Infrastructure will drive growth in Asia-Pacific. Whether it's progressing with carbon-cutting goals or moving people and goods, the common connecting theme is that each nation will be investing heavily.

Strong economic growth in Asia-Pacific calls for more infrastructure. This is particularly true in India and Indonesia. China and Australia are accelerating their exit from fossil fuels, and this also requires heavy expenditure on renewable facilities.

But how will entities and governments pay for all this building? It's a pressing matter, given high interest rates for dollars. Participants are getting more experimental in project financing, and in adopting new forms of funding such as private credit.

Investors commonly ask us about the direction of Asia-Pacific's infrastructure building, given this mix of issues. We address their frequently asked questions, drawing comments from an event we hosted on April 18, 2024, titled, "Asia-Pacific Infrastructure Virtual Conference 2024: The Energy To Propel Forward."

Frequently Asked Questions

How does growth figure into the development of Asia-Pacific infrastructure?

Vishrut Rana (S&P Global Ratings):  Infrastructure plays a critical role in the development of economies. It's an expense in the national account so capital expenditure is directly good for growth. Indirectly, but more significantly, such spending provides a foundation for growth. When you have the right infrastructure, a country's productivity expands--there is easier provision of goods, greater access, and more manufacturing materials. Infrastructure is the critical element.

A lot of governments in Asia-Pacific would like to expand infrastructure. There are constraints. Post-pandemic, many governments have experienced an erosion of fiscal capacity (see chart 1).

Chart 1

There are many private-public partnerships that have a big role to ensure projects succeed. However, fiscal capacity varies by region. Many governments used deficits to get through the pandemic. Many economies are still in a consolidating phase after that period, and policymakers want to restore financials.

Of course, infrastructure remains on the agenda of governments across the region, but they will take a beat as the fiscal space is rebuilt.

Chart 2

Where are the next investments going in Asia-Pacific?

Diwakar Vijayvergia (AllianceBernstein):  Southeast Asia and India will be the powerhouses for growth. The economies of both regions will expand sharply in the next decade and infrastructure will be a big part of that growth. India's infrastructure spending will rise 11% this year, and it will increase in most countries.

The Indonesian government formed a plan in 2016 to invest in infrastructure, and that continues. The commodities boom has given the country fiscal space to invest. Indonesian President Joko Widodo emphasized infrastructure-led growth and in 2022 there were 200 projects in play. The incoming president will likely continue with this approach.

There is some impetus to move to India as most investors are looking at "China plus one" [to diversify sales and supply chains away from China, to avoid an overreliance on the country].

India is also capturing a demographic dividend. The country is young. The World Bank forecasts that India's real GDP will grow 6%-7% annually for the next five years. That will require infrastructure.

How is private credit being deployed in regional infrastructure projects?

Sabita Prakash (ADM Capital):  We look at smaller deals, typically financing small and midsize enterprises (SMEs) that can't access traditional funding. They contribute about close to half of GDP growth but they have a hard time finding funding.

The other thing we offer is flexibility. Tenor, size, currency, structure, collateral, use of funds are all up for discussion based on borrowers' needs and cash flows. We can look at lending at different levels in the structure, from senior, second lien to mezzanine and for different needs such as promoter funding, mergers and acquisitions, or bridge finance.

Some examples of our financing include midsize companies in the supply chain that involve infrastructure, sustainability, and technology. For instance, we have invested in a firm in India that is getting into smart metering. This improves efficiency and reduces the carbon footprint.

Another example is the financing we provided for an SME to expand its operations in digital freight forwarding in the regional logistics space. We are reviewing numerous deals in electric mobility and charging infrastructure.

The Asian Infrastructure Investment Bank (AIIB) has actually defined infrastructure to include a social component. So areas such as education, health care, elderly care, affordable housing and financial inclusion are going to become increasingly relevant within infrastructure.

