Asia represents an important, and potentially vital, source of LNG demand. It is the part of the world with the fastest economic growth rates, not just in China but in other fast-industrialising high-population countries such as India, Indonesia and Vietnam; and in most cases, these countries face a shortage in energy.

Today, though, it’s the more mature markets in Asia that constitute the greatest demand. “The main users of gas in Asia currently are Japan, Korea and Taiwan,” says Sonia Song, regional head of oil and gas research for Asia Pacific at HSBC. All three of them purchase their gas in LNG form, in prices linked to oil. Japan in particular is a growing market for gas demand, partly because of the problems it has had with nuclear energy. “With the Japanese nuclear moratorium, there has been a step change in demand for gas, which we expect to continue in the long term,” says Song.

For the future, though, it’s the high-growth markets that should provide the more dynamic demand for LNG. China, for example, is showing increased demand, and has also agreed to oil-linked prices for long-term contracts. “Some of these give a degree of upside protection to China, but prices remain oil-linked, just with a lower sensitivity,” Song says. “We expect Chinese demand for gas to grow at around 10% a year.” Specifically, imports of LNG are expected to double to 40 million tonnes per year by 2015, and double again by 2020.

India is another important potential market. India does have impressive domestic gas supply – 126.1 million standard cubic feet per day in the 2011 financial year – but imported LNG has been increased at a compound average 7% a year since 2007, and stood at 33.1 million standard cubic feet per day in FY2011, according to India’s Ministry of Petroleum and Natural Gas. “With domestic supplies likely to be stable, increased demand for gas in India will have to be satisfied by increased imports of LNG at the regas [regasification of LNG] terminals in Dahej and Hazira,” says Song. New import terminals are being built in Dhabhol and Kochi, which gives a clear indication of the momentum India expects in LNG imports. But India’s perennial struggle is infrastructure development, and its attempts to boost its own gas distribution networks have made slow progress.

The impact of this demand on Australian LNG exporters is interesting, and being closely watched by analysts and fund managers. “Australia is in a very nice sweet spot in terms of power demand,” says Malcolm Smith, Director at BlackRock in London, and part of the commodities team there. “But it remains to be seen exactly how much demand for natural gas there will be in Asia. You are seeing more natural gas and coal-based methane coming on in the Chinese market. And a huge amount of new supply has come to the market, mainly US-based from shale gas. When I speak with Australian analysts they are incredibly bullish, and there may be a good story, but it is too early to say for sure.”

Also on the supply side, a potentially very significant project is taking shape in Asia itself, in Papua New Guinea, where the PNG-LNG development – one that should completely transform the PNG economy, for better or worse – is about half way through its construction period. Nomura says it expects delivery of PNG LNG by early 2014; its confidence in the project is one reason it recently upgraded Oil Search, the Australian company most closely linked to the project, to buy. Oil Search itself says the project is expected to produce 6.6 million tonnes per annum of LNG, and that 9 trillion cubic feet of gas – in addition to 200 million barrels of associated liquids – should be produced over the project life. The gas will be liquefied at an LNG plant near Port Moresby and then shipped to international gas markets.

There are many other plants under development too, but HSBC believes it’s still going to fall short of growing Asian and European demand. “We believe that the number of new liquefaction plants currently planned will be unable to meet this demand and so Asian buyers will be in competition with Europeans leading to a tight market for spot LNG cargoes,” says Song. “We have already seen signs of this trend emerging with several LNG cargoes with default destinations in Europe being diverted to Asia.”

Infrastructure is often painted as a perfect fit for pension and sovereign wealth funds. It gives off regular and steady income over the long-term; its income stream behaves in a predictable manner, matching pension fund liabilities; and it suits an investor in no rush to get money out again.

In Asia Pacific, it has another advantage too: an inflation hedge. Most of the world has far more pressing things to worry about than inflation – chance would be a fine thing – but many Asian nations are battling strong inflationary pressures, notably China, Indonesia and (to an alarming degree) Vietnam. Infrastructure, again because of its long-term and defensive nature, but also because of its lack of correlation with other asset classes or commodities, makes for a useful hedge.

Australia, with one of the biggest and most sophisticated pension fund environments in the world, has been a forerunner in this process, particularly through the not-for-profit industry superannuation funds.

One asset consultant in particular, called Access Economic Advisers, has built a name for itself putting clients into infrastructure assets. As recently as August, it bought a 20.8% stake in International Parking Group, which owns nine hospital car parks across New South Wales and Queensland, on behalf of Prime Super. Other assets AEA has bought into on behalf of pension fund clients include Adelaide Airport, Flinders Ports, GasValpo (a Chilean gas distribution company), and Texas Tollroad.

A super fund advised by Access typically has two portfolios: a market-linked portfolio, made of mainstream assets in debt and equity, and a target return portfolio, which is made up of alternative asset classes. This target return portfolio can make up as much as half of total assets. Investors in the MTAA super fund, for example, share in the fund’s A$1.371 billion of directly managed holdings in infrastructure including Southern Water and Thames Water in the UK, the airports of Brisbane, Sydney and Adelaide, and ports in Adelaide and Gdansk, Poland, among other things. That’s on top of holdings in infrastructure funds from groups like Macquarie, and another fund that specializes in Latin American power. Westscheme, recently merged with Australian Super, is another example of an Access superannuation fund client that has built separate portfolios in this way. Another, Victoria Funds Management Corporation, has a direct holding in Birmingham Airport in the UK.

The king of infrastructure investment and funding in Australia has long been the Macquarie group, which over the years has built numerous listed and unlisted infrastructure funds. Several super funds get their exposure to infrastructure through holdings in Macquarie vehicles. But this also raises a cautionary tale: infrastructure doesn’t necessarily perform well as a stock market vehicle. An example is Macquarie International Infrastructure Fund, an Asia-focused listed infrastructure fund which floated at S$1 per share in Singapore in 2005. Six years on, it’s trading at about half its listing price, having been mauled by the financial crisis and never recovered. Its assets – stakes in Changshu Xinghua Port, Hua Nan Expressway, Miaoli Wind and Taiwan Broadband Communications – all have good prospects, and the underlying premise of the fund is very sound: Macquarie, citing the Asian Development Bank, says that infrastructure investment needs in Asia are estimated at US$8 trillion over the next 10 years. Very clearly, there is money to be made in that process. But a combination of market suspicion about debt loads, and of listed vehicles generally, mean that investors in the stock have wasted six years of patience to lose half their money. It could be worse: Babcock & Brown, the Australian institution built on a Macquarie-like model of infrastructure development, folded in the financial crisis, although its listed fund lives on.

Investors have become wary of vehicles like this because of their lack of liquidity. It is often whispered in Australia that some industry funds dodged a bullet in the financial crisis in this respect. Industry funds had, for several years, posted better returns than their commercial peers, partly because they had a higher level of holding in unlisted assets, which raised the thorny question about how such illiquid assets could be valued accurately. As the financial crisis kicked in, the value of those assets unquestionably declined  – but to what? At that stage, had a fund needed to sell infrastructure, it probably couldn’t have done so at any price, since there is no liquid market and there were no obvious buyers in a period of panic. If one of the infrastructure-heavy industry funds had faced a lot of redemptions and needed to sell assets, it might have struggled to do so. One of the reasons this never happened is because Australian superannuation is governed by strict laws on when people can access their retirement savings; most Australians had no option to redeem funds, hence no big redemptions as markets started to fall. But the questions about the prudence of having up to half the fund in unlisted assets are valid, and continue to be asked.

But for institutions that really don’t need liquidity, infrastructure is still a good fit, and clearly the part of the market best suited to this approach is sovereign wealth funds. Here, too, Australia is an early mover. As of June 30 2011, the Future Fund – the closest thing Australia has to a sovereign fund, tasked to meet future pension liabilities – had A$3.911 billion in infrastructure and timber investments, accounting for 5.3% of the fund; the long term target allocation is for 20% to be invested into ‘tangible assets’ (which is infrastructure, timber and property). Specific examples include Southern Water in the UK and the owner of Melbourne and Launceston airports. This has proved promising for external managers – the Future Fund discloses seven managers in infrastructure and timber – and the Future Fund has also made several internal hires of people brought in for their infrastructure expertise.

