South East Asia Infrastructure: Why The Euphoria?


BMI View: G rowing interest towards investment opportunities in emerging South East Asia infrastructure markets has reached a crescendo in 2013 . We believe this is justified given that there are a number of positive tailwinds prevalent in the region's macro fundamentals. That said, there remain key country-specific issues that must be addressed in order for infrastructure activity in South East Asia to yield the anticipated returns .

Despite strong interest in South East Asia infrastructure in recent years, BMI has noticed a heightened level of excitement amongst financial and corporate investors towards opportunities across the region in 2013. While the opening up of the region's final frontier market, Myanmar dominated headlines in 2012 ( see our special report from last year entitled 'Myanmar: Unearthing Asia's Hidden Gem'), the region as a whole is offering opportunities not seen for many years. In this analysis, we outline our core views on the traditional emerging market (EM) economies in the region - namely Indonesia, Malaysia, the Philippines, Thailand and Vietnam - and the key concern surrounding the outlook for their respective infrastructure markets.

ASEAN Rising
Global - Real GDP Growth, % chg y-o-y

Naturally, the risk-to-reward analyses of any market is relative to conditions in the broader market and so it stands to reason that investor enthusiasm towards South East Asia is (to some degree) a function of weak growth prospects elsewhere globally. Notwithstanding a few bright spots (such as US energy or housing), attractive infrastructure opportunities across developed markets are few and far between, mainly concentrated either in smaller social infrastructure projects, or the secondary market, which has gained momentum on the back of large scale privatisation programmes.

On the EM front, China's long-term investment story will take a hit from rebalancing efforts, while India's growth picture is constrained by land acquisition, project execution, and inflationary concerns. The relative outperformance of the South East Asia region is factored into our long-term macro projections. We expect the broader Association of South East Asian Nations (ASEAN-10) region to register average real expansion of 5.3% over the coming decade (on a GDP-weighted basis). This would put the region well above the global mean of (3.4%), but also our EM average of 5.0%.

Why Now?

Still, it would be wrong to suggest that interest in South East Asia is solely down to a weaker external backdrop. We see a number of positive tailwinds that, if harnessed, could drive the region's macroeconomic performance and, by extension, investment opportunities in the coming years.

Greater Political Stability: The overall political landscape across South East Asia's emerging economies has improved markedly in recent years. Indonesia's growth story has flourished in line with greater political stability and an improving business environment ( see ' Assessing The Key Risks To The Growth Boom', March 13 2012 ), and the Philippines is headed in a similar direction under the stewardship of President Benigno Aquino. Moving over to Thailand, the administration of Prime Minister Yingluck Shinawatra has managed to shrug off initial concerns about populist uprisings, and the threat of a military coup has diminished. There is an element of near-term uncertainty in Malaysia due to upcoming national elections, but our impression is that this will have little impact on longer-term policy direction. Finally, the more frontier markets of Vietnam (and Myanmar, for that matter) are seeing economic and political reform going in the right direction.

Young & Competitive
Global - Demographic & Infrastructure Data

Favourable Demographics: South East Asia's demographic outlook will underpin the long-term growth story. Not only do we expect strong overall population growth, but working age population ratios are set to increase significantly, particularly in Indonesia and the Philippines. This trend is in stark contrast to much of the region. Japan's working age population is already shrinking rapidly as a share of the total population, with South Korea and China set to stumble from 2014 onwards. From an investment perspective, this latter point is particularly pertinent. Back in October 2012 ( see 'China After The Hard Landing: Global Winners and Losers' ), we looked at which emerging market economies with population sizes above 100mn could stand to benefit from the rise in labour costs in China. As the accompanying chart clearly illustrates, based on a combination of infrastructural capacity and labour costs, South East Asia appears best positioned to profit from the end of 'cheap China'.

Prudent Policymakers
Asia - Real Lending Rates, %

Monetary Credibility: Previous growth cycles across South East Asia have typically been associated with violent bouts of inflation. In more recent times, however, we have seen an increased level of monetary credibility which has provided the backdrop for an improved track record on consumer price containment. As the accompanying chart shows, real leading rates (adjusted by CPI) have remained firmly in positive territory across South East Asia. This compares favourably to India and China, for example, where inflationary swings have been much more of an issue in recent years. The impressive scorecard of regional policymakers on inflation-fighting has allowed base rates across several countries (such as Indonesia and the Philippines) to fall to all-time lows.