John Dowel (FTI Consulting Australia):  In developed markets such as Australia, private credit funds have a key role in infrastructure development funding. They compete well with private-equity investors, having similar cost-of-capital profiles.

In many cases it's probably still a better option than private equity from a cost-of-capital standpoint. Its flexibility and ability to have longer-tenor structures is attractive in the case of infrastructure projects.

There is an increasing trend for senior debt providers to welcome private-credit players, working in partnership with them due to manage cash-reserve restrictions. The arrangement can also reduce their risk.

Most of the large projects are tied to public funding in accordance with government policies and strategic objectives. Governments have made considerable commitments to energy transition and net-zero targets, and infrastructure projects that support these goals have substantial fiscal backing to make them financially viable.

Yuehao Wu (S&P Global Ratings):  We can consider nonstandard debt in China as private credit, including trust loans, entrusted loans, lease financing, among others. The name of the game is also lending with flexibility, especially on the use of funds, which means you can use it to pay interest in certain cases.

Some of this nonstandard debt has already gone into default. The government stance is to limit high-cost debt, and growth in such capital is slowing. Despite that, there are measures in place to make the investments more viable and more attractive to private capital.

Chart 3

How did the pandemic affect project finance?

Pablo Lutereau (S&P Global Ratings):  COVID was a shock. The portfolio performed well but there is a caveat. What we rate is the tip of iceberg, because what goes into the global capital market is really the better-quality credit.

But let me give you some numbers: I looked at ratings from December 2019 to December 2023, dividing the portfolio into investment grade and speculative grade. At the end of 2023, 72% of the portfolio was investment grade. The number for December 2019 was 71%. So 72% versus 71%--that's nothing.

However, if you look within investment grade, there was some transition moving from 'A' or high 'BBB' levels into lower 'BBB' territory. The overall conclusion stands, but if you look within categories, you can still differentiate.

If I go to outlooks, at end-December 2023, 79% of ratings in the portfolio had a stable outlook. In December 2019, that number was 80%. So 79% against 80%--again, really no difference.

But if you look at December 2020, during full COVID, the number of stable outlooks went down to 65%, and the number of negative outlooks was maybe double the number that you had in 2019 or even 2023.

The main conclusion is that the portfolio performed well, keeping in mind that it represents the best credit quality you could find within the space.

What are the challenges of project finance?

Mary Anne Low (S&P Global Ratings):  Jurisdiction, currency risk, and structure. Protections to lenders are just as important as the security package.

Security may be available but if the government and judiciary don't enforce these pledges, it's not effective. For example, in some jurisdictions various physical assets may not be pledged if they are under government concession. We need to unravel all of that.

With regards to currency risk, Indian projects receive cash flow in rupees but borrow in dollars. They may then hedge, but are they using swaps or options? In India the swaps are shorter than the life of the projects. Perhaps three years, versus a project life of 20 years.

Indian participants typically use options. These may be cheaper but it adds risk. The strategy depends on management's view on rupee depreciation.

We are also seeing different nontraditional structures. So many corporate entities in India, and across Asia-Pacific, have floated different restricted groups with varying degrees of flexibility. We focus on the key credit risk rather than the nomenclature. That means we don't rate a transaction only considering the fact that sponsors call it a restricted group.

How do you assess risk for renewable power, while considering factors such as grid constraints?

Hugo Batten (Aurora):  We spend more time with market modeling, and we scrutinize grid issues. Everything is late and overbudget. People have been burnt in Australia by grid risk.

In the Philippines, it's very early to renewable power, so we have a lack of data. It's hard to quantify the risk. What happens when the grid does not keep pace with the renewables expansion? It's hard to get it right and easy to get it wrong.

In Japan, the population is declining but you still need to build a ton of renewables. The consistent themes are grids, land, and social license. Japan has liberalized its renewables market but governments want guardrails. They don't completely trust markets to deliver decarbonization.

