Southeast Asia Infrastructure interviewed Srinivas Sampath to ask him about the road ahead for infrastructure investment in ASEAN countries, impact of Covid-19 on the region and his goals for Southeast Asia during the next decade.
In your opinion, what are the biggest roadblocks to attracting private sector infrastructure investment in the Asia-Pacific region?
In the context of urban areas, the following are some of the biggest roadblocks to attracting private sector investment in infrastructure in the Asia-Pacific (APAC) region:
- Lack of bankable infrastructure projects prepared in a transparent manner
- Poor project preparation
- Limited funding for urban infrastructure
- Weak revenue base among municipalities, which makes cities less creditworthy
- Uncertain regulatory and policy environment
How important is land value capture (LVC) to generate financing for infrastructure projects? This method may not be viable in some countries due to their policy framework. What is the next best alternative in such countries?
LVC is a financing method by which a municipal government increases land/property value through regulatory actions such as change in land use and infrastructure development and then takes steps to capture all or part of the value appreciation. The proceeds from the value capture are then used to finance infrastructure development or other projects or programme to offset the impact related to the changes.
If managed well, LVC allows local governments to tap into increased land value in locations made attractive and liveable through government investments. Through LVC, the government generates broader public benefits. For example, governments can redistribute some of the revenue generated by higher-end residential and commercial development to pay for affordable housing and social services for lower-income residents in the area.
For LVC to be successful it is critical that city governments develop a transparent structure for LVC. When implementing LVC, many cities in developing countries face governance challenges, such as out-of-date or insufficient land registries that make it difficult to track and tax properties; significant under-reporting of transaction value to avoid stamp and income tax liabilities; a lack of political will to invest in LVC; and weak institutional capacity to oversee LVC projects.
There are some good examples of LVC in Asia. However, for LVC to truly take off as a reliable funding mechanism for urban infrastructure, it is important that the value generated by a proposed investment (mostly in public transport) is transparently captured. Many cities in Asia do not have a robust and market-oriented policy framework in place to enable local governments to capture the value of land.
In addition to LVC, city governments can set up a local infrastructure fund to pay for infrastructure. A local infrastructure fund allows governments to combine different forms of municipal government funding and maximising their buying power for investment. Some municipal governments can also borrow against some of their existing resource funding streams, such as federal/provincial fiscal transfers, municipal tax, or property tax base to fund capital projects or accelerate debt payoff. Once some of the debts are paid, the fund will provide a larger stream of resources to repeat the process. City governments will need a stream of resources to get things started in the first place until revenues and other incomes start flowing. In some special circumstances, a bespoke fund can be created to jump-start the process.
The Covid-19 pandemic has severely affected government and public-private partnership (PPP) infrastructure financing. How will this affect the long-term development prospects of the region? How long will it take before PPP investments reach pre-pandemic levels?
Even before the Covid-19 crisis hit the region, the annual infrastructure gap in the APAC region was estimated to be $1.7 trillion. As many governments face significantly higher expenses for social welfare and health services amid the Covid-19 pandemic, the funding gap for key infrastructure is likely to have expanded even further. In the medium to long term, good quality infrastructure will be crucial to sustaining growth.
The pandemic has affected PPP projects at all stages of the development life cycle, as governments, sponsors and lenders are making procurement, investment and lending decisions in an uncertain environment. PPP projects will require careful consideration and quality project preparation practices.
So, let us look at the risks at various stages of a PPP project and how Covid-19 affects these:
PPP projects in their pre-commercial operations stage: Impact on supply chains
- Government closed facilities and work sites deemed non-essential during the Covid-19 pandemic, slowing down PPP projects yet to reach their commercial operations date.
- In contrast to the operational phase of projects, the construction phase is labour intensive and vulnerable to supply-side factors, such as workplace restrictions for construction workers, the unavailability of materials and equipment, and longer lead time.
Impact on the availability of expertise
- The quarantining and social distancing measures in response to the Covid-19 pandemic have changed the way we work.
- Social distancing measures implemented by central governments and corporations have significantly cut the number of workers at a certain location at any given time. Staggered work hours and workforce rota systems have led to lower productivity.
Infrastructure demand profiles
- Social distancing and pandemic response measures have changed infrastructure usage and demand patterns worldwide. Many of these changes are likely to persist in the coming years.
- Air and rail travel dropped internationally and domestically. News outlets recently reported that leisure travel may not resume on a global scale until mid- to late 2022 and international air travel would return to pre-pandemic levels by 2025. This has left airports and travel terminals largely underutilised, reducing their usual source of air-side revenues, such as gate and landing fees; and land-side revenues, such as retail.
- For some existing PPP projects, these changes have significantly affected the underlying economics.
- Regardless of vaccine availability and rollout, which is very lopsided across the world at present, it is likely that health authorities look at social distancing measures more strongly. This could change the density of infrastructure usage, such as permitted maximum rail carriage densities. In the medium term, this is likely to affect capacity and farebox revenue of urban transport projects.
- The good news is, overall, it has been rare for government-procured projects to be cancelled because of Covid-19.
In terms of the long-term prospects and how long it may take PPP investments to return to pre-pandemic levels:
- The impact of Covid-19 on PPP projects is being closely monitored by all stakeholders, including banks, project sponsors, and government contracting agencies.
- Covid-19 is causing significant disruptions to the infrastructure sector in the APAC region. Disruption and suspension of services has led to financial strain on private sector operators.
- Governments are already feeling fiscal pressure due to the pandemic and now face liquidity problems.