Elsewhere in the region, too, infrastructure is growing in popularity as an asset class. China Investment Corporation moved to a 21% allocation to alternatives in 2010, with specific areas of focus in REITs, infrastructure and private equity. CIC is an example of a sovereign fund very clearly attempting to hedge against inflation, and not just with infrastructure: new strategies it added in 2010 included a metals and mining indices swap, a gold equity fund, an active commodity index strategy, and various futures also apparently geared towards inflation targeting. CIC now has a dedicated department for special investments, which covers energy, mining, precious metals, agriculture and infrastructure.

The Government of Singapore Investment Corporation doesn’t separate out infrastructure, but has a figure combining it with private equity and venture capital. In 2010 that figure was 10% of the whole portfolio; and Indonesia has been a recent target for its infrastructure investment. Also in Singapore, Temasek, the other sovereign fund, made a S$100 million investment in Hutchison Port Holdings earlier this year. And the Korea Investment Corporation is targeting 20% of the portfolio in alternatives generally, including infrastructure.  (It’s also been boosting inflation-linked bonds.)

Groups like these, perfectly geared towards infrastructure’s characteristics, are likely to do more and more of this kind of investment in future; it’s a happy coincidence of interests with Asia itself, which needs a huge amount of infrastructure development and will clearly need more funding than governments can directly provide in order to do it. At this end of the investment spectrum, there’s a great deal to recommend the asset class – but those who seek to package it into listed trusts to be sold to retail have more work to do before they can regain public trust.

Note: this was a sponsored report and not editorially independent, but is included here as a resource

SECTION 1 – interview with Alisher Ali, Chairman, Eurasia Capital

EM: Set the scene: what is the opportunity in Mongolia today?

AA: Mongolia has so many things going for it. It is physically located next to China, which has become the de facto engine of growth in the global economy. It has been blessed with natural resources. And you have the government and political system: the country is a true democracy, so as a result there is a good chance of the country being able to manage effectively not only its mineral wealth but the economic growth that will come with the development of those mineral resources.

So we have been early believers in Mongolia. We opened our office in 2008 in the same week as the Lehman disaster, and even though the timing may not have been perfect, we are still proud of the fact that we saw the opportunity for Mongolia’s growth potential and investment opportunities much earlier than many others. We built the infrastructure, we focused on building relationships with government entities, and with the corporate sector and international investors. Now we have the largest investment bank in the country, well positioned to capitalize on opportunities. The mission for Eurasia Capital is to provide a bridge between Mongolia and the international markets: to give international investors access to Mongolia growth, and to facilitate the entrance of Mongolian companies and banks to raise capital internationally.

EM: What shifts have you seen in the business climate since 2008?

I’ve appeared at least 20 times in studios for interviews with Bloomberg, CNBC, Al Jazeera and others to talk about Mongolia. And I always get the question: why haven’t we heard about Mongolia before, with its massive resources? The reason was that for years, the Mongolian government, parliament and public in general have had intense debates about how to develop those resources. It took a long time and was frustrating for foreign investors trying to bring big mining projects into production. The big example was Ivanhoe Mines, which discovered the Oyu Tolgoi deposit a decade ago yet only signed the landmark agreement allowing it to develop it in October 2009. But when we set up here there was no doubt in our mind that the government would decide to develop its strategic projects and large mines. The question was when.

The 2008 crisis hit Mongolia very hard: by the first quarter of 2009 the government was running out of money, foreign exchange reserves were depleted and investors were fleeing. It led to a bailout with support from the IMF and a number of bilateral agreements. But that crisis, in my view, had a silver lining, because it helped the government and public to focus on the key need to develop mineral resources. It became clear they had no luxury to wait and debate further. So we were all relieved when, on October 6 2009, they finally came to agreement with Ivanhoe and Rio Tinto. That was a turning point. It was a big sign: this country is ready for business. It was a crucial milestone and the catalyst for a change in investment sentiment towards Mongolia. The country has never looked back since then.

EM: Where are the opportunities in investment? Everyone knows about the mining, but how about the knock-on effects in the economy?

One of the main reasons for us spotting the opportunity in Mongolia early on was our early experience in Central Asia, especially Kazakhstan. Our time in frontier markets and Eurasian countries allowed me to see the parallels: that once you have momentum, and the development of world class resources, you are going to see knock-on effects. Yes, mining is going to be the largest and most important sector for Mongolia, but there will be other sectors and the opportunity is not going to be confined only to mining.

In January 2010 we produced a report called Mongolia Outlook 2010 – a historical document in the development of our firm. It was positive and optimistic about Mongolia at a time when the turnaround wasn’t obvious, but we said that Mongolia was going to go through a multi-year bull market: that there would be growth in GDP and in FDI. Beyond that macro vision, we made two important calls which were – this is important – executable investment recommendations for international investors. The first was that the Mongolian tugrik was going to appreciate and influence FDI. There is no derivative or spot market, so investors had to initiate bank deposits with Mongolian banks, which at that time were offering 16% in tugrik local currency deposits. Those investors who followed our advice made over 25% return after subtracting all costs, a combination of high deposit rates and the appreciation of the currency.

The second important call was that we recommended investors start investing in local equities. In January 2010, this was considered an optimistic call: the local market collapsed in 2008 and was also negative in 2009 in dollar terms. But we were confident the worst was behind us and estimated the market would gain 70% that year. In fact, it went up almost double that amount. In 2010 the tugrik was the second best performing currency globally, and the stock market was the best in the world.

From the beginning I have trained our research team to think in a way so as to come up with actionable recommendations. We look at opportunities in the currency markets, in fixed income, in public equities – domestic and international – in private equity, infrastructure and property, then tailor recommendations around them. We have built indices allowing investors to track performance of Mongolia-related companies listed in countries around the world.

EM: What funds and businesses have you built to do this?

Eurasia Capital Management is a Central Asian investment and fund management business. Silk Road Management, which started in 2008 as a wealth management advisory firm, is now being transformed into a Mongolia-focused investment management firm. We aim to build the largest such institution in the country. Our first product was the first ever venture capital and private equity fund focused on Mongolia, the Mongolia Human Capital Fund, which raised US$30 million from investors. The idea of this fund is to focus on non-resource sectors where human capital is going to be crucial in the success of the business: areas such as media, healthcare, education, professional services industries and information technology. These are industries in their infancy stage that are going to benefit from strong economic growth.

We have plans to launch funds across different asset classes. We intend to launch a publicly-listed Mongolia-dedicated fund. And we have teamed up with a Korean group, Goran Capital Partners, to launch a Mongolia-Korea resources fund and to tap the interest of Korean institutional investors looking for investments in Mongolia. We tailor investment products around the interests of investors.

Eurasia Capital itself has been recognized by several international publications; this year it was named the best investment bank in Mongolia by Euromoney magazine.

SECTION 2 – interview with Ganhuyang Chuluun Hutagt, Vice Minister of Finance, Mongolia

Euromoney: At a time when the rest of the world is struggling, economic projections for Mongolia are extremely positive. Is the outlook realistic?

Minister: The outlook will be as good as the demand for what we are producing. In recent years what we possess in terms of minerals has attracted a lot of investor interest, based on global demand for these commodities: copper, uranium, gold, coal, iron. There will be demand for our products despite what happens with Chinese inflation, the American budget and debt ceiling, and European defaults.

EM: What is a realistic expectation for GDP growth?

Minister: It will depend on what’s going to happen in the US and how it will affect production in China, and what appetite China will have for Mongolian commodities. I don’t think the Mongolian government can become too arrogant: I advocate we watch out for negative trends, and manage risks. Consecutive crises have shown that they do have an impact on the Mongolian economy.