Brad Hopkins (AEMO Services):  Australia has a coal-based system, where transmission runs to the mouth of coalmines. Those sites are not the same as renewable sources. So we are having to build new transmission. That is expensive. Affected landowners have a lot of rights, and there is a lot of community objection to power lines. It can take a decade to get built. Australia is large and sparsely populated so it needs a lot of transmission. That is on everyone's minds.

What new asset classes in project finance are getting your attention?

Shiv Sivarajah (MUFG Bank):  We are excited about batteries and storage technology in general--hydrogen and ammonia. There are whole new value chains that need to be created for large-scale green hydrogen and ammonia-based systems.

Data centers can be project-finance friendly as they are critical infrastructure that can secure long-term contracts with creditworthy counterparties.

Life's never straightforward, though. For instance, we're conscious that while a data center operator may be critical to its hyper-scaler client, the operator may also be beholden to that buyer.

How is Asia-Pacific performing in its energy transition?

Kaori Tachibana (S&P Global Commodity Insights):  Asia-Pacific contributes half of global carbon, and China contributes most of those emissions. Most markets in the region are starting from a base of coal-fired plants. Renewables are still a small part of the energy mix.

India and Indonesia have strong economic growth. They need to balance sustainability with that growth. In India, we assume GDP expansion of 6.8% in 2024. Moving from coal is challenging. Solar power is taking off in India but wind is coming in less quickly.

There are long lead times to developing projects. Participants need to structure in the risk of payment delays. All such factors can affect the integrity of the market in India.

Chart 4

We project Idonesia's economy will grow 4% annually, compounded, through to 2050. So that will require a lot of energy. Meanwhile, thermal power backs most of the country's electricity output. There will be a slow shift from coal to gas with coal capacity peaking in the 2040s.

Renewable development has been slow in Indonesia. It's comprised of a string of islands, which makes transmission difficult and expensive. This points to a need for storage, which ramps up costs. It will also ramp up investment. Indonesia aims to have renewable capacity of 21 gigawatts (GW) by 2030. The target is ambitious but we expect the market to at least move in the direction of this goal.

Apple Li (S&P Global Ratings):  China added 300GW of renewable capacity in 2023, half of new renewables capacity in the world. Total renewable additions including hydro accounted for 51% of China's new power capacity last year.

We expect the country to add 200GW of renewable capacity each year over the next two to three years. The country is deregulating the power sector a little each year, and it is moving to market-based trading for all renewables by 2030.

Coal-power generators will receive capacity tariffs to compensate for the loss of utilization hours and ancillary services provided to renewables. We project continued government support for renewables. While China is adding coal-backed capacity, the extra power will be used to stabilize supply from renewable producers.

What is the state of batteries and hydrogen in Australia?

Brad Hopkins (AEMO Services):  Australia is a smaller market but it will transition quickly. We will go from coal generating 70%-80% of the country's electricity to none in 2035. It's a fascinating market just for the pace of this transition.

At this point in the shift, the country is making technology choices about dispatchable capacity. Different technology suits different durations.

Batteries are generally the answer for storage up to eight hours. Beyond this we are technology agnostic. We tried batteries of all types of chemical composition, versus pumped hydro and gas. Lithium batteries work best for eight hours in our tests. Pumped hydro may yet prove competitive.

However, we need to address longer duration storage. We are very worried about how a renewables-backed operation runs when you get long droughts, cloud cover for extended periods, or limited winds. Our system reliability is just diving into these scenarios.

Emerging hydrogen projects could solve this problem, but they are still expensive relative to gas and pumped hydro. Technology advances could reduce cost and make hydrogen competitive.

Parvathy Iyer (S&P Global Ratings):  Australia is going through a generational change in transmission. About 45% of the investment required for the transition will be needed by 2030. The timing of some of the projects may need to be adjusted.

Planners will need to ask whether the renewable capacity should come first, or if they need to wait for the grid. The other issue is funding, which we expect will flow to regulated markets. There is good support for this segment from institutions offshore and onshore.

Writer: Jasper Moiseiwitsch

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