The Edge Market: MySay: Malaysia’s development financing institutions need rebooting

The Star

This article first appeared in Forum, The Edge Malaysia Weekly, on October 15, 2018 - October 21, 2018.

Policymakers often justify the high cost of infrastructure investments with the belief that they are supply led, that is, the demand for their usage will increase once the facilities are built. The question now lies in how to finance these infrastructure investments, knowing that it will be a while before the demand or usage ramps up.

Infrastructure investments play a key role in economic growth. A high-quality infrastructure investment has positive spillover effects that range from job creation and increased foreign direct investment to improved tax revenue. These impacts were not widely recognised in the past, but organisations like the Asian Development Bank (ADB) have done work to quantify the positive spillover effects delivered by quality infrastructure.

For example, in the case of the Tashguzar–Boysun–Kumkurgon railway line in Uzbekistan, ADB identified a 2% increase in the gross domestic product growth rate in the affected regions, 5% value add in industry and 7% value add in services as a result of the project. A similar ADB study of the STAR highway in the Philippines found that the project had “a significant impact not only on business taxes, but also on property taxes and regulatory fees”.

Another recent innovative study by ADB, UKAID, JICA and World Bank on “The Web of Transport Corridors in South Asia” appraised the wider economic benefits (WEB) of several transport corridor projects in South Asia, going beyond infrastructure hard costs and economic returns. Many of these projects will eventually link to cross-border projects promoted under China’s Belt and Road Initiative. The study considered the impact of these projects in five areas — economic welfare, social inclusion, equity, environmental quality and economic resilience.

WEB is an additional tool to help policymakers prioritise infrastructure projects and to avoid white elephant projects.

Financing infrastructure investments

Traditionally, public infrastructure has been financed through government budgets, either from tax revenue or from government borrowings. Some may be financed through special-purpose vehicles (SPVs) — for example, DanaInfra, which was set up to raise financing for several infrastructure projects. The debts of these SPVs are guaranteed by the government, and hence, can be considered ultimately as government debt.

Some public infrastructure projects may be privatised and the private investors would recover their cost of investment through collecting tolls or charges from the users. Examples of these include the toll roads, independent power producers and land-swap projects. In these cases, the government does not carry any liability for these projects unless it has given some form of revenue guarantees to these private investors. This financing model (using private-sector finance and project development expertise) is known as a public private partnership (PPP).

There is another variant of PPP, where private investors recover their cost of investment through payments from the government. This is generally known as a private finance initiative (PFI). International Public Sector Accounting Standards (IPSAS) now requires these government payment obligations to be reflected as government debt, hence, they cannot be considered as off-balance sheet in the government’s books. PFI payment obligations comprise a large proportion of the PPP debt of RM201.4 billion, which was announced by the government in May. Nonetheless, PFI can be a useful financing model for certain infrastructure projects, if it is structured well.

Financing through national development financing institutions

Many countries have set up national development financing institutions (DFIs) to provide financial services in sectors or regions that are underserved by commercial banks or financial institutions. DFIs are known by a variety of names — state investment banks, mission-oriented or challenge-led banks, promotional bank (as in Italy) and policy banks (as in China). They are usually owned by the government and their roles are mainly:

• Promoting innovation and structural transformation to support a dynamic economy;

• Supporting the financing of infrastructure investment that is crucial for economic growth;

• Counteracting the pro-cyclical behaviour of commercial banking and private financing;

• Enhancing social inclusion (usually marked to some sustainable development goals or SDGs); and

• Supporting green growth and environmental sustainability.

A good example of how national DFIs have helped in developing the lending market in an underserved sector in Malaysia is in PFI projects. In the early stages of these projects, commercial banks were more reluctant to provide debt project financing for PFI projects due to their unfamiliarity with the PPP model. A national DFI financed many of these initial PFI projects. It was only later that commercial banks “crowded in” when they became familiar with PFI projects and, as a result, most of the later PFI projects were financed by commercial banks or via the capital market. The national DFI has fulfilled its role in developing the financing market for a previously underserved sector.

In some countries, DFIs have evolved to serve home companies overseas. Successful ones include KfW of Germany and China Development Bank (CDB), which provide financing for projects outside their home countries. Another example is the Development Bank of Singapore (DBS), which has evolved into a regional financing powerhouse with a market capitalisation of about S$100 billion. DBS was set up in 1968, slightly earlier than Malaysia’s first DFIs. Malaysia has a number of national DFIs, each with its own mission. The major ones include Bank Pembangunan (mainly for infrastructure projects), SME Bank, Agro Bank (for agriculture), Bank Simpanan Nasional, EXIM Bank and the Credit Guarantee Corporation.

