December 1, 2016 10:00 am JST
FT Confidential Research

Philippines -- Pushing the accelerator on infrastructure build-out

President Duterte is pushing hard against the barriers to get big project funding

  • New Philippine president Rodrigo Duterte has been swift to push through measures designed to create a more dynamic environment for infrastructure development.
  • A number of recent moves and project approvals should help alleviate crippling traffic congestion in Manila over the longer term.
  • Mr Duterte is playing off China and Japan against each other to secure investment in big-ticket projects, although implementation risk remains high, with many fundamental challenges to large-scale project development as yet unaddressed.
  • A number of obstacles faced by foreign investors remain, including major restrictions on foreign bank lending and tight rules on asset ownership that make it hard to recycle funds.

During the six-year tenure of former president Aquino, the successful launch of an initiative to boost infrastructure through public-private partnerships (PPP) made the Philippines Asia's third largest PPP market, behind China and India.

However, implementation still fell well short of targets, with 12 projects worth 292bn pesos ($6bn) actually awarded out of a targeted 53 projects with a value of 1.31tn pesos. Of the 12 awarded, only 3 have actually been completed (see chart). Projects were often delayed by a lack of government coordination.

Since assuming office, however, President Rodrigo Duterte has taken steps to inject new momentum into the process.

Fostering healthy competition

The government is hoping that three planned regulatory changes will create a more dynamic environment for infrastructure development:

  1. Allowing unsolicited bids, whereby companies submit proposals that are subsequently opened for competitive bidding;
  2. Granting emergency powers to secure land for infrastructure projects and shortening timelines for procurement; and
  3. Raising caps on foreign equity ownership from 70 per cent to 40 per cent in several industries.

FT Confidential Research found significant support for the introduction of unsolicited proposals, including from local conglomerates and foreign investors such as Macquarie Capital, which in 2014 invested in the consortium that operates and manages the LRT Line-1.

"Toll roads attract particular interest since private groups - often with myriad real estate interests - have incentives to connect their land banks, and are better placed to assess commercial risk," according to Rodrigo Franco, CEO of Metro Pacific Tollways.

Discussions have been revived over blueprints for projects such as a planned 20km Manila subway (see map), a 15km "Trans-Manila" bridge connecting Cavite province with Bataan, as well as a planned $20bn international airport in Cavite province, proposed by San Miguel.

Rene Almedras, CEO of Ayala's infrastructure unit, told FTCR that, for the more ambitious projects, the key issue is the level of government support, which remains unclear. "The new administration's revival of interest in the planned subway linking Pasay, Makati and Taguig is certainly a positive step. However, with an $8bn price tag, tunnel depths of 50 metres and an untested regulatory structure, it will require significant subsidisation and regulatory clarification."

Others voice mild concern about the government's hasty approach. "On the one hand, we've had a sclerotic process for too long," Karim Garcia, vice president of business development at Metro Pacific, said. "On the other, a number of PPP projects carried over from the Aquino era need to be heavily reassessed, either in terms of their planned costs, their financing structures, their planned land-use or their execution timelines."

Unclogging Manila's streets and airport

Nevertheless, initial progress has been tangible, particularly in Manila. Moves have already been made to accelerate the roll-out of infrastructure projects in the city, in addition to a series of stopgap measures, including widening side streets, introducing vehicle fees and improving bus and ferry connections.

The city's traffic congestion is now among the worst of any major world city, and without action will only get worse. Vehicle sales rose 22.9 per cent in 2015, and are set to rise even further this year (see chart).

In late September, the National Economic Development Authority (NEDA) - in its first meeting under the new administration - approved a PPP proposal to upgrade Ninoy Aquino International Airport (NAIA), Manila's main airport, worth 76bn pesos.

NAIA handled over 35m passengers in 2015, exceeding its designed capacity of 31m. Arrivals are set to rise further this year (see chart). According to industry insiders, the plan would upgrade NAIA's existing hardware and software infrastructure, ideally through a partnership between a foreign airport operator and a local conglomerate.

