Approaches to PPPs in Southeast Asia

Infrastructure investments are typically large, with stable but modest returns. When investors deal with governments in Southeast Asia and other emerging economies with less mature PPP policies, they face a higher risk of changing regulations or being guided by unclear rules. A potential investor in an infrastructure PPP in these markets will often spend many months and a great deal of money to land a contract. But even having done this, it is not unusual for the bidding to be cancelled or postponed, and no reason given. Pitfalls such as these lead to high sunk-costs in many infrastructure PPP projects in Southeast Asia. Contracts, as much as legal and regulatory frameworks, therefore, play a significant role in securing a finalized PPP deal.

Infrastructure projects in the region face two high-profile challenges: lack of capacity in the public sector to handle PPPs, which is discussed later in the chapter, and underdeveloped financial markets. Because of this, potential funds for infrastructure are not being tapped because there are no capital market mechanisms to channel them. As a result, large institutional investors, such as pension funds and insurance companies, have less opportunity to diversify their portfolios into infrastructure projects. The absence of this potential avenue for financing infrastructure is an added difficulty for governments promoting PPPs to help close Southeast Asia's infrastructure gaps, and will likely remain so for some time, given the slow progress being made in developing countries' capital markets. It should be noted, however, that a well-developed local capital market increases a country's exposure to global financial risks, which many governments in developing countries are trying to avoid. So far, Southeast Asia's emerging capital markets have relatively little foreign participation, except in Indonesia and Malaysia.2

Variations in implementing PPPs depend on the maturity of national policies for these partnerships, but there are three basic stages (Table 11.4). Countries at the initial stage mainly use PPPs to fill infrastructure financing gap, including privatizing state assets. At the intermediate stage, countries focus on construction and operation, including management and services contracts. At the mature stage, countries tap into the advanced benefits of PPPs, such as innovation in design and technology. In Southeast Asia, Singapore is at the mature stage; Indonesia, Malaysia, the Philippines, and Thailand are at the intermediate stage; and Cambodia, the Lao PDR, Myanmar, and Viet Nam are at the initial stage.

Table 11.4: PPP Implementation Stages Based on Policy Maturity

PPP = public-private partnership.

Source: Fauziah Zen and Michael Regan, eds. 2015. Financing ASEAN Connectivity. Economic Research Institute for ASEAN and East Asia Project Report 2013-2015. Jakarta.

Infrastructure PPPs in Southeast Asia are not-at least for the time being- going to be marked by technical or financing innovations given the resources. Because of this, governments need to set realistic expectations on their PPP targets, improve PPP systems and the capacity of agencies to handle these partnerships, and work on narrowing their infrastructure gaps.

Within this context, Southeast Asia can be divided into countries with more-developed PPP systems (Indonesia, Malaysia, the Philippines, Singapore, and Thailand), and countries with less-developed systems (Brunei Darussalam, Cambodia, the Lao PDR, Myanmar, and Viet Nam). For infrastructure financing, four main factors determine a project's attractiveness, options, and size of financing:

• Stage of economic development. This determines the types of available projects, economic demands, and the fiscal and knowledge capacities to carry out a project.

• Fiscal management. This determines the capacity to provide fiscal support, guarantees, cofunding, and securing loans for infrastructure financing.

• Capital market development. This determines the confidence level to invest in a project and the available financing channels, especially for long-term investors.

• Regulatory framework. This determines the ease of investing in a PPP, the level of secured investments, and cost efficiency.

Southeast Asian countries belonging to the more-developed PPP group have similarities: they typically have the fiscal capacity to secure loans and cofund infrastructure projects. These countries have mature fiscal management systems that reduce the potential to default, and they provide support for infrastructure projects. The capital markets of some of these countries are already at a mature stage, enabling the participation of institutional investors in PPPs. The legal systems of this group are generally complete, clear, and predictable. This group's main challenge is to accelerate the strengthening of their PPP systems, though this could be complicated by political economy factors; for instance, changes that require approval from legislatures or political deals during the election cycle. The demand for infrastructure is strong in Southeast Asia's more developed economies, especially in urban areas and from a growing middle-income class. This will likely continue, given the region's strong economy and political stability.

Demand for infrastructure tends to be lower in countries in the group with less-developed PPP systems, with the level influenced by population size, geographical challenges, and purchasing power. The PPP systems of these countries are also shaped by their stage of development, since this determines the types of infrastructure to be prioritized. Some countries in this group have narrow fiscal capacity, debt management problems, and less macroeconomic stability. These countries also do not have an investment grade rating, and their capital markets are at an early stage of development or do not exist. Before they can make progress on their PPP systems, they need to improve their investment climate. Table 11.5 shows the countries in the two groups in the World Economic Forum's 2017-2018 Global Competitiveness Index.

Table 11.5: Global Competitiveness Index 2017-2018 Rankings for Southeast Asia

Lao PDR = Lao People's Democratic Republic.

Note: Rankings out of 137 economies. Myanmar is not included in the 2017-2018 index.

Source: World Economic Forum. 2017. The Global Competitiveness Report 2017-2018. Geneva.

The ability of government institutions to handle infrastructure PPPs is a challenge for most countries in Southeast Asia. Because many PPP projects are large, they often require complex financial structures and involve several stakeholders, including central government and local authorities. Against this demanding backdrop, governments must nurture their infrastructure ecosystems to create complete PPP markets. The tendency in Southeast Asia is for governments to create new agencies to tackle unperformed PPP tasks instead of pushing the responsible agency to perform better. As a rule, large government units handling PPPs result in more complex PPP mechanisms.

Southeast Asian countries should consider using the learning-by-doing approach-a country picks a priority project and makes it a showcase one-for their infrastructure PPPs. Here, cross-border projects are a good opportunity to share knowledge, gain economies of scale, and impose the same standards for all stakeholders. By doing this, governments will see the areas that need improving and the regulations that are missing or are insufficient. They will also be able to identify the skills that agencies will need to carry out PPPs, with these agencies gaining valuable experience by working on projects with the private sector. Despite these benefits, cross-border PPP projects are more complicated because of the involvement of numerous stakeholders with different interests, capacities, and legal systems. Multilateral development banks can help address these inconsistencies, as they did in the Nam Theun 2 hydropower project in the Lao PDR, which produces power for export to Thailand. In this project, the Asian Development Bank and the World Bank provided political risk insurance that lowered project risks, increasing the confidence of financiers.