Re-pricing Risk
ASEAN 5-Year CDS Spread Average

Sovereign Balance Sheet Improvements: South East Asia has continued to see structural improvements in terms of external sovereign creditworthiness over the past decade, withstanding the tumultuous events of global recession in 2008-09. As a share of nominal GDP, public external debt for our five focus countries has halved from an average of 35.4% in 2000 to an estimated 15.7% in 2012. It should however be noted that much of the debt issuance from regional governments has been in the form of local currency paper, which has helped to reduce external vulnerabilities. As a result, sovereign credit spreads have come down dramatically to pre-2008 levels (see chart) and access to overseas financing has vastly improved. Indonesia was promoted to investment grade status (in line with Thailand and Malaysia) in 2012, and the Philippines will su rely follow this year as well.

ASEAN Connectivity: While the ASEAN community dates back to the 1960s, plans to implement the ASEAN Economic Community (AEC) by 2015 continue to be a major driver of investment activity in the region. The AEC will aim to create a more liberalised regional economy with a single market and production base. Such lofty ambitions may be difficult to achieve, but from a growth perspective we have already seen capital allocated into a number of transport projects that will help to improve intra-regional connectivity. Such growth momentum is likely to be sustained as trade barriers are removed and infrastructure linkages are built out.

Greater Government Resolve

A favourable macroeconomic backdrop is a necessary but not sufficient condition for strong infrastructure growth. A cohesive policy framework and increased access to project financing are also required and we have seen significant progress recently on this front .

Firstly , respective governments have vigorously sought to spur infrastructure development through a variety of public spending and privately-procured public-private partnership (PPP) programmes .

Secondly , these governments have looked to carry out reforms in the areas of project execution and regulatory bottlenecks such as land acquisition in a bid to galvanise private sector interest .

Lastly, they have remained committed to accelerating and enhancing the flow of project financi ng for infrastructure by re viewing bank lending laws and introducing greater diversity in funding sources such as Islamic bonds and infrastructure funds .

That said, there remain some key country-specific issues that must be addressed in order for regional infrastructure activity to realise its potential. We provide our insight into some of these concerns below.

Market-Specific Risks

Indonesia - Political Stability A Given?

As highlighted above, Indonesia's growth story has flourished in line with greater political stability and an improving business environment. This has benefited the country's infrastructure sector as not only has there been greater infrastructure spending from the private sector in recent years, but there has also been progress in facilitating greater ease in project execution. For instance, we highlight efforts such as the launch of a new land acquisition bill, a comprehensive master plan for infrastructure development and the formation of various government institutions to support infrastructure activity - namely the Sarana Multi Infrastruktur, the Indonesia Infrastructure Finance, and the Penjaminan Infrastruktur Indonesia.

Negative Trajectory
Asia - BMI's Short-Term Political Risks Ratings*, Out of 100

However, we caution that political stability and appetite for reform in Indonesia should not be taken for granted. President Susilo Bambang Yudhoyono is constitutionally prohibited from standing for the presidential elections in 2014 and the prospects of his Democratic Party for the upcoming elections are shrinking due to successive corruption scandals. This creates the potential for a more populist regime to rise in prominence as the Democratic Party and other presidential candidates could seek to secure popular support by increasing subsidies, watering down pro-business reforms and enacting nationalistic polices. The dominance of personalities over parties in Indonesian politics makes this a key challenge for infrastructure investors (who are typically looking at long-term returns),

Malaysia - Elections The Biggest Test For ETP?

Malaysia's 10-year economic plan, the 2011-2020 Economic Transformation Programme ( ETP ) , has had a successful start, with construction and infrastructure activity in 2012 hitting heights not seen in over a decade. This has much to do with the private sector's increasing level of confidence with regards to the government's ability to carry out the ETP, with heavy private sector participation seen through foreign direct investment and uptake of government debt issuance.

Record High
Malaysia - Construction Industry Value Data

However, we believe that the upcoming general elections - to be held no later than June 27 2013 - could be the biggest risk so far to investor confidence in the ETP . The ruling Barisan Nasional (BN) coalition is set to face one of the closest general elections in recent times, which could put an end to the party's uninterrupted rule since independence in 1957. Although we believe that the BN will win by a marginal vote, there is an increasing risk of a swing vote in favour of the opposition. With this in mind, the BN government has become increasingly populist in its policy-making, unveiling a generous 2013 budget for its citizens, providing greater support for affordable housing, as well as deferring toll road hikes and a nationwide goods and services tax. These lax fiscal practices could require a cutback in other expenditure plans such as infrastructure investment due to growing subsidies and higher borrowing costs.

The Philippines - PPP To Live Up To The Hype?

The Philippines' PPP programme has been identified by the Aquino administration as one of its key strategies to achieve inclusive growth. However, progress on the programme has been lethargic since its announcement in November 2010, with only two projects awarded at the time of writing. Several factors have been suggested for the slow pace in the PPP rollout - namely, the government's rigorous push to ensure transparency and prevent corruption in the PPP programme, delays in the right of way and resettlement issues, difficulties with reaching financial closure, and a lack of regulatory clarity and institutional capacity for preparatory work.