This brings the number of projects that have secured NEDA approval but have yet to be tendered to 12 (see chart).

 

Progress is, however, likely to be quicker in contracting out regional airport PPP projects in Bohol, Davao, Iloilo and Bacolod, according to Matthew Bubb of law firm Ashurst. Regional airports generally do not require new land acquisition, while terminal upgrades can quickly generate revenue through tourism-related shopping.

According to Marianne Hontiveros, CEO of AirAsia Philippines, the private sector will also be brought in to co-invest in:

  • Additional runways at both Clark and Cebu airports; and
  • Night landing facilities in six regional airports - Cotabato, Osamiz, Dumaguete, Dipolog, Roxas and Tuguegarao

These projects should help take pressure off Manila.

Urban rail network crucial for Manila

In addition, the expansion of Manila's rail transport system is ongoing, including:

  • A 12km extension of LRT Line-1, awarded as a PPP to Ayala and Metro Pacific;
  • Upgrading and extending MRT Line-3;
  • New LRT lines. Line-4 is only at the planning stage, while Line-6 has received NEDA approval; and
  • A new MRT line - Line-7 - being developed by San Miguel and South Korea's Korail, which is in pre-construction.

The expansion of MRT Line-3, which currently services 600,000 passengers daily, nearly double its designed capacity, has stalled due to poor maintenance. "In 2012, the transport department refused to renew Sumitomo's operations and maintenance contract for MRT-3, insisting on handling it itself. This has resulted in a huge mess, with a train derailing in 2014," a senior executive at Metro Rail Transit, the original contractor of the project, told FTCR, adding that the company is in early negotiations with the government on how to deliver the MRT-3 expansion and improve its management.

Progress on the construction of MRT Line-7 has also stalled, due in part to disputes between commercial property developers over the planned location of a station linking LRT-1 and LRT-2 with the new line.

However, in late September, the Department of Transport proposed a compromise that placed the new station at a halfway point between SM'sNorth EDSA shopping mall and Ayala's TriNoma mall. The two parties have since returned to the negotiating table, although a formal deal has yet to be finalised.

The NLEX-SLEX Connector elevated toll road, which connects two major arteries to the north and south of Manila, has also regained momentum. Following a review of the bid during the last months of the Aquino administration, the contract was formally awarded to original bidder Metro Pacific in late September.

Reaping the benefits of the Japan-China rivalry

Mr Duterte has also been looking to push infrastructure forward via diplomatic means. A recent visit to Beijing by the president yielded $15bn of pledged investment (see chart).

Most of the significant infrastructure deals unveiled - including port expansions in Cebu and Davao, and upgrading Manila's transport systems - involve China Harbour Engineering and other subsidiaries of China Communications Construction, a state behemoth similarly lobbying for projects in Indonesia.

Although not on the list of pledges, China also expressed interest in bidding for NorthRail, a 45km component of the north-south commuter rail project that Transport Secretary Arthur Tugade indicated would "take centre stage" in coming months. It would link Manila with Clark International Airport, the growth potential for which is substantial, with under a million passengers using the airport in 2015.

This sets the stage for another competitive bidding process between China and Japan. In late 2015, Tokyo signed a $2bn loan agreement to develop the line, using narrow gauge rails. China's rival proposal uses standard gauges, with the additional bonus of a separate rail link between Clark and Subic Bay, a strategic industrial zone 150km north-west of Manila.

Following his China visit, Mr Duterte went to Tokyo, where he secured investment pledges of close to $17bn for mass transit, power, road and water projects, particularly from conglomerate Marubeni, which has an existing portfolio of investments across multiple sectors in the Philippines, ranging from telecoms to power.

Caution on China investment pledges

Playing Japan and China off against each other could prove a fruitful strategy for Mr Duterte, in the short term at least, though pledges do not always turn into action.

