A bumpy road

In the developing countries of Asia, concrete roads littered with trash and cracked by weeds are not an uncommon sight. In some, wild animals and livestock share the lanes alongside cars. This is hardly the ideal picture for a region hoping to maintain strong economic growth.

The need for public and private investment in transport infrastructure is not in question. Indeed, according to Asian Development Bank estimates, emerging Asia will require at least $10 trillion invested in the sector over the next 10 years.

Michael Cooper, head of Asia Pacific infrastructure project finance at HSBC, adds that Asia’s unprecedented urbanisation rate will create demand for different kinds of transport infrastructure, such as subways, and that will take around $10 billion of investment per annum.

To date, however, he acknowledges that there has been “under-investment” in the sector. Many private sector investors, such as Partners Group, have chosen to focus on more specialised infrastructure sectors such as renewable energy, and there are only limited examples of successful transport infrastructure investments.

EVER CHANGING RULES

Cooper points to a fundamental disconnect between demand for investment and viable opportunities for the private sector. The culprits are numerous, but he chooses to underscore the hindrance that regulatory regimes place on transport infrastructure projects. Few governments in Asia appear able to balance the demands of local municipalities, which for foreign investors is unsettling.

Nothing demonstrates this issue more starkly than the failed bidding for the LRT Line 1 Cavite Extension public-private partnership (PPP) project in the Philippines. After delaying the bidding repeatedly for a year, the PHP60.6 billion (€1.0 billion; $1.4 billion) project received no qualifying bids, and had to apply for a rebidding in September.

The real “deal-breaker” for the LRT was the realty tax that local municipalities in Manila could charge. Municipalities in the Philippines are largely independent, so there is no legal limit on the taxes they can charge private sector contractors for building the metro through their land.

The risk variability was almost impossible to price, says Cosette Canilao, chief executive of the Philippines’ PPP Centre. “The experience of the private sector is once they take over, local governments tend to impose higher taxes.”

“The interface between the public and private sector on transportation infrastructure is very complex, more so than in other infrastructure sectors like energy,” says Christopher Thieme, director of the Asian Development Bank’s infrastructure finance division’s private sector department. Assets like roads and railways involve large spaces of land and all the permits, taxes and compensation that go alongside.

Those are risks Thieme believes should be taken on by governments, but which are often pushed to the private sector in Asia. Unfortunately, over the years it takes to complete a highway, the private sector cannot be certain those terms won’t change.

“The regulatory regime needs to be suitable for foreign investors to make long-term investments,” Cooper says. “What you don’t want to find is that there’s been a change in government and thus a change in the regulatory regime as well.” Unfortunately, many Asian countries are found wanting in regulatory consistency, he confesses.

COMPOUNDED RISK

Investing in Asian transport infrastructure is already risky enough, Cooper warns. The region is a very competitive market, and even with its strong growth, is still fairly poor on a per capita basis compared with the West. The nature of transport infrastructure and its related risks makes the private sector more dependent on solid regulatory frameworks for protection and to ensure returns, according to Thieme.

One risk Cooper points to is that of domestic competition. The only way to win a secure place in Asian markets is to bring a unique skill or capability to the table – something domestic firms can’t easily replicate.

That’s easier to do for sectors like renewable energy than roads, he concedes. “You need to develop good relationships in Asia, more so than in some developed countries, to make transportation investments workable,” Cooper says. An international firm’s relationships will have to stretch from the financial sector to the construction sector.

There is also a large element of speculation in traffic predictions, and much of the time these turn out to be “grossly inaccurate”, Cooper laments. With Asia’s 3.5 billion people, there is always traffic; the key question is whether drivers are willing to pay tolls. “You’re not talking about a high level of disposable income,” he explains.

For some routes that have no alternatives – such as inter-city national highways in India – users are willing to pay, according to Partha Dey, president of infrastructure at ICICI Venture, the Indian bank’s private equity arm. Since 70 percent of the traffic on those highways is business- or shippingrelated, the private developer can easily make a profit from building those out.

However, roads within cities are a different story. Even if traffic jams in Mumbai are lamentable, a toll road within the city may well be untenable because of the plethora of alternative routes available, Dey says. Drivers will take any number of back roads to avoid paying a toll.

Cooper also warns that a project’s competitiveness depends largely on how it links to the existing road system. Thus, to make acceptable returns, a private contractor needs the government to provide optimal points of connection in its planning, as well as assurance that no competing routes will be constructed to steal traffic (which he has known to happen).

With all these extraneous factors to consider in connection with government, it’s hardly a wonder private sector players shy away from unstable regulatory regimes.

NOT GIVING UP

However, Thieme insists that the private sector cannot retire completely from transport infrastructure because of government budget constraints. While there is space for pure public investments, the track record of large public projects isn’t great, Thieme points out. For the private sector, if transport infrastructure is done right, the potential exists for significant upside, Cooper adds.

On a basic level, Asia’s superior growth rate in population and gross domestic product (GDP) generally leads to higher equity returns, Cooper explains. There are more people to use the roads and better growth in economic activity. Generally, investors anticipate an approximate 15 to 20 percentage point difference in risk for Asia’s transport sector, they require a return premium of approximately 10 to 15 percentage points compared with developed economies, he says.

Indeed, Thieme does not believe financing for transport infrastructure will be the major problem. There is enough liquidity among Asian institutions, and governments across Asia already recognize the importance of the space. The bottleneck will simply be rolling out well-structured projects.

“The best structures I see involve governments which understand that they can assume risks that relate to their own conduct,” Thieme tells Infrastructure Investor.

Cooper adds that Asian countries such as India and Vietnam “are taking huge strides” toward attracting foreign capital. Given how fast the region is evolving, Cooper suggests that private investors could get away with taking on a project with less than ideal conditions attached.

Even if all the needed elements – a transparent regulatory regime, clear requirements for land permits and right-of-way, and good integration into the existing network – are not quite perfect, Asian governments have indicated they will put in the required effort to make the transport sector as facilitating to investment as the power sector.

“You may not have everything you want in a project, but you must look at it from its local context and what will come in the future,” Cooper urges.