Despite that, the outlook that is being projected by the international community, our development partners and ourselves is pretty positive. We will have tremendous growth in our economy based on mining and the building of physical infrastructure to make our products more available to international markets: border ports, railways, roads, airports. We are going to need to build new cities in the new mining areas, currently mostly in the Gobi. Most of the business will happen around the mines and in the value chain. We need new power plants, new houses, and even here [Ulaanbaatar] with growing incomes we have a minimum of 200,000 people who will need houses and apartments. You don’t need too much imagination to think of the investments behind these numbers in terms of water, sewage, energy, roads, schools and hospitals. It entails huge business opportunities, but mining can support it only through steady and growing cashflows.

What will be the role of the state in all this investment?

The role of the state is going to not diminish in the near future. At this stage of development the government needs to take a leading role, creating not only the environment and good opportunities for foreign investors, but also intervening in managing the economy, supporting our traditional industries such as agriculture, as we did today [in an issue of bonds to support agricultural producers and SMEs]. We need to help our industries in this tough environment with foreign competitors coming in and cheap imports, aggravated by the impact of the strong tugrik. We will need to continue direct involvement such as the development bank, to build public services. This year we budgeted MNT627 billion for capital investments, and the number will go above 1 trillion this year. Altogether in the past 20 years put together, the capital expenditures were only MNT1.6 trillion; in two years we are doing what was done in 20.

What will be the role of the private sector in this?

The private sector has plenty on its plate already. Almost all of the banking sector is in private hands: out of 70,000 registered companies, only 100 are state-owned, although they include the champions.

How do you rate ease of doing business in Mongolia?

We have fared pretty well. Mongolia is one of the friendlier environments in which to do business. Because we are latecomers we can implement some systems immediately: for example we rank one of the top countries in terms of extractive industries transparency. If you compare us with some Eastern European countries, we are pretty similar; if you compare us to former Soviet Republics, we are way better.

And what still needs to be done?

Last year the government announced the year of Business Environmental Enabling Reform, or BEER. The results of it are yet to be fully reflected, but the government made an important decision to continue with reform here in 2011.

Can you explain the mandate of the new Development Bank? For example will it fund small business as well as long-term infrastructure?

It’s not for small business, it is to support large national projects and to help the government invest in energy, infrastructure and to help us utilize our mines more efficiently. It is specifically stated in the law what sort of projects will be funded, and they will include housing. The bank is operational – it has not yet funded projects, but we have given them the guarantee to issue MNT800 billion of bonds. They are working hard to issue those bonds, get the funding and start financing projects.

Are you considering a sovereign wealth fund?

We have set up a stabilization fund, which by the end of the year will have MNT180 billion. When it hits 5% of GDP we will start investing it actively; in the meantime it’s in cash. I will do my utmost to make sure the government makes the right decisions and does not have incentives to spend it all right now. It is a big responsibility for our future.

What are its sources of funding?

Any income that is in excess of certain fixed prices for coal and copper. We also have the Human Development Fund; we put revenues from the mines in that fund and will start investing this money outside of the country to protect our economy and insulate it from foreign currencies, as well as preserving wealth to share with future generations.

You said Mongolia is dependent on demand for commodities. What is being done to diversify the economy away from such reliance on mining?

Traditionally Mongolia has been an agrarian economy: livestock and anything related to it like meat, pelt, felt, wool and cashmere. They are all industries of high potential. Food security is a big concern for us; Mongolia has become self-sufficient in terms of wheat, which is a success. We could focus on and develop other industries: our increasingly educated workforce will be able to drive industries such as tourism and financial services to become major contributors to the economy.

The financial services industry had a rough time in 2009. How is its health today?

Over 95% of the financial industry is commercial banks. The system is doing well: it is growing, NPLs are decreasing on the back of the economic boom, and the stock market has consistently outperformed most others. But we start from a low base and there is a need for reforms. We need to approve the draft law on securities – hopefully this year – and reform in the pensions system will need to happen. We need to overhaul our insurance sector. And with this we will create local institutional investors who will help us create robust, dynamically growing local stock markets.

The world is watching the forthcoming Erdenes Tavan Tolgoi IPO. How transformative will it be for Mongolian markets?

The current capitalization of the local stock exchange is $2 billion; we are talking about $10 billion in an IPO of one company. That’s the magnitude, and if we decide to float some percentage locally it will have a huge impact. Right now 10% is owned by the Mongolian people and another 10% will be sold to Mongolia-based companies. This will provide a strong incentive for international investors to come in early and take part in the trading of those securities.

What is the idea behind giving shares in it to every Mongolian citizen?

It gives people a feeling that they are benefiting from the big national treasure directly. It’s a good lesson to all Mongolian citizens in terms of managing capital, really understanding what a stock market is and how it works, and what being a shareholder entails. It brings accountability to the person, whereas if the state was to manage the wealth for our own citizens, it is more indirect. Tavan Tolgoi will be a better governed organization because it is owned by individuals, not just the faceless state.

With the US and Europe in turmoil, what is your resilience to external shocks?

I don’t think we have been particularly resilient at any time in history. We depend on our buyers; we have one rail line. Economically we are dependent on two neighbours: we import all of our gas from Russia, we export most of our coal to China.

What message do you want to give to foreign investors about Mongolia?

It makes sense to get exposed to Mongolia. It is the top opportunity globally in terms of our mineral resources. We possess almost all the elements in the periodic table. We are tripling coal exports this year. The ambition with our partnership with the London Stock Exchange is that one day Asian investors can trade on the Mongolian exchange with their stocks listed in London, on the same platform, the same systems.

Cashflows are exploding, the budget is in surplus and we have record high cash levels in our treasury. We will one day make a decision on sovereign bonds: we are issuing local currency and giving a very good return to our investors. Debt to GDP is just 17%, so we can borrow, and I think we want to borrow to make investments and increase the capacity of the economy.

SECTION 3: ECONOMY

Economy

Mongolia has experienced rapid economic growth since the global financial crisis. Eurasia Capital, an Ulaanbaatar-headquartered investment bank, estimates that Mongolia became the world’s second fastest growing economy in 2010 in terms of US$ GDP growth rate at current prices, with a 44% year-on-year increase, driven by the 12.9% appreciation of the Mongolian tugrik (MNT), the national currency, against the dollar over that period. This means that Mongolia outperformed the BRIC emerging economies as well as all other leading frontier and high-growth economies globally. Fueled by investment in the mining sector and a significant increase in exports, real GDP growth reached 6.1% last year, according to official data, versus 2.7% in developed and 7.1% in emerging and developing economies. And it is getting better still: in the first half 2011 it was up 14.3%, or in nominal terms 29.1%. The second quarter, with 17.3% year on year growth, was the fastest expansion since 2005.

Significant investments and demand from China, the major market for Mongolian products, have allowed Mongolia to double coal output to more than 25Mt in 2010, up from 13Mt a year earlier. Coal exports increased 2.9 times in 2010, overtaking copper for the first time, and in 1H2011 Mongolia overtook flood-hit Australia as the largest coal exporter to China. Crude oil production rose 17% to 2.2MMbbl, and iron ore output more than doubled to over 3.2Mt. Major manufacturing industries, such as food and beverages, grew 24% in 2010.

Mongolian foreign trade surpassed its historical high in 2010. Trade turnover surged 53.5% year-on-year to US$6.2bn. 2010 was a record year for exports, reaching US$2.9 billion, with a 53.8% annual expansion driven primarily by Chinese demand (it bought 85% of Mongolia’s exports), commodity price increases and volume expansion. Record level exports have been the primary driver of Mongolia’s impressive economic growth. And they are getting better still: Mineral exports jumped 72% year-on-year in the first half of 2011, with coal up 135% and iron ore exports 122%.

Increases in international prices for Mongolia’s major export commodities boosted already substantial export earnings. The price of coal, the largest 2010 export earner for Mongolia, rose more than 14% over 2010, with copper, gold, iron ore and crude oil gaining 28%, 26%, 52% and 8%, respectively.

