PFI Indonesian Project Bonds Roundtable: Introduction 2018

Rod Morrison, EDITOR, PFI: Welcome to Project Finance International’s Project Bonds Roundtable, sponsored by Allen & Overy, CGIF, Moody’s and SMBC. The timing of this event could not be more perfect, given last week’s pricing of Star Energy’s 15 year US$580m Wayang Windu international bond. The sub-investment grade deal followed on from the investment grade US$2bn Paiton international bond financing, which was completed last August.

Meanwhile the local rupiah markets are starting to gain traction, with deals such as the Jasa Marga toll road and ABS. And we have seen the emergence of the new Komodo bond asset class, paper denominated in rupiah and payable in US dollars. This is set against the backdrop of demand for infrastructure, combined with the need to fund it with private capital. That is the essence of good project finance.

We’re delighted to welcome our keynote speaker, Adelina Halim, director of Tusk Advisory, which last week released a detailed report, ‘The Impact of Indonesia’s Infrastructure Delivery.’ The findings from that report will set up the context for our panel discussions.

Clearly there’s an infrastructure gap in Indonesia. The Government is doing its best to bridge the gap. Finance is just one – albeit important – part of the problem. Raising long-term debt is an important part of financing and infrastructure project, because projects involve high up-front capital expenditure, which can only be sensibly repaid over a long period of time. But the project finance market, which provides this long-term debt, is going through some important structural changes right now. The commercial bank loan option, combined with export credit agency support, is still a favoured option in Asia. But the growth of project bonds and debt capital markets increasingly offers a viable alternative around the world.

Investors seek steady long-term yields, and project finance is one asset class that can deliver them. By exploring debt capital market funding solutions, Indonesia is following a path already trodden by the likes of Malaysia and Thailand, though it is also developing its own characteristics. In Indonesia, state-owned enterprises are starting to raise debt to fund their schemes away from the government’s balance sheet via project bonds. Indonesia has also adopted the Malaysia bond concept from India, via the new Komodo bond concept, as a way to attract international investors to rupiah bonds.

Two recent dollar bond issues showed international investors can be attracted to Indonesia via the dollar route. This is an important source of new capital. There is more than US$90trn in institutional money in the global markets, sitting in pension funds, insurance companies, investment funds and others. It is still early days for Indonesian project bonds, but the potential, backed by a decent project pipeline and a large pool of funds, is vast.

We’ll split this discussion into two: first rupiah bonds, and then dollar bonds. There is likely to be plenty of overlap as we look at the prospects and challenges facing the two asset classes. But first it’s my pleasure to introduce Adelina Halim, director of Tusk Advisory.

Adelina Halim, TUSK Advisory: Thank you. It is an honour to be given the opportunity to present the results of an independent study by Tusk Advisory at this Indonesia Project Bond Roundtable.

Our study looked into the economic impact of Indonesia’s infrastructure delivery, particularly of National Strategic Projects and Priority Projects of the Joko Widodo administration. But first it is worth considering infrastructure conditions before 2015.

Back in 2014 Tusk Advisory supported Badan Perencanaan Pembangunan Nasional (BAPPENAS), the Ministry of Planning, in the development of the national mid-term development plan, or RPJMN, from 2015 to 2019, spanning all infrastructure sectors. At that time we found Indonesia was behind its peers in almost every infrastructure-related industry.

We had poor quality roads and high congestion, making travel time one of the worst in the region at 2.6 hours per 100 kilometres. With 70% of logistic costs dependent on road transportation, this gave Indonesia one of the highest logistic costs in the region, making it non-competitive.

There was also a lack of quality public transportation. Last year in Jakarta alone congestion costs ran to US$5bn-$10bn. That implies a cost to the economy of around 0.5% or 1% of GDP per year, depending on which study you use.

We also looked at the ratio of double tracking, which indicates the efficiency of passenger and freight services by rail, where Indonesia also lags its peers. Even in cities with very good quality public transportation, such as Singapore and Tokyo, the ratio of roads to rail was two to three times higher than in Jakarta. Jakarta only had 6% of the land area allocated for roads.

Despite being a maritime country, Indonesia’s seaports were also inefficient. Dwelling times in its seaports were higher than in many of those in other countries, and though in some cases they have come down, they remain relatively high.

