” Yee warned.