Eurasia Capital expects Mongolian foreign trade to grow at an even faster rate in 2011. A positive outlook on commodity prices, increased output from existing operations, the launching of new mines, and strong growth prospects in major trading partner markets – particularly resource-hungry China – should fuel increased exports from Mongolia. Eurasia now believes that Mongolian economic growth should beat its original projection of 10% GDP growth for 2011.

Foreign direct investment (FDI), which was considered frozen until as recently as 2008, hit a record high of US$1.6bn in 2010, according to official data, further underpinning the economy. The mining sector was the major destination for FDI.

China was for many years the only major FDI player into Mongolia, accounting for US$2.5 billion between 1990 and 2010. That is changing. Canadian FDI, the second biggest in Mongolia, increased more than 140 times in 2010 to US$147.8 million. Investment from Hong Kong is also climbing.

By sector, geology and mining have attracted US$3.15bn in FDI – 65.3% of the total – since 1990. The majority of this investment has come since 2008, when the mining industry began to entice resources giants around the world. Hong Kong and Canada’s FDI focus is mainly on mining and related activities, while South Korean and Japanese investments have targeted trade and service, engineering construction, and financial sectors. The biggest investor, China, has followed varied targets covering almost every sector. Infrastructure is likely to attract more FDI in coming years, with 1100km of Mongolian railways planned, for example.

Remarkably, Mongolia is thriving with limited inflation. Prices rose around 13% last year, and there were concerns from the World Bank that an expenditure plan – including major increases in salaries – could push inflation over the 25% mark. Yet according to N Zoljargal, deputy governor of Bank of Mongolia, the central bank, inflation has instead declined to around 6.5% year on year in June. In any case, he says, Mongolia is an exceptional case when it comes to considering inflation. “Mongolia has for so long been under-invested,” he says. “So when you see a flow of new cash wealth, how much of it do you sterilize and how much do you let trickle into the economy? That is the challenge we faced in 2010, we are facing it now and we will probably live like this for the next few decades.” Last year the bank sterilized around 30% of net inflows in foreign exchange, feeling that it was short-term and speculative; this year, it has sterilized far less.  “Yes inflation is a worry, with banks over-extending credit in the good days; people argue the economy is getting too hot,” he says. “I say we are nowhere near to that: we are just warming up. Everybody has their own temperature.”

Indeed, some argue inflation should actually be higher, and monetary policy looser. “Economists say that if there is inflation, just take out money from the economy,” says Sambuu Demberel, Chairman and CEO of the Mongolian National Chamber of Commerce & Industry, and a key economic advisor to Mongolia’s president and prime minister. “It’s nonsense. We need money in circulation: the more money the better. People in real sectors want money to create business and profit, but the majority of SMEs don’t have access to lending. We need decisive action to change our monetary environment to drive the economy.”

Rich mineral resources

Mongolia hosts world-class mining deposits, including estimated coal resources of over 160Bt, ranking fourth in the world after the USA, Russia and China. Erdenes Tavan Tolgoi, one of the world’s largest untapped coking coal mines, is a vivid example of a world class resource: it is estimated to contain 6.4Bt of thermal and coking coal worth approximately US$390bn. The Government of Mongolia is in the process of finalizing the deal with international bidders.

Another world class mine is Oyu Tolgoi, which is one of the world’s largest undeveloped copper-gold deposits, rivaling Escondida and Grasberg. Oyu Tolgoi contains approximately 37Mt of copper and 1,300 tonnes of gold, with a project cost of US$5.9bn. Based on conservative calculations, the monetary value of the Oyu Tolgoi project is approximately US$252bn. It may become as much as US$424bn if measured, indicated and inferred resources are taken into account.

Balanced Political Environment

Mongolia is to hold parliamentary elections in the summer of 2012. The newly elected parliament will oversee the implementation of major mining, infrastructure and industrialization projects, which will define Mongolian politics, economy and society for years to come.

The parliamentary election in 2008 saw a brief period of turmoil, but the formation of a coalition government between the two main political parties, the Mongolia People’s Party (MPP) and the Democratic Party (DP), has resulted in a stable functioning government. Domestically, the coalition government has focused on expanding investments in Mongolia’s vast natural resource wealth, diversifying the economy, job creation and improving living standards. Internationally, the government has maintained good relations with Mongolia’s traditional partners, Russia and China, as well as expanding relations with countries beyond its traditional partners.

In June 2011, Mongolia and China agreed to upgrade bilateral ties to a strategic partnership level and to bolster economic ties. The agreement is expected to bring more Chinese investments and financial support into resource and non-resource sectors and infrastructure development. Mongolia also enjoys strategic partnership status with Russia. In terms of “third neighbor” relations, Mongolia has held high-level meetings with Japan, the USA, Korea and India, among others: it expects to sign an Economic Partnership Agreement, roughly equal to a free trade agreement, with Japan in 2012. During the visit of Mongolian President Tsakhia Elbegdorj to the USA in June 2011, the Obama Administration stated that it was committed to developing a broader, deeper and more strategic relationship with Mongolia, including expanded commercial, political and cultural ties. India is actively pursuing cooperation with Mongolia in nuclear energy and mining.

With upcoming elections, the coalition government is eager to start the Tavan Tolgoi coking coal project in partnership with major international mining players. Large mining deals, infrastructure development and poverty reduction will remain recurring themes of parliamentary elections in 2012. There is a wide political consensus among major political parties about the development needs of Mongolia. Therefore, regardless of the election results, the country should be expected to stay on its current course of resource-driven growth.

SECTION 4: CAPITAL MARKETS

Public equities: Best Performing Market Globally

Despite its relative tiny size in global market terms, the Mongolian Stock Exchange (MSE) is increasingly gaining importance for local and international investors intending to gain exposure to the Mongolian market. Naturally, most of the market is resource-related.

Mongolia has so far this year maintained its title as the world’s best performing equity market. Having gained 138.4% (173.7% in US$ terms) last year, the MSE Top-20 Index has continued its global outperformance in 2011 at +43.8% at the time of writing. By comparison, the MSCI Frontier index gained 16.6% in 2010 and is down 11.6% so far in 2011; the MSCI EM Asia index gained 12.9% in 2010 and is down 0.7% year to date; and the Shanghai Composite Index fell 14.3% and 5% respectively.

After the Mongolian Stock Exchange benchmark surged 123.3% within the first two months of the year, hitting 32,954.97 on February 25, it went through a significant correction, losing 43.8% by the end of May. This volatility is a function of speculation, low liquidity, a small free float in listed companies, and unrealistic and uninformed investor expectations. Improved investor sentiment driven by the expected launch of Tavan Tolgoi coal mining operations and proposed IPO, the strategic partnership agreement between the MSE and the London Stock Exchange (see box), and a strong outlook for commodities, contributed to the surge and underpin further growth.

The MSE market capitalization grew 2.5 times in 2010, passing the landmark US$1bn in November 2010  and reaching US$1.7 billion by July 2011. The top five stocks (Coal groups Baganuur, Tavan Tolgoi, Shivee Ovoo and Sharyn Gol, and beverage group APU) contributed 82.1% of this growth. The combination of expected double-digit economic growth, and the experience of other commodity-linked emerging markets, suggests that the momentum has just begun: Kazakhstan Stock Exchange’s market capitalization grew 100-fold to US$100 billion between 2000 and 2008, while the Qatar Stock Exchange grew 31 times from 1997 to 2007 to US$95 billion. Stock market penetration – total market cap representing just 20% of GDP – is relatively low compared to other emerging and even frontier markets, underlining the growth potential.

The MSE, with its huge gains, is still challenged by companies with small free floats and low trading volume. Average daily trading volumes were US$234,000 from January to February 25, and US$33,000 from then to May 30. It is likely that the lack of liquidity will remain a concern in the short term.

The Mongolian government has approved a list of state-owned enterprises that are slated for privatization starting from 2011. These SOEs are in mining, mineral processing, construction materials, power distribution and generation, telecommunications and airline industries. Many will pursue a listing locally on the MSE to serve as a vehicle for privatization and then seek additional listings in regional or international markets to raise capital for expansion and modernization.

