Electrification is a priority for many development finance institutions (DFIs) and the sector has attracted investment through green and blue capital and incentives. However, because renewable projects are 3-4 times smaller in size than traditional power infrastructure, they can be less attractive to fund due to high transaction costs, including the high cost of due diligence in East Asia and Pacific markets. To identify trends and opportunities, our team has put together a two part series presenting a picture of the private participation project pipeline (projects that are not 100% funded by government, concessional loans or donors) across key East Asia and Pacific markets.
Electricity infrastructure is the predominant investment across Indonesia, Philippines, Vietnam and Cambodia, with the Australian-PNG Electrification partnership now stimulating investment in Papua New Guinea. As green and blue external capital influences project selection, governments are increasingly looking at renewable energy investments. Because renewable energy is a newer sector it has needed to overcome hurdles in the conventional banking sector to achieve appropriate senior and mezzanine debt leverage. Because renewable projects are 3-4 times smaller in size than traditional power infrastructure, they can be less attractive to fund due to high transaction costs, including the high cost of due diligence in East Asia and Pacific markets.
Telecommunications and water are key priority areas for Pacific nations, which are attracting capital from key donors and MBDs. Basic road infrastructure remains challenging and is a difficult segment to finance privately, if not impossible in the Pacific. Infrastructure in the Pacific is domestically political with the complexities of customary land use and public acquisition in absence of an eminent domain or fair value mechanisms for Pacific governments to work from. It is also internationally political. Pacific nations are sub-scale for the capital needed. For example, a $300m water treatment plant may only support 20,000 people, which will not support an investment case. As such, investors and governments need to coordinate a portfolio of projects and drive clustered procurement – which to date has proven challenging for Pacific nations. Sovereign wealth funds such as Fiji’s National Provident Fund (FNPF) are limited to domestic investments under their mandate, with capital deployed across tourism assets. Whilst sovereign funds have potential to deploy capital into infrastructure projects, institutions are limited in their ability to take early stage risk in projects. Build, operate, transfer PPPs provide a capital recycling route for early stage investors, however the domestic economics of scale remain, which destroys viability. Viability Gap Funding may be considered by DFIs looking to support Pacific projects.
Without a strong domestic tax base to drive big projects, infrastructure development will ultimately be decided by foreign investors and multilateral development banks. As the scale economy issues are resolved through project portfolios the issue for Pacific infrastructure development will not be a lack of capital, it will be the real price that comes with it.
The pacific has not seen significant private investment in infrastructure. Excluding small local projects, in total only three private investments were made in Fiji’s infrastructure over the 1995-2019 period as recorded in the World Bank PPI database, totalling USD$474 million in nominal terms. A total of three private investments were recorded for Solomon Islands infrastructure projects over the same period totalling USD$362 million in nominal terms – all three in the electricity sector. Solomon Islands established its first large PPP in the Tina River Hydropower Project which is expected to replace the country’s diesel generation and is fully funded by the World Bank, ADB and the Green Climate Fund – not appearing in the PPI dataset.
In total only two significant private investments were made in Papua New Guinea infrastructure over the same period. Infrastructure that has been developed is typically project specific and not for a broad public use. A key constraint for attracting and rewarding private sector participation in infrastructure projects across the Pacific is the scale and subsequent revenue models that are not strong enough to sustain projects and deliver investor returns.
Vulnerability to Regional Shocks
East Asian and Pacific countries have exposure to China’s economy, both on an imports and exports basis. This drives volatility in the macroeconomic context, with upstream countries such as Vietnam and Cambodia where approximately 25% of manufacturing GDP contributions have been exposed to import supply volatility and disruption over 2020. This will impact foreign exchange, interest rates, and fiscal policy, which can translate quickly into large infrastructure finance problems.
Tourism income is a significant exposure for many Pacific economies, and more generally all tourism exposed economies are vulnerable to supply shocks that knock on to demand for travel or movement restrictions within the region.
In the infrastructure sector, well-structured PPPs share risk effectively
and avoid pushing government-controlled risk onto private investors, such as the risk of development approvals, as these drive up the cost of projects
significantly. Governments are well placed to take on development risk and the responsibilities of chaperoning projects through approval processes. On
completion governments can recycle capital through an exit to private investors – once the asset is established with a track record of revenues. Government equity (public assets) can provide a degree of stability in economically volatile environments and the development of sophisticated capital structures for Pacific infrastructure projects is important for reducing volatility for investors over the long-term asset lifecycle.
Asian Development Bank. (2017). Meeting Asia’s Infrastructure Needs. Asian Development Bank.
Asian Infrastructure Investment Bank. (2019). Bridging Borders: Infrastructure to Connect Asia and Beyond. AIIB.
Carlsson-Szlezak, R. a. (2020). Understanding the Economic Shock of Coronavirus. Harvard Business Review.
Economist Intelligence Unit. (2019). Asian Infrastructure Finance. Asian Infrastructure Investment Bank.
IJGlobal. (2020). Project Finance and Infrastructure Journal. Euromoney Institutional Investor PLC.
World Bank. (2019). Private Participation in Infrastructure 2019 Annual Report. World Bank.