Both KfW and CDB are actively addressing key social and environmental challenges in their home countries. KfW is a major funder of renewable energy projects in Germany and have successfully crowded in commercial funders into this sector.

CDB is actively involved in the planning and implementation of China’s five-year plans and works with relevant government agencies in the formulation of major national plans for strategic emerging industries. CDB has also developed provincial-level financing plans for provinces and municipalities and is actively involved in conducting research on regional development. CDB has given out twice the amount of loans that the multilateral DFI, the World Bank, has made. Both KfW and CDB have significant numbers of technocrats with sectoral expertise in their employment.

Patient capital and blended finance

Most DFIs play a capital development and countercyclical role. Some have even played key venture capitalist roles, which help to part-finance their developmental roles by providing “patient” capital. This can be longer-term equity, debt or guarantees that would wait “patiently” for returns from these infrastructure investments. The trend now is for DFIs to use blended financing to fund infrastructure and SDG projects. These DFIs use their development finance as a catalyst to crowd in commercial lending and private investments for infrastructure investments, instead of competing with them. Many of the multilateral development agencies are promoting the use of blended financing. In Indonesia, the state-owned DFI, Sarana Multi Infrastruktur, has been tasked with developing this market.

Rebooting Malaysia’s DFIs for current relevance

The challenges that Malaysia’s national DFIs face are not dissimilar to those faced by DFIs in other countries. The World Bank published a comprehensive report, “2017 Survey of National Development Banks” in May this year. The report highlighted several urgent challenges:

• Relooking the relevance of the current mandates and mission: Are the mandates of the DFIs aligned with current focus and policies of their government. All DFIs play the important role of supporting their governments’ current economic policies, hence, they have to be active participants in discussions with policymakers to influence and to seek clarity and alignment. In the case of Malaysia, the Ministry of Economic Affairs is the main ministry for many of the major DFIs. China’s CDB is actively involved in policy formulation, together with the government. Another question to ask is whether Malaysia has too many national DFIs and whether a consolidation is necessary now.

• Performance measurement: DFIs are not commercial banks, so their performance should not be measured in the same way as that of commercial banks. DFIs should be marked on the additionality that they create through their lending and business operations. For example, how the DFI has developed the debt markets for underserved sectors by crowding in commercial banks and financial institutions; or how it has helped towards the achievement of SDGs. DFIs cannot and should not compete with commercial banks. If they find themselves not competitive against commercial lenders, then they should be deemed successful in having crowded in commercial lenders and should withdraw from that lending market.

• Strengthening the risk management capacity: DFIs generally serve underserved sectors and areas with higher failure rates. Striking a balance in risk management is always a challenge, should they provide less finance to these borrowers due to the inherent risks or should they fulfil the goals they were set up for, that is to catalyse those sectors or areas? Risk management frameworks should include, at the minimum, access to relevant market information in the sectors or areas they serve, for example, production costs, market size, competitors, historical returns, failure rates, and the economic climate. In other words, DFIs should have some sectoral technocrats and economists in their teams. It is timely to relook the risk management frameworks for DFIs in Malaysia to reduce the high bad debts and non-performing loans. The frequent restructuring of distressed loans to avoid being classified as NPLs only served to kick the can down the road. Malaysia’s DFIs can also draw useful lessons from a recent case of the Indian DFI, Infrastructure Leasing & Financial Services, which had to be bailed out after the board was removed.

• Financial self-sustainability: Many DFIs rely on the government for funding for their lending activities. Some are able to raise money through returns from equity investments while others enjoy the benefits of cheap sources of funds through their current account, savings account. Most DFIs in Malaysia do not enjoy these cheap funds, thus making them less competitive against commercial banks. It is a good time to look at merging some of these DFIs.

• Corporate governance and reduced political interference: Most DFIs surveyed have indicated that there should be a clear distinction between the roles of the non-executive boards and management, saying they would prefer higher management autonomy while being subject to high standards of transparency and disclosure. Most DFIs advocate more autonomy for senior management and the ability to say “no” if stakeholders pressure them to take excessive risk.

In the Malaysia Baru environment, the roles and the interfaces of the board and management of all the DFIs should be reassessed as a matter of urgency.

DFIs have historically been set up for economic and social reasons. They play very important roles in catalysing the mandated sectors and areas. Their current mandates have to be refreshed and realigned to the government’s current policies, urgently. It is timely, with the new Pakatan Harapan government, to look again at all DFIs in the country and evaluate how they can support the policies of the new Ministry of Economic Affairs and other ministries more effectively and efficiently. The DFI should perhaps be at the “head table” to participate in policy formulation for infrastructure investments. That would also require them to start thinking more like development bankers.