The leader among these expected privatizations is the highly anticipated IPO of Erdenes Tavan Tolgoi, expected early next year, and potentially worth over US$10 billion. This government-owned company holds the licence for Tavan Tolgoi, the world’s largest undeveloped coking coal mine. The government has distributed 10% of the company’s shares to Mongolian citizens, with a lock-up period that has not yet been decided, and plans to sell another 10% to Mongolian companies and offer 30% on a combination of domestic and international markets. It should substantially boost MSE market capitalization and liquidity while also enfranchising citizens in the capital markets. “The entire population of Mongolia will become shareholders,” says Munkhtushig Dul, Deputy Director and head of finance and logistics at the MSE. “When that happens, new brokerages will have to develop, as will the capital markets themselves.”

“There are several separate pipelines of new listings,” he adds. “First there are the big strategic mineral deposits, which by law should have no less than 10% listed on the MSE. Then there are many companies with huge assets in Mongolia who are not listed here: we are hoping to repatriate them to create more involvement in the Mongolian markets. And then there are local privately held companies: cell phone companies, food companies, very strong businesses that will need more money.”

There have been no new IPOs on the MSE in the last two years, but it is expected this will change dramatically in the coming years as a number of leading domestic private companies are expected to launch IPOs first internationally and later on MSE. Mongolian private business groups that are expected to launch IPOs at a group or subsidiary level include MCS Holding, Petrovis Corp, Bodi Group, Newcom Group and Monnis Group. New IPOs, whether from state or private sources, should ease liquidity concerns and therefore volatility.

Many Mongolian companies – now over 20 – have listed overseas, often instead of domestically, in locations including Toronto, London, Hong Kong and Australia. But Mongolian authorities do not see this as capital fleeing the country. “I don’t see it as a bad sign,” says Bayarsaikhan D, chairman of the Financial Regulatory Commission of Mongolia. “Companies are using the opportunity to raise funding in large amounts.” The hope is that companies that have listed overseas will come to list more of their stock domestically as the Mongolian market gains in scale and sophistication.

Eurasia Capital believes the outlook for Mongolian equities in the short to long term is very positive. This year, it expects the MSE to retain its title among the top three equity markets, if not the best.

BOX: The LSE partnership

Mongolia took a historically important step to develop its capital markets when MSE and London Stock Exchange (LSE) signed the landmark Master Service Agreement to manage the MSE on April 7 2011.

Through this agreement the MSE will be modernized with the LSE’s support over the next three years. LSE will introduce an integrated securities trading system, create an effective legal and regulatory environment, and will bring infrastructure, technology and human resources capability in line with international standards. LSE has appointed a management team at the MSE to oversee its development and privatization, and has brought in Millennium IT, the leading global exchange technology provider, to assist with trading, surveillance and post-trading infrastructure.

The partnership should bring modern market rules, procedures and operations, as well as broadening tradable asset classes to derivatives and ETFs. The ultimate aim is for MSE to become a regional resources hub for international investors. In future it may even attract resources listings from neighbouring countries.

“The main purpose of the agreement is to bring the stock exchange to international standards,” says Bayarsaikhan. “A lot of work has been done so far on the legal framework, on IT, and in corporate governance and transparency. The future is bright and all the professional players in the market are working hard.”

In Eurasia Capital’s view, this partnership should accelerate the process of MSE becoming a viable source of capital for Mongolian companies and an efficient channel for wealth distribution from mineral resources among the Mongolian population.

Private equity

Flurry of M&A Activity

In recent years Mongolia has seen a flurry of M&A activity, particularly in the resources sector. M&A volumes doubled from 2009 to 2010 to a record level of over US$1bn, most of it in mining, and chiefly coal; international interest has grown dramatically since the investment agreement on the Oyu Tolgoi (OT) mine was signed in late 2009. The origins of acquiring companies were diverse but Hong Kong and Australia led the charge: Hong Kong was involved in US$473mn worth of M&A deals through injections of resource assets into existing publicly listed companies.  Australian companies have not only bought assets but held IPOs.

This year M&A activity is more vibrant still. Total deal value for the first half of 2011 increased 45% year on year to US$636mn, and had reached US$690mn by July 27; Eurasia Capital expects another record year. Close to 50% of the announced deals were reached in participation with Australian companies, suggesting Mongolia will continue to be on the radar of cash-rich mining companies that have strengthened their cash positions through improved operational efficiencies and high commodity prices. The Erdenes Tavan Tolgoi deal will impact this year’s numbers: some bankers estimate the overall worth of the asset at US$15-20bn.

Fixed income: Bond Market Kicking off

Until very recently, not many people knew of the existence of the bond market in Mongolia. But it is becoming more active. The market has been waiting for the right time and conditions while building knowledge, experience, and infrastructure. News about bond issues is not on-and-off anymore; the market is underway.

The Mongolian Government is being cautious in approving new issues, knowing the damage any default would cause to the reputation and credit rating of the market. Government issues have focused on national benefit: for example, in September 2010 it issued a MNT60bn bond, half of which was offered to the public, to fund the “4000 Apartments for Public Servants” project. So far, offers worth MNT69.6bn out of a planned MNT72bn have been launched for project funding.

Backed by confidence in Mongolia’s expected growth, the government is planning another offering to support the cashmere and wool sectors, and small-to-medium enterprises.

Through the Development Bank, established in 2010, big industrial, infrastructure and mining projects will be funded and the government will issue MNT800bn bonds for necessary funding as new projects come up. The Bank also supports those projects by providing guarantees to the loans. Both domestic and international investors can participate.

Corporate bonds will become an interesting area for investors. For most of the companies who intend to tap the debt markets, it is a testing period: they need models to follow, but there have been only 12 issues since 2001. But by waiting, they risk losing out to competitors. Just Agro has made the first move this year to attract bond investors with a MNT30bn bond offering. If successful, other companies may follow.

Trade and Development Bank (TDB) is the only bank in Mongolia to tap the international bond markets so far, with a US$75mn deal in 2009 (successfully repaid), and two new bonds in 2010. Other banks, Khan Bank and XacBank, have followed suit and announced smaller debt issues. But bank deposits, offering more than 11% returns in MNT, remain favoured by many local investors.

BOX: Currency

After an impressive 12.9% appreciation in 2010, the Mongolia tugrik (MNT) has been relatively volatile this year, appreciating 1.6% year to date by August 4. Eurasia Capital believes it will remain a strong currency to hold. This confidence comes from expected capital flows to the large projects in the mining industry and infrastructure: FDI was US$1.5bn in 2010. The revenues from the two mega-projects of Tavan Tolgoi (coal) and Oyu Tolgoi (copper and gold), both under development, will consolidate the MNT for many years to come. Mongolia’s exports of mineral resources will dramatically increase when the necessary infrastructure, including the rail lines, become ready.

The currency is comparable to other resource driven currencies, such as the Australian dollar or Brazilian Real, which have experienced large appreciation. The MNT has emerged as a new resource currency and is increasingly correlated to the export commodities. It represents an excellent carry trade opportunity.

SECTION 5: PROPERTY, INFRASTRUCTURE AND FINANCIAL SERVICES

Property

As mining has brought wealth to Mongolia, the property market has experienced speculation and rapid expansion. After the highest ever price for a luxury residential apartment was registered at US$8000/sqm in the new Blue Sky Tower, an April Fool’s joke by a local broker about Donald Trump’s plans to build 120-storey “Trump Tower” for US$1bn in the center of Ulaanbaatar was picked up and distributed by some respected online sources.

Although Mr. Trump is not planning to build a tower in the capital city of Mongolia, the property market is poised to benefit from the country’s mining-led economic growth. Already, the residential, office, retail and hospitality property segments have consistently grown over the last few years, with supply struggling to meet demand. The market in Ulaanbaatar stabilized in 2010 following the turmoil of 2008-2009, and has benefited from increased inflows of foreign capital. Industry experts expect a period of accelerated growth.