- The lockdowns in most of the countries are likely to affect PPP projects that rely on cash flow from user fees.
- Evidence suggests that, in general, the private sector can effectively and efficiently finance, construct, operate and maintain infrastructure assets. Therefore, in the post-Covid-19 “new normal” world (once the crisis phase is over), PPPs will become even more relevant and useful. Governments struggling to come up with upfront capital expenditure on building infrastructure and services may structure PPPs using an availability payment model (where government retains the demand risk for the project but makes contractually determined performance-linked payments). Banks and investors will no longer take full demand risk as they have done in many of the PPPs in the developing countries of Asia. Therefore, the use of availability payments may become a key consideration in the way governments look to pay for PPP projects.
- Governments will need to consider using various credit enhancement measures to support PPP projects and provide comfort to banks and investors.
New thinking is required to finance Asia’s infrastructure needs in the post-Covid 19 world
- Commercial banks will find it difficult to lend to projects structured on demand risk alone. So, I would expect to see more type-based PPPs being brought to the market. But governments must first develop a strong business case for investing in a project before considering the most appropriate procurement model, including if PPP would meet the affordability threshold and deliver value for money over the life of the asset.
- Governments should explore options to realise value from existing operational infrastructure assets with cash flow. Asset recycling and monetisation would help government raise funds, which can then be ploughed back to pay for new infrastructure.
- In some projects, governments may be able to fund the capital expenditure through multilateral development banks (MDBs) with private sector operations and maintenance (O&M) expertise. Such hybrid PPPs are increasingly being used in Southeast Asia.
- In the current global environment, it remains challenging to secure project debt financing. Major international banks have become more risk averse. Long-term financing beyond 7 to 10 years is looking less appealing to many commercial banks. In smaller countries, the local banking sector does not have sufficient capacity to provide large-scale, long-term financing to infrastructure projects.
- MDBs like the Asian Development Bank (ADB) and their credit enhancement products can help the public sector counterparts attract investment into PPPs. ADB has developed credit enhancement products that can be used to enhance credit for PPP projects.
Water and sanitation projects are known to attract little private investment. With the existing financing gaps in these sectors as well as the need to achieve the 2030 SDGs, what can the region do better to attract financing?
In most urban areas in APAC, the public sector remains the predominant source of infrastructure financing, but it is constrained by the overall financial resources available at its disposal. This leads to funding not being available to projects that could otherwise be financially viable in the long term. The problem is further compounded by low credit quality of most urban local governments, which significantly limits private sector participation in the delivery of urban services. Commercial banks mostly offer short maturities, with terms not suitable for infrastructure projects that have a long payback period. Most countries in the region have not tapped into domestic capital markets to fund urban infrastructure, although a few creditworthy cities have managed to issue bonds.
So, what can cities do to attract more private sector infrastructure investment to deliver urban infrastructure like water, sanitation and solid waste management?
There are several steps municipal governments can take to attract private sector participation in urban infrastructure projects.
- Ensure robust project preparation and pipeline development: Proper project preparation is the key to programmatic infrastructure delivery. This means defined, predictable governance and legal processes that boost investor confidence and visibility.
- Improve the enabling environment: Areas include appropriate sectoral policies, tariff reform to achieve full cost recovery, public sector commitment and leadership, the ability to understand key project risks and its management, and the public sector’s capacity to prepare, procure, and manage PPP projects.
- Tap into domestic capital markets: This is the most important avenue for sustained financing of urban infrastructure that generates cash flows in the local currency. Accessing private domestic savings on a large scale will boost the efforts of governments and international funding agencies to finance infrastructure at local and regional levels.
- Use of multilateral financial institutions to support payment obligations under a PPP contract: Multilateral financing could help pay for part of the initial capital expenditure of a PPP project, including converting a debt into a grant for a PPP project to enhance overall project viability. Multilateral financing can also be used to meet payment obligations – like availability payments – of municipal governments. This helps spread the cost of paying for urban infrastructure over many years, as MDBs can offer much longer debt tenors than commercial banks.
- Use of credit enhancement products more creatively: Multilateral banks’ risk mitigation and guarantee products can crowd in private sector financing by leveraging the multilateral bank’s credit rating. Project-specific guarantees help governments attract private financing by obtaining cover against the risk of non-payment based on a commercial or financing contract. Similar guarantees are available to private sponsors.
- Develop a programmatic approach to bring private sector into urban infrastructure like water and sanitation: Without sustained tariff and sector reforms, city-wide privatisation and city-wide concession contracts will not be successful. Stand-alone urban infrastructure assets with a ring-fenced cash flow to an offtake contract, such as bulk water treatment plants and wastewater treatment plants, are more attractive options for private sector investments and operations. As most water distribution coverage in urban areas is either limited or has high system losses, the private sector can play a crucial role in improving performance, reducing non-revenue water, augmenting capacity, improving and expanding the network, and in metering and collection. Once the distribution network is stabilised, backed with necessary sector and tariff reforms, this incremental approach can encourage the private sector to participate in water distribution in the long term. Similarly, the capital-heavy mainline sewer lines and the reluctance of users to pay for sanitation services (as against water supply) means private sector participation in sanitation will be more suitable in the O&M of the network and in wastewater treatment plants.
Srinivas Sampath is the director of the Urban Infrastructure and Water Division, SEA Department at the Asian Development Bank. Sampath has over 27 years of experience in delivering infrastructure financing solutions across 40 countries. He has extensive experience in transport, social, energy, and urban infrastructure projects as an investor/project developer, lender and adviser.