Building blocks of growth at risk from Asia's woes
Foreign financiers have expressed concern over the pace of infrastructure development, which is expected to slacken as part of the knock-on effect of the financial crisis sweeping the region.
They said Beijing's pledge to support regional stability by keeping the yuan at its present strong level could undermine competitiveness and hurt economic growth which, in turn, would slow infrastructure development.
The mainland also is expected to suffer from slower capital inflows from key sources, including Hong Kong, Japan, South Korea and Taiwan, and encounter wider spreads on debt issues.
Morgan Stanley Asia managing director Songyi Zhang expected the country's transport development to slow, along with its financing, as a result of regional fallout. But that would be offset by domestic spending to stimulate growth.
He said capital markets would come back in the near term.
'Although people are still cautious, interest is certainly there. Infrastructure provides the most attractive area of investment and has the strongest growth potential.
'Given the strong flow into mutual funds - and there have not been a lot of redemptions - and the falling treasury rate in the US, emerging market investors are still looking for investments in Asia.' Societe Generale Asia managing director Ashley Wilkins agreed.
'There has been growing interest in capital market financing,' he said. 'That will slow down in Asia because of the current economic turbulence. But China is one of the very few countries which may currently remain on the radar.' The Asian financial woes would lead banks to pay greater attention to - and find ways to minimise - currency risks, Mr Wilkins said.
In the mainland, foreign-exchange risk was now largely controlled through indexing repayment to US dollars, he said.
Despite Beijing's insistence it will not devalue the yuan, foreign investors such as New World Infrastructure and GZI Transport are gauging the possibility of raising yuan lending to fund their infrastructure projects to reduce foreign-exchange risks.
Bankers said that made sense, although it thwarted Beijing's main purpose of bringing in foreign investors to enlarge its pool of capital.
'I don't think it's going to be the major trend,' Mr Zhang said. 'The key reason [for China] to bring in foreign investors for power and infrastructure projects is for foreign financing.' He said Beijing's announcement that it would pour US$750 billion into infrastructure over three years to counter the negative effects of the Asian economic crisis should open up opportunities for foreign players.
'Given the fact that the domestic capital market will not be able to satisfy infrastructure funding needs, [Beijing is] really going to be looking for more foreign-currency financing,' Mr Zhang said.
Finding the money to feed its enormous infrastructure requirements, including the tapping of domestic capital markets, remains the most fundamental challenge.
In the mainland the equity financing portion of infrastructure projects is less than 25 per cent. The vast majority of capital for transport infrastructure projects originates with central and local governments. Other important sources include export credit agencies and multilateral agencies.
The mainland has yet to complete a true project finance deal. Those that have been attempted feature only a small portion of commercial-bank lending, with commercial institutions foregoing construction risks.
This dearth reflects foreign financiers' concerns over mainland regulatory issues, including tariff and fee adjustment; transparency, including the project approval process; credit risk; quality of project contractors; and other hidden risks.
Domestic debt, equity markets and international capital markets continue to play only a limited role. Issues of project bonds in the road sector, for example, amount to only $1.2 billion.
Bankers and multilateral agencies, such as the World Bank, have advocated a greater mobilisation of domestic savings, for project bonds in particular, to raise much-needed infrastructure development capital.
'Infrastructure is a necessity,' Mr Zhang said. 'You can't pay equity returns to build [it] because it is too expensive.
'Fees would be too costly for the average citizen to use.
'That's why the vast majority of infrastructure in the world has been traditionally financed with debt, with as much domestic debt and as little foreign debt as possible.' A mainland domestic-bond market for infrastructure financing will, nevertheless, take time to develop.
Constraints brought about by Beijing's credit plan, domination of treasury bonds over corporate issues, relatively low levels of liquidity and the absence of strong professional and institutional investors as potential buyers need to be overcome.
Capital financing of infrastructure through equity issues has, likewise, been only moderately successful.
Equity financing, at present, is more often seen in the purchase of existing operating assets, which are generally less expensive than developing greenfield projects. That is particularly true for toll-road projects.
Banks had been reluctant to provide project financing to toll roads because of higher risks on completion than power plants, Mr Wilkins said.
Unlike power projects, roads, ports, railways and airports are user-based without an off-take agreement to provide a guaranteed stream of revenue.
Mr Wilkins said toll roads were usually left for equity financing for which investors were more willing to take higher risks, hopefully for higher returns.
In Hong Kong, mainland-related toll-road stocks have recently come under pressure from a glut of supply and, in some cases, the failure to live up to traffic projections.
Investor interest in mainland infrastructure stocks could be rekindled should listings of Beijing and Shanghai airports materialise.
Growth prospects for airports and ports are brighter than toll roads, as they usually have earmarked space for future expansion, which toll roads by their nature lack.
While there are actual and planned listings of railways, market observers do not expect equities to serve as a key fund-raising channel for the sector.
They said strong policy pressures to maintain railway tariffs made stock market returns unattractive.
The transport sector remained a difficult area to finance, Mr Wilkins said.
However, he said projects could go forward so long as they held sufficient sponsor equity and a state-support package that mitigated the more difficult risks related to land acquisition, ridership volume and fare structure.
Despite equity financing's increasing popularity, Mr Wilkins said that bank and export financing would remain the key fund-raising channels for infrastructure, satisfying about 70 to 80 per cent of financing needs.
He said 80 per cent of the opportunities in project financing would remain in the power sector, with transport included in the remaining 20 per cent.