Residential property prices in Ulaanbaatar have nearly quadrupled since 2002, although the global financial crisis corrected the steep market growth up to 3Q2008. The past year’s strong economic growth, national currency appreciation and speculative inflows of foreign capital for Mongolia have driven residential property prices up nearly 20% in the capital; the average residential property prices in 2010 was around US$900 per square meter, although much of that can be attributed to the 12.9% MNT appreciation.

Although foreign investors have an impact, the growing number of wealthy Mongolians is also significant, boosted by successful capital raising by mining companies. Fundamental demand for housing in Ulaanbaatar and nationwide will be a key driver of near-term growth. Since 2005, the population of Ulaanbaatar has increased 22% to 1.16 million, which represents over 40% of the total Mongolian population. More than half of Ulaanbaatar’s inhabitants live in traditional “ger” settlements, whilst the others live in old buildings that are deteriorating fast. Facing the need to accommodate its population, the Mongolian Government has initiated several measures that stipulate construction of mid-budget accommodation through government support. These initiatives include programmes such as the “100,000 Apartments Project” which aims to alleviate the strains on infrastructure services, social services and pollution.

Despite the newfound wealth, more than one third of the Mongolian population lives below the poverty line. Increasing prices might deter low income earners from buying property. However, 2010 was marked by a revival in the mortgage market as major Mongolian banks have started providing loans to the population, albeit at high rates – currently from 11% to 28.8%, with required downpayments as high as 50% (but more commonly 30% and sometimes 10% if the construction company takes on some of the risk).

Ulaanbaatar is again crowded with construction cranes, just as before the 2008 crisis. Maybe Mr Trump will really build a Trump Tower in Ulaanbaatar during the next few years.

Infrastructure

Mongolia’s mining boom may stutter if the country cannot solve its infrastructure problems. Infrastructure is regularly listed among the major inhibitors of Mongolian growth, and vast investment is needed, probably in excess of the current GDP of the country.

The Concession Law, adopted in 2010, sets the legal framework for private sector participation in the development of infrastructure projects. The Mongolian government has approved a list of 121 projects in road and railroad construction, power generation and transmission, industrial development, urban development, telecommunications, education and healthcare, inviting private sector investments. Both foreign and domestic companies can participate in the projects individually or jointly. Concessions can be gained via open tender, competitive bidding or direct contract.

The development and expansion of railroad infrastructure is one of the most pressing issues in the Mongolian economy. To support its mining sector, Mongolia is currently focusing on extending its railroads to major mining areas within the country, as well as on opening trade corridors and export routes to neighbouring countries. In the next five to ten years, the country is planning to build about 5,700km of new railroads, providing easier access to Mongolian minerals and exports to neighbouring and international markets. The railroads will be constructed in three stages. The first stage, which has already started, envisages construction of a new 1,100km main rail line from the Tavan Tolgoi coal deposit to Choibalsan, the town connected to Russia by the existing railroad. The new main line will intersect the existing Trans-Mongolian Railway in Sainshand station in Gobi region. Mongolian Railways was selected to implement the project. The project is in feasibility study stage. It is expected to be completed in the next 4-5 years.

In the near future, major infrastructure projects in Mongolia may offer numerous investment opportunities. Construction of new railroads would create opportunities for investors, construction and operating companies. A new US$10 billion development, the Sainshand Industrial Complex near the Chinese border, will be a hub to process Mongolian raw materials for export, and should spur investor interest. A number of other government-priority projects will be open for private bidding in the coming year.

Financial services

Mongolia’s banking industry endured a difficult financial crisis in which two banks failed. But there is a sense that it has returned to health on the back of the growing economy. N Zoljargal, Deputy Governor of The Bank of Mongolia, the central bank, says the banking system has “never been better than it is today. It is very healthy.” Those banks that survived the crisis are now strong. “During the crisis our banks were well managed, beefed up their liquidity, and since then have seen high growth in assets.” Non-performing loans, which at one stage topped 20%, are now around the 6% mark, he says, and “coming down dramatically” as previously troubled businesses in construction and other areas pay back their loans. As Zoljargal says: “It the economy is growing 10%, it’s hard to produce NPLs. You have to be doing something very wrong.”

Some local banks with distinct strategies look healthier still. Xac Bank’s NPLs peaked around 7% and today stand at 1.7%, according to CEO Bat-Ochir Dugersuren, because its portfolios are well diversified. Xac Bank is an interesting study: founded in 1998 under a UNDP program, it is fundamentally a microfinance institution, with a governance and shareholder structure unique in Mongolia (EBRD and IFC are stakeholders, and the board is independent). Today, SMEs are very much a focus for expansion. “We have big corporates in this country but I don’t believe they are going to expand and carry the country’s growth forward,” says Bat-Ochir. “We need a broad base of promising SMEs to allow double-digit growth to take place in our economy.” Xac Bank, like most, gets around 90% of its income from interest, and accepts that growth in other business lines will have to take place to diversify earnings.

Another example of an unusual strategy is Chinggis Khaan Bank. Chairman Sergey Gromov – a pioneer investor in Mongolia whose holdings also including the leading brewery APU and the insurer Mongol Daatgal, discussed below – says the bank focuses on areas like agriculture and building materials, but not mining. “Agriculture has huge potential,” he says, pointing to the sheer scale of land and the as yet limited use of fertilizer or other techniques.

International players such as ING and Standard Chartered have started to appear in Mongolia, though chiefly with representative offices rather than significant on-the-ground commitment so far. PricewaterhouseCoopers, KPMG and Ernst & Young are also represented.

Eurasia Capital is the nation’s leading investment bank today, and it is likely that this will be a growing part of the market in future. “There will be more of a focus on long term investment funds and institutional investors in future,” says Bayarsaikhan D, Chairman of the Financial Regulatory Commission of Mongolia. As the finance ministry interview explains, two quasi-sovereign wealth funds – the Stabilization Fund and Human Development Fund – are being developed, while a development bank focused on long-term infrastructure has been formed and will soon start lending. The development of new investment, capital markets and securities laws, in varying states of readiness, will help growth.

Another area ready for dramatic growth is the insurance industry. Mongol Daatgal, the country’s first insurer, dates from 1924, but the industry is still in its infancy; only one company provides life insurance, while a handful of others provide property and commercial cover. “It is a very virgin market,” says Batzul Tumur-Ochir, Mongol Daatgal’s CEO. “It only holds 7.4% of GDP, and total premium income in 2010 was just US$30 million for the whole industry. People have not understood insurance, or have seen it as a cost in the past; but now the economy is growing because of the mining industry, people have more money from wages and may spend some on insurance.”

On top of general economic growth, legislation will drive the industry too. Mongolia today does not have mandatory insurance for drivers, but this year a new law is likely to change that. “That will automatically give a 30 or 40% increase to the market,” Batzul says. Professional liability insurance will also become mandatory in the near future, while the growth of the mortgage market is also going to feed through to insurance – through corporates and banks, and through individuals. Batzul plans to enter life insurance too within three years, as he also sees momentum for growth there.

Indonesia’s finance minister believes a crucial new law, one he hopes will galvanize the country’s flagging infrastructure sector, will be passed in the third quarter of this year.

The development of infrastructure is widely seen as the biggest impediment to Indonesia growing from its solid growth rates today – 6.1% GDP growth in 2010, and an average of 5.7% a year since 2006 – to being a true leader in global growth. “To be frank with you, the bottleneck [stopping] our economic growth achieving 7% or higher is infrastructure, so it is a national priority,” said Bambang Brodjonegoro, head of the Fiscal Policy Office within the Ministry of Finance.

One of the biggest problems, particularly endemic for highways, is disputes over the rights to the land the highways will pass through. This has stopped development and impeded a public-private partnership (PPP) infrastructure program taking root. “If we review PPP projects in Indonesia for the last eight years, we have to admit that no one can be executed,” said Agus Martowardojo. “One of the main obstacles is land acquisition.”