Implementation of Chinese investment pledges has been patchy across much of Asean. This includes in Indonesia where much of the $20bn promised via bilateral deals in 2014 has failed to materialise.

Planned rail deals in Indonesia and Thailand face significant delays, in large part due to the inability to agree on financing terms, and there is little to suggest this would be any different for the Philippines. Chinese companies looking at the Philippines are likely to remain cautious until it is clear that the thaw in bilateral relations under Mr Duterte persists.

Moreover, there is growing resistance to some of the planned investments, with question marks over the prior behaviour of some of the companies involved and worries that China will use such investment as political leverage to extract concessions over disputed maritime resources.

Foreign investment still required

As such, securing foreign private capital remains important to creating sustainable infrastructure improvement.

The government's commitment to raising foreign ownership caps is aimed at boosting such investment - a strategy that should find support in growing international interest in the country's renewable energy sector and the planned listing of PPP projects on the Philippine stock exchange.

However, of the 292bn pesos in PPP projects awarded during Aquino's administration, only 15bn pesos was accounted for by foreign capital, and there are some important issues with the current PPP model that have yet to be resolved.

"Fundamentally, the PPP programme has not been designed to attract foreign capital and it is unclear if this is changing. Major restrictions on foreign bank lending remain, even though domestic banks are often unwilling or unable to unilaterally finance projects," said Dean Van Drasek, executive director at Arch Advisory.

Existing investors in the country also find that the excessively tight rules on asset ownership make it hard for investors to recycle funds, according to John Walker, head of Asian infrastructure at Macquarie Capital. Capital recycling is the process by which small portions of a project's development are sold or leased to private buyers, the proceeds of which are used for re-investing elsewhere or improving the project's general cash flow. The idea is to improve risk management by outsourcing various portions of the risks inherent in project development to third parties.

Progress still likely to be slow

Furthermore, while government measures to expedite land transfer will streamline construction of transportation projects, completion remains distant for many.

"If you take NorthRail, even assuming it is awarded the government will need to resettle hundreds if not thousands of squatters," said Andre Palacios, lecturer at the University of the Philippines. "Significant new land acquisition in prime downtown areas would also be required. While there is an existing, antiquated link between Manila and Clark, this terminates in the old downtown area of Manila Bay, rather than Makati, Fort Bonifacio and Ortigas."

A planned rail link in Mindanao, another major Duterte-led initiative, presents an even greater challenge.

"Mindanao is 100 per cent greenfield, where you also have mountainous terrain, security risks and sparsely populated areas. Perhaps a link from Cagayan de Oro to the city of Butuan is feasible, but this is several years away," a World Bank official told FTCR.

Vested interests could also drag on progress. The Davao Sasa port project in Davao City, for example, one of the NEDA-approved projects currently in the PPP pipeline, was "very close" to being awarded in the last few months of the Aquino administration, but has since been left in limbo, according to advisors working on the project.

"This is a bit puzzling, particularly since this is Mr Duterte's own hometown. However, we think that other private port operators in the city are pressuring the President to postpone the deal, since it runs contrary to their interests."

This highlights that many legacy problems - including the pernicious influence of local cliques - remain an obstacle for infrastructure development. Foreign investors will remain somewhat cautious until tangible progress is made on resolving these and other fundamental issues.

But it is also clear that progress is being made in pushing forward PPP projects. And Mr Duterte's preference for more centralised governance and sovereign-backed projects may yet win over the domestic conglomerates and the country's traditional elites - economic and political constituencies crucial to maintaining the momentum of the infrastructure build-out.

These article was first published on Nov. 2 by FT Confidential Research.

FT Confidential Research is an independent research service from the Financial Times, providing in-depth analysis of and statistical insight into China and Southeast Asia. Team of researchers in these key markets combine findings from proprietary surveys with on-the-ground research to provide predictive analysis for investors.

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