Japanese infrastructure looks to private finance
October 2008 - Sometimes local events that seemingly are of little relevance to anyone outside the vicinity can resonate unexpectedly half a world away. The recent announcement of the privatization of the Pennsylvania Turnpike in the USA gave me that feeling as I read the news behind my Tokyo desk. After heavy competition from several bidders, the US state of Pennsylvania accepted a USD 12.8bln bid by a consortium for a 75 year lease for the 800km road, setting a record for a US infrastructure asset of three times the amount of the previous all-time high. The deal, although the state legislature could still overturn it, would mark an important next step in the coming of age of privately financed infrastructure projects in the United States. With municipal bonds traditionally providing the natural source of financing, but also due to the ambiguity around decision making authority between federal, state, municipal and even local government authorities, the US has lagged not only the early birds in this area Australia, the UK and Canada, but also regions such as Europe and South Korea towards the development of a privately financed infrastructure sector. In the latter regions, the privatization of formerly publicly financed infrastructure assets (roads, sea- and airports, bridges, tunnels, oil- or gas-pipelines, water-sewage, electricity generating assets and social infrastructure such as schools or hospitals) has taken off in recent years not least due to restraints on government budgets to invest the huge amounts of capital necessary to provide for what are mostly indispensable utilities/services. Emerging markets such as India and China are now taking on the baton, although volumes may be lower in the near term than some investors appear to expect and these markets present unique risk issues for investors.
Given the level of government debt, leaving Japan with a Moody’s credit rating at par with Botswana, one would expect the Japanese authorities to be keenly following developments in the area of public-private partnership or outright privatizations, but so far actual cases of private funding of infrastructure projects have been few and far between in the land of the rising sun. Hopes were raised in 2004 when Macquarie and the Japanese Development Bank jointly bought the exploitation rights of the Hakone Turnpike, a road used by tourists with some stunning views on Mount Fuji. This was followed in 2005 by a similar transaction for Ibukiyama Driveway, also a tourist-targeting road priding itself in the floral richness through which it runs. Larger infrastructure projects in the mainstream however remain largely funded by conventional public finance methods. Local governments meanwhile are mired in debt (Osaka for example where the new governor Toru Hashimoto is propagating the use of private funds to alleviate the nearly USD 50bln of pr efectural debt), but do not seem to get projects off the ground. On the demand-side of the equation however, investors with long term liabilities such as life insurers and pension funds have started to appreciate the attractive characteristics of infrastructure, as a provider of stable and predictable cash-flow based on long term contracts. Stability and predictability being anchored in the low degree of business risk as most projects derive fixed tariffs to provide capacity, be it a pipeline, a waste-yard, a school or a port, in a highly regulated, sometimes monopolized, industry. With inflation making a come-back on the minds of investors, the practice of linking tariffs to a price-index adds to the attractiveness of the asset-class. After a dismal investment year (average returns for fiscal 2007 for corporate pension funds and sector funds were -9% and -13% respectively), the need to move to investments that are less related to financial market volatility remains high.
This leaves Japan in the situation where the need for private capital to fund infrastructure projects and alleviate the burden on local and national governments is unusually high, whilst a vast pool of capital accumulated to provide for retirement of the fast-aging population is looking for the returns that can be had from infrastructure. So far however the lack of an efficient platform to divert this capital into large scale domestic projects means Japanese investors are, like in other asset classes, again forced to look outside their home-country to access the opportunity.
On behalf of Japanese institutional investors, let’s hope the Pennsylvania Turnpike announcement from the country that, more than any other country, draws the attention of Japan’s policymakers will resonate in the right circles in Tokyo.