To counter this, a draft law, the Land Acquisition Bill, was put into parliament earlier this year. The bill – naturally somewhat controversial among Indonesian landowners – means that land rights in public infrastructure will be cancelled and owners compensated. Vitally, where disputes arise, a court must rule on them within 30 days. This is in sharp contrast to the situation today where disputes often take two years or more, sometimes longer than building the road itself.

Asked about the bill’s progress by Emerging Markets, Agus said: “The government has already reached consensus with parliament that we will have a special law for land acquisition. We believe by the end of the third quarter, we will have that law.

“With that law, we are confident that infrastructure projects can be executed faster.”

Analysts say progress here is vital for the broader economy. “The only major drawback for Indonesia is still the infrastructure,” said Ferry Wong at Macquarie. “Inflation and the fuel subsidy are challenges, but not so much of an issue, as the government can absorb high oil prices. Infrastructure is the main problem.” Mr Wong said that infrastructure development would have spillover effects into the economy such as encouraging greater and more confident foreign direct investment.

In every other respect, the Indonesian economy is humming: a commodity rich economy in a demographic sweet spot; a stable democracy with vibrant domestic consumption and record high foreign currency reserves that passed US$100 billion earlier this year. “The vital signs for the Indonesian economy are at their strongest in the last decade, and the fundamentals are improving,” Mr Agus said. He is targeting growth rates of as much as 7.7% annually by 2014. Rating agencies, most recently Standard & Poor’s in March, have been upgrading the country, with all three international agencies rating it just one notch below investment grade. There are only two concerns: inflation and the danger of a sudden outflows of foreign capital.

“Even though there is pressure from commodity prices, specifically food, core inflation has been relatively stable,” Mr Agus said. “We are confident the government will be able to retain inflation within the target for 2011.” That target is 5.3% and not everyone agrees with him: Fitch, which calls inflation “a near-term risk to economic prospects”, estimates it will average 6.5% in 2011.

Intheblack magazine, July 2010

In late May, Juan Miranda was in the Afghan town of Mazar-e-Sharif, attending the inauguration of Afghanistan’s first railway. As Director General of the Central and West Asia Department of the Asian Development Bank, Miranda had been involved in the funding and development of this railway, a vital 75-kilometre link to the border with Uzbekistan and the international railway networks beyond. But as he stepped back to take a photo of the train moving slowly backwards and forwards on the tracks, he noticed a huge transmission line in the back of a shot, and a road behind it. He realised he had been involved in the development of all three.

When you are a multilateral banker in this part of the world, the work can be tough, but when it works out there’s the joy of seeing a tangible difference being made. And Miranda’s patch of Asia is all about high challenge and high reward. His department operates in 10 countries most of which few people could successfully locate on a map (and, if they could, it would be for all the wrong reasons): Afghanistan, Armenia, Azerbaijan, Georgia, Kazakhstan, the Kyrgyz Republic, Pakistan, Tajikistan, Turkmenistan and Uzbekistan. It is a patchwork of mostly landlocked countries with sometimes random borders, stubborn bureaucracy, limited commercial laws, dominated by mountains and deserts, into which Miranda must coax international private capital to invest.

The challenge is not just about getting foreigners to come in, but to get these disparate nations to work together too. One might expect the former Soviet states to be kindred spirits, but that’s often far from the truth. “After independence from the Soviet Union, these countries embraced sovereignty like you and I would a long lost brother,” Miranda says. “But as a result of that they created economic structures that were directed towards self-sufficiency and putting up borders.” The ADB is one of six multilaterals that backs the Central Asia Regional Economic Cooperation (CAREC) programme, which seeks to improve efficiencies between Central Asian nations, focusing on connectivity, energy security and trade facilitation. “The nearest port to some of these countries is 2,000 kilometres away,” he says. “Unless people can move from point A to point B efficiently, you’re not going to be very competitive.”

Miranda, CAREC and the ADB have focused their energies on transportation, and have devised six transport corridors, some north-south through Afghanistan and into Pakistan, others traversing Kazakhstan from east to west to link Europe and China. And this speaks to an advantage Central Asia does have: being in the way, separating Europe and China. Becoming an efficient conduit for goods between these states will be to Central Asia’s benefit, and will cement a shift away from reliance on Russia and towards greater integration with China. Other less visible things are no less important: trade facilitation, such as removing tariffs and speeding up the flow of goods across borders, is crucial to the ADB realising its ambition of doubling per capita income within the region within a decade, pulling poverty down from 40% to 25% in the process.

The good news is that when something works, it really has an impact. That transmission line in the back of Miranda’s photo in Afghanistan runs from Uzbekistan to Kabul, and supplies it with constant electricity for the first time. “Delivering electricity 24 hours a day instead of two hours a day is a transformation,” he says. “It’s not a solution in itself, but it’s a means to an end.” By this he means that helping with infrastructure makes it a little easier for Afghanistan to find its footing as a country. “Optimism is something that can come and go, but we have to let it be with us,” he says. “You’ve got to wake up in the morning thinking that you’re doing good. The task is not for the faint-hearted and the security aspects are not getting any easier but I am optimistic this resilient country, these resilient people, can put things together.”

“The political differences between groups across the country are clear, but one thing that binds them together is to reconstruct the nation, and to do that you need development,” he says. “We are part of that agenda, to do projects that will make a little difference to the country.”

Elsewhere in Central Asia, the ADB has been making gradual headway. Talking to IntheBlack at the ADB’s annual meeting in Tashkent, Uzbekistan in May – the first time the bank had held its meeting in Central Asia – Miranda bemoaned the lack of a landmark public-private deal that would get the region truly noticed. “We haven’t had in Central Asia the unique transaction that says: the future looks like this,” he says. “If one happens, we’ve created a message. We convey an opportunity to the international investment community that this place is open for business.”

A month later, over the phone in the ADB’s Manila headquarters, he is able to suggest that such a deal is finally close to the finish line. The $3.2 billion Surgil project in Uzbekistan will involve the construction of a petrochemical plant with a production capacity of more than 500,000 tons of polypropylene and polyethylene, made by converting gas deposits. It will be structured as a PPP (a public-private partnership) and will combine a number of foreign investors – who have not yet gone public in their involvement – with the Uzbek state oil and gas company, with the management and the exports run by international shareholders. “In turning gas into chemicals it moves a commodity into a value-added product with an international market ready-made,” Miranda says. “If it works well, instead of just exporting their gas they can get foreign investment into the country and generate jobs.”

Getting foreigners in requires more than just a visible opportunity. What’s also lacking is the legal infrastructure to protect and encourage an investor. “In Central Asia we have the big ticket projects waiting for the private sector to invest, but unlike other parts of Asia the upstream work lags behind,” he says. There are places where concession laws do exist – Kazakhstan has gone so far as to build a dedicated PPP unit within its government and has an approved list of projects for it to pursue – but few foreigners have so far been willing to jump in. “There is a comfort zone that is not that huge here, and we need to expand that comfort zone.”

Uzbek landmarks apart, he thinks it’s important to be reasonable in expectations. “Would you be able to have an all-singing, all-dancing concession and BOT [build-operate-transfer, the classic public-private model in more developed markets]? Maybe not right now. Maybe you go in more realistically and expect a management contract to start with. If you go from zero to something that’s no longer zero, that still represents success.”

Miranda himself, who is Spanish-born and English educated with a degree in agricultural economics from Reading University, first visited Central Asia in 1992 after the Soviet Union was dismantled. Back then he was working at the European Bank for Reconstruction and Development. When he took over his current department for the ADB in 2006, he felt that he had “a longer memory of the region” thanks to his earlier role, and he remembered its potential. “They have the things that everybody should want: a growing market, investment opportunities for regional and international players, and an area strategically as important as most. It is an area with rich traditions but is landlocked and needs to be integrated into the world economic system.”

