ADB wants to get private sector into Asian infrastructure

IFR Asia, ADB edition, May 2008

In one corner: Asia’s vast savings pools. In the other: Asia’s equally vast infrastructure spending needs. Getting these two to meet in the middle is of vital importance to Asia’s future, and has become a keystone of Asian Development Bank policy.

Rajat Nag, managing director of the ADB, estimates the demand for infrastructure in Asia is around US$300 billion a year, and growing – and that doesn’t include investment in agricultural infrastructure. “Official assistance can provide just a tiny fraction of that,” says Nag. The ADB lent just over US$10 billion last year, roughly half of it for infrastructure; governments can provide a similarly small chunk. “So most of that $300 billion has to come from the private sector, and from public-private partnerships.”

There’s no shortage of money. Around 34% of GDP is saved in the Asian region. But mobilising that capital, and getting the private sector involved, has been impeded by two things in particular. One concerns dispute resolution mechanisms. “Even if you have the right legal framework, we find the private sector is very keen to know what is the dispute resolution mechanism, what will be the procedures for arbitration, where will the courts be where these things are settled.” This relates to a broader query about the governance structure for infrastructure investments – “who will be our counterparty? Will we be working the ministry of public works or will there be a project authority set up for this particular project?”

The second impediment is perhaps more surprising: lack of projects. It’s not that there’s a shortage of infrastructure that needs to be built. But there’s a big difference between identifying that, say, Bangladesh needs more power, and coming up with a carefully considered project in which to invite private sector involvement.

“I must confess we had not thought this was much of an issue, but it is increasingly becoming one,” says Nag. “Many times private sector sponsors will come in and say: we are willing to work with the ADB and the government, but where are the bankable projects? That means you’ve got to have projects that are prepared technically, socially and environmentally, so that you are not talking just in abstract terms about ‘coming in to infrastructure’.”

How to move that forward? “We now recognise that somebody has to invest money up front,” Nag says. “We would be willing to do that with the governments, and we are starting to do it, by creating what we call the project preparation facility. We go into countries and say: let’s look at this particular water project, and let’s spend $25 million up front – at our risk – so when the private sector comes in we can say: here are the details.”

The ADB’s long term strategic vision aims to put 50% of bank lending into private sector development (both in terms of creating an environment for the private sector and putting money into private sector projects directly) by 2020.

Getting there is going to have to involve greater development of domestic debt capital markets in Asia. “One reason we have not been able to get investment in infrastructure to the extent that we should is the lack of a suitable financial architecture in Asia,” Nag says. “We’ve got huge savings but we don’t have the mechanisms to mobilise those savings, excepting the banks,” which by necessity are short term funding options. “One of our priorities is to get a regional financial capital market.” The ADB backs this as an issuer in its own right; “I think that is of equal importance to having the right legal framework and dispute resolution.”

But how does it work in practice? Take the technical assistance recently offered to the Indian state of Bihar, granted approval on April 4. The words ‘private sector’ don’t appear once in the 14-page technical assistance report, which can be found on the ADB site, but everything else about it – long term demand forecasts, the development of capacity expansion scenarios, assessments of generation and transmission investments, a loss reduction program, software, a capital works program – implicitly increases the appeal of investment in the state to the private sector. “Ultimately that’s the objective but you’ve got to do quite a few things before you get there,” Nag says. “The private sector is not looking for goodies and handouts: don’t give them a tax incentive for five years, give them a level playing field, the right dispute resolution mechanisms, the right institutional support. That’s what the private sector wants, not financial incentives.”

India’s an interesting market, because one couldn’t really claim that there is a shortage of legislation or judicial establishments – its legal code goes back more than a century and a common complaint of local lawyers is that there is too much law and regulation, not too little. Nag points to the development of the public private partnership scheme in India, which the ADB has backed, as a way of getting past this. “Often it is not that the people at the top are not willing to move ahead – they are,” he says. “And the right legislative framework is in place. But the details, the implementation, that’s an issue and a constraint. We are working with the government both at the central and the state level to strengthen public-private partnerships, where you have a team of lawyers, engineers, economists and financial analysts in place to look at these projects.” Nag also believes the long-moaned battles between federal and state governments in India, long seen as a headache for infrastructure development which commonly involves both, are in the past and “there’s more of a common purpose. The central government certainly recognises that many of these projects have to be done at a state level. There’s a greater convergence of interests.”

It will take time, he says, “but I think we recognise that the issue is no longer whether there is a political will. That took some time, but I think we are over that. It is now a question of how we get the private sector in.”

Sticking with South Asia, a look at recent private sector-type lending from the ADB shows a lot of activity. On April 17 the ADB board approved a US$113 million private sector loan to help Gujarat Paguthan Energy Corporation set up wind energy facilities in Gujarat and Karnataka with an installed capacity of 183.2 MW. The objectives and scope include “demonstration of the successful implementation of large-scale wind power projects by the private sector.” The same day, a US$450 million private sector loan was approved for the Mundra Ultra Mega Power Project, to build and maintain a 4000MW coal-fired power plant in Gujarat. Among its aims is to “promote private sector participation in the Indian power sector.” In May a private sector credit committee meeting will discuss the Phulbari coal project in Bangladesh, involving a US$100 million private sector loan and $200 million political risk guarantee, with project sponsor Asia Energy. And in July the board is scheduled to consider approving two projects in Sri Lanka involving modest private sector loans, one for a biomass power project, the other a hydro plant.

The theory of putting the bank’s money where its mouth is – giving comfort to the private sector not just through guarantees but through active participation – will be tested in the years ahead. For example, the bank has gone quite heavily into significant power projects in markets like Vietnam, “and the precondition for doing that is to give comfort to private sector investors that there is a legal framework.” But Nag himself point out: “The test will really be if the dispute resolution mechanism works. We’ve got it in there, which has been enough for the private sector partners in these countries to come in, but the test will be, when you have a dispute, how it is resolved – how equitably and quickly.”

Today, Nag reckons private sector funding covers 20 to 25% of what’s needed: perhaps $60 billion a year. The hope is that as the private sector becomes more familiar with participation in these projects, the figure will grow quickly. “For example, as some of the infrastructure projects India is doing through public private partnership come to fruition, there will be a demonstration effect and others will come through,” he says. “There is a huge unfunded gap but we are quite hopeful the rate of uptake will increase.”

And even if the commitment of capital is slow, it is clear that the debate has moved on from a few years ago, when the broader question was whether the private sector should be involved at all.

“It is no longer an ideological debate about whether the private sector is good or not,” says Nag. “I think everyone recognises that without them we won’t go anywhere near $300 billion. It’s a question of how we implement it.”