Airports were also overcrowded, with the growth of air traffic outpacing new airport development and expansion of existing airports. Soekarno–Hatta International Airport was designed for 50m passengers, but handles over 55m per year. But this airport was ranked number one in Asia Pacific for connectivity – the number of connecting flights, you can use within the airport – and though it is no longer first, it remains one of the highest in the region. The airport also shows the potential of alternative financing methods such as asset recycling, which can be used to fund expansion and the building of its third runway.

The 2014 study revealed an infrastructure crisis that needed to be remedied as soon as possible. Acknowledging this, President Joko made infrastructure a priority for his administration, launching various initiatives such as the National Strategic Project List, which gave hundreds of major projects additional funding and human resources. He also granted special treatment in permitting, speeding up processes to ensure the airport can reach its growth targets in 2019.

In 2017, the National Strategic Projects consisted of 245 projects and two programmes worth over US$342bn. They span all infrastructure sectors and all regions in the nation.

By the end of 2017, 61% of the National Strategic Projects were completed or under construction, with 47% of the projects under the electricity programme completed or under construction. Of the US$342bn investment needed, we estimate that the public sector, which includes the state budget, regional budget and state-owned enterprises, can only account for 41% of the cost, leaving 59% of the costs needing to come from the private sector. This is a challenge.

By the end of 2017 we had US$103bn of projects that have been completed or were under construction. This included 146 projects worth US$81bn under the National Strategic Project List, and 140 projects worth over US$22bn under the National Electricity Programme. This is an unprecedented amount in Indonesia and we wanted to assess the impact these projects will have on the economy of Indonesia.

First we looked at the positive impact infrastructure can have on the economy. This comes directly from the construction itself, and indirectly, via employment in industries that supply goods and services for the construction, and the multiplier effects stemming from spending by these workers into other industries. There are also long-term effects, including land value appreciation, reduced impediments to businesses, better connectivity, lower costs of production, innovation and so on.

These effects need to be quantified because they contribute to the growth of the country, the Gini index and the poverty level. We looked at data from the World Development Indicators database for 32 developing and emerging countries between 1990 and 2016, performing regressions to analyse which variables explained variations of GDP growth rate among these countries in the given time period. These variables included fixed capital investment, foreign direct investment, manufacturing value added and costs of government.

We found that if the current US$100bn projects under construction can be completed on time Indonesia can achieve 7.2% growth by 2023, or around 1.7% above the growth estimated by OECD. If the government can deliver 50% of the remaining balance, or an additional US$120bn worth of projects on time, we estimate Indonesia can achieve 9.3% growth in 2030. And if Indonesia can complete 50% of the remaining balance we expect it will knock down 2 points from the Gini Index, while poverty rates will also decline by 2% to just below 8%, using the national poverty line. If we use the international poverty line, which is three times higher than the national poverty line, we expect Indonesia to achieve a 10% reduction, to around 22%.

To sanity check the result we also looked into the historical relationship between gross fixed capital formation and the GDP growth rate. Before the Asian financial crisis Indonesia had a 35% gross fixed capital formation ratio and a growth rate over 7%. After the crisis the gross fixed capital formation declined to 28%, while growth also fell. Countries such as India, China and Malaysia show a similar relationship between gross fixed capital formation and growth.

India is a particularly interesting example. Before the Asian financial crisis it had a 26% gross fixed capital formation ratio and 5.5% growth, but it actually increased its infrastructure spending after the crisis, achieving a 36% gross fixed capital formation and 7% growth.

Of course, there are caveats for that 7% growth. In particular, its National Strategic Projects will have to be funded and completed on time. Some of you may have attended the launch of this economic paper last week, where we held a discussion on how to make this happen. Once the projects are completed they also need to be utilised effectively to support productive activities.

In Indonesia too, it is important projects receive the necessary funding, and that the right policies and human capital is developed to ensure projects are used productively. But today we will focus on how to ensure projects are properly financed.

There have been encouraging developments, particularly in fixed income sectors, which have seen breakthroughs in the past year. These include the first issuance of future revenue based securities by Jasa Marga, the first Komodo bonds by Jasa Marga, and the first perpetual bond by Pembangunan Perumahan. These are a good start. But none of these pioneering bonds have a maturity of over five years, meaning there is still a gap between the long-term financing needed for infrastructure development, and the current short and medium-term appetite. To compare, in Malaysia these bonds come with maturities that can reach 15 to 25 years.

In summary, our findings show the government needs funding to complete its ambitious infrastructure programme. There have been breakthroughs but they need to be sustained and significantly improved. I hope the discussion today provides guidance on the way forward on these issues.