Far From Done
The Philippines - Projects Under PPP Programme

Among them, we believe that a lack of regulatory clarity and institutional capacity for preparatory work are the most pertinent issues as they could take years to be resolved, potentially derailing the country's PPP programme . Despite the political stability offered by the Aquino administration, the lack of maturity in the Philippines' regulatory environment means that policy continuity continues to be an issue in the country with two recent instances - the revision of guidelines for the bidding of airport projects and the tightened of rules and investment requirements for foreign companies - highlighting the issue. Meanwhile, the lack of institutional capacity has lead to a slow pace in carrying out feasibility studies, documentation and evaluation for solicited and unsolicited projects as well as resolving contract disputes such as the Ninoy Aquino International Airport Terminal 3 dispute, which has been ongoing since 2004.

Thailand - Financing To Be Forthcoming?

Since Yingluck Shinawatra's victory in the 2011 prime ministerial elections, we have seen the policies made by her administration take on a greater populist tone than those of her predecessor. This change has altered the country's plans for infrastructure development, where a deeper emphasis is now being placed on improving Thailand's inter- and intra-city transport system, and not just the country's transport links with the global economy. This change is evident in the government's plan to develop around THB2.0trn (US$67bn) worth of infrastructure projects from 2013 to 2020. Besides plans to increase regional connectivity through roads, ports and high-speed rails, there are plans to build new ring roads around Bangkok, new metro railway lines in Bangkok and new high-speed railway lines to far-flung provinces.

Rail Dominates
Thailand - Infrastructure Investment Plan 2013-2020, THBbn

However, it remains to be seen whether the Thai government is able to secure financing for its ambitious infrastructure plans . The authorities would need to juggle their massive capital expenditure plan with costly flagship spending programmes, such as the rice price policy. Additionally, the latest attempts to increase private sector financing and participation in infrastructure development are unproven. Thailand is set to launch the first of many infrastructure funds and the first fund - the THB62.5bn BTS Rail Mass Transit Growth Infrastructure Fund - will already be the country's largest-ever initial public offering. The Thai government is also expected to introduce an amendment to the country's PPP law soon to increase clarity and execution for PPP projects.

Vietnam - Time To Revisit Asia's Forgotten Story?

In the last two years, Vietnam's infrastructure sector has largely been off the radar among foreign investors. This is despite numerous project opportunities. Latest estimates from the Vietnam Ministry of Planning indicate that Vietnam needs around US$160bn between 2013 and 2020 for infrastructure development. The lack of a comprehensive PPP framework, decade-low economic activity and slowdown in project financing from European banks due to the European sovereign-debt crisis have exposed deep fault-lines in the country's business environment for infrastructure. These frailties include excessive investment in certain infrastructure segments (i.e. roads, cement), slow land clearances, poor planning, high levels of corruption and a weak regulatory environment.

Turning Things Around
Vietnam - Net Foreign Direct Investment Inflows, US$bn (LHS); Real GDP Growth, % chg y-o-y (RHS)

Although these business environment issues are far from resolved, we believe that improving economic conditions and a willingness by the Vietnamese government to resolve some of the underlying drivers for these frailties are improving the investment climate for infrastructure . The country's economy is currently at the early stages of an upswing as the government has moved from an administration concerned with combating inflation to one concerned with generating economic growth. Meanwhile, the government is currently carrying out reforms regarding easy credit from domestic banks (a leading factor for excessive allocation of resources in certain sectors) and high electricity subsidies (a leading factor for insufficient public fixed investment).

Beware Bubble-Like Behaviour

On a final note, it is worth keeping in mind that the last time we saw such investor euphoria towards South East Asia was in the early 1990s. While sovereign and corporate balance sheet health is a much improved picture nowadays, the individual investment stories outlined above are not without risk. To be sure, we have already seen a massive influx of portfolio investment into the region, which has lifted asset prices at a much faster pace than earnings. As a result, valuations are already looking rather steep to us.

Multi-Year High
Stock Exchange of Thailand Property Index (SETPROP) - Price-To-Book Ratio

For example, t he Stock Exchange of Thailand Property Index (SETPROP) is currently trading at 3.5x book value, marking the highest level in close to 17 years. With foreign investors and speculators already heavily exposed to the region, our concern is that a sudden shift in global risk sentiment could ignite pronounced equity market losses, a re-pricing of credit risk and currency weakness, which could see some of the current excitement towards the region start to fade.

This article is tagged to:
Sector: Country Risk, Infrastructure
Geography: Asia, Asia, Indonesia, Malaysia, Philippines, Thailand, Vietnam, Asia, Asia, Asia, Asia

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