Miranda’s career has involved plenty of private sector work between the multilaterals: at once stage he set up and managed his own project finance boutique investment bank that he later sold to Morgan Stanley, becoming a senior executive at the US powerhouse as well as a stint in a Spanish investment bank. People who have sold their own banks to Morgan Stanley don’t generally need more money, and one suspects he is drawn to this ADB role, with its dismal flights and endless visa queues, out of a sense of duty. “Central Asia has the importance and that thrill where things are yet to be done,” he says. “As a development bank we like to be involved with change.”

And, once in a while, there’s a visible reward. That Afghan railway, the first in the country’s history, built across unforgiving topography in a nation at war? It was finished ahead of schedule.

BOX: Out of Hours

What are your interests?

Lots of them – music, sports; I play golf well enough to beat most of my colleagues. I like classical and jazz music and I like to watch football – I’m a long-standing fan of a team called Deportivo La Coruna. I’m happy to report to you that we beat Manchester United twice.

What words do you live by?

Accountability and responsibility.

What keeps you awake at night?

The happiness and health of my healthy and happy children.

What are you reading?

Henry Kamen’s Spanish Empire. It argues that the empire could well have been the first big example of globalization and outsourcing!

If you want to get a sense of the challenges facing Central Asian trade, take a look at a map. Landlocked countries, some of them with at least two other nations between them and the sea in any direction; harsh terrain; and intricate, apparently random Soviet-era borders, often drawn without regard for communities or trade routes. “The nearest port to some of these countries is 2,000 kilometres away,” says Juan Miranda, Director General of the Central and West Asian Department at the Asian Development Bank. “Unless people can move from point A to point B efficiently, you’re not going to be very competitive.”

The CAREC programme – for Central Asia Regional Economic Cooperation – aims to help create this efficiency. It includes eight countries – from Azerbaijan in the Caucuses, across Kazakhstan, Kyrgyzstan, Uzbekistan and Tajikistan, plus Afghanistan to the south and Mongolia and China to the east – and is backed by six multilaterals, including the Asian Development Bank, which serves as secretariat to the CAREC Institute. “The programme aspires to find ways for countries in the region to work together for the good of all,” Miranda says. Specifically, it tries to work in three main areas: connectivity; energy security; and trade facilitation.

Part of the challenge is historical, Miranda explains. “After independence from the Soviet Union, these countries embraced sovereignty like you and I would a long lost brother,” he says. “But as a result of that they created economic structures that were directed towards self-sufficiency and putting up borders – economic borders. CAREC is about doing away with those.”

The most practical illustration of this is in building roads to enable goods to move. And here, the region does have one geographic advantage: it’s in the way. It separates the powerful blocs of Europe and East Asia, and if it can become an efficient conduit for the goods moving from one region to the other, then Central Asia should benefit.

The program spent more than US$2.5 billion on the transportation field alone last year. It envisages six transport corridors: one traverses Kazakhstan to link Europe and China; another links East Asia to the Mediterranean through the Caucuses; others go north-south, connecting the region through Afghanistan and Pakistan. It’s not all roads: the program is backing a rail link between Hairatan, on the Uzbekistan border, and Mazar-e-Sharif in Afghanistan. Here, an Uzbek company – the national rail utility, Uzbekistan Temir Yullari – is handling the construction in Afghanistan in exactly the sort of regional cooperation the ADB wants to see more of.

The program’s ambitions on energy embrace security, efficiency and trade. The idea here is to ensure balanced development of energy infrastructure and institutions in the region, with better integration of energy markets themselves. An example is a new transmission line from Uzbekistan to Kabul. “Today, it supplies Kabul with 24 hours of electricity a day,” Miranda says. “Ten months ago if you went to Kabul you would only get two hours a day. It has been transformational: it has helped business and people.”

Trade facilitation, while less visible than a road or a power station, may prove to be the most important of all, and the toughest to effect. If it works, some of the ADB’s grander ambitions – that increased regional cooperation could double per capita income in the region within a decade, and pull poverty down from 40% to 25% in the process – become realistic. “Cross-border activity is critical,” Miranda says, “especially when many countries are landlocked.” He estimates that within the next 10 years five to 10 per cent of Eurasian trade will take place through the various corridors the program is working on – but that’s only going to work if, to go with the new roads, there are streamlined border and customs processes to go with it. “We cannot only focus on the hard infrastructure: the roads being safe and well paved and maintained. We also have to focus on border arrangements so there are fewer delays on the borders. At the moment it takes too many days; we have to bring it down to several hours.”

Getting the cross-border side going requires not only cooperation but trust. “We have to build confidence between the countries again,” Miranda says. Efforts in this area include customs reforms and modernisation, such as harmonised and simplified procedures and automated systems; and integrated trade facilitation, with the adoption of a single window scheme to streamline transport, trade logistics and customs. There will also need to be reforms to create sound legal frameworks and regulatory environments in order to give the private sector confidence to come in and invest.

When IFR Asia spoke to Miranda Kyrgyzstan was in the headlines following the coup there, but in fact – Afghanistan apart – the region has been reasonably peaceful. “We’re very sorry to see the events in Kyrgyzstan but we haven’t generally had political instability – in fact there has been considerable stability,” he says. He hopes it won’t put off investment and that people will be able to distinguish one market from another. “Many countries are opening up and looking for investors and financiers,” he says. “The investment requirement is high and the opportunity is high.”

For many years now, the Asian Development Bank has being trying to coax the private sector to take a leading role in its projects and initiatives. The logic is straightforward: the ADB’s own assets as a lender are finite and inadequate for the social and infrastructure challenges the region faces, but if the bank can be a catalyst for private sector investment, then impossible funding targets become potentially achievable.

Last year the ADB put out a book, Infrastructure for a Seamless Asia, which argued that between 2010 and 2020 Asia needs to invest approximately US$8 trillion in national infrastructure, as well as $290 billion on specific regional infrastructure projects in transport and energy. On the flip side, it argued that if this happened, “developing Asia’s real income during that period and beyond could reach $13 trillion.” This contention – that if you spend money, you will make money – is the message the ADB must get across to the private sector.

How’s it done so far? “As a bank I think we’ve made tremendous progress both from the perspective of real investment, and catalysing additional investment in the region,” says Philip Erquiaga, director general of the Private Sector Operations Department of the ADB. Firstly, the bank has “ramped up our operations rather dramatically” in pure dollars and cents commitments, Erquiaga says. “Back in 2001 we were doing less than $100 million a year [private sector operations] in terms of approvals; last year we were close to $1.7 billion, with $1.8 billion anticipated this year.” By 2020, the bank hopes that engagements in private sector development will account for 50% of approvals.

Alongside that, the ADB has put heavy resources into what Erquiaga calls “upstream work” – creating the right environment for private investment, from company law and land registration to adjudication. Another challenge has been capacity. “If there is one lesson we have learned in dealing with the private sector in our operations, it’s that they don’t want the rules of the game to be changing on them midway through their investment. To ensure that does not occur you need to establish the right environment and to ensure that a PPP is staffed with the right people with the right competence.”

Since the ADB can only ever take a 25% role in the financing of a project, it has necessarily moved from being a banker to a broker. “It’s in our nature to act as a broker to make sure the deal gets done,” Erquiaga says. This, though, has changed as a consequence of the financial crisis: these days the ADB finds itself putting a lot of deals together with other international agencies, rather than with commercial co-financing. When the New Bong Escape hydro plant in Pakistan, the country’s first run-of-river hydro development, was financed last year, the ADB was alongside the Islamic Development Bank, IFC and Proparco, the French development finance institution. “Otherwise the financing would not have been available,” Erquiaga says.

Hopefully, though, that retreat of the private sector is temporary, and in the meantime the ADB continues to try to provide the facilities to keep them interested, such as political risk cover, partial credit cover – a guarantee can cover as much as 99% of credit on an individual transaction – and simply the ADB’s own participation. “A lot of people look to us for the halo effect,” says Erquiaga. “The fact that the ADB is involved in a transaction, with our close relationships with governments and so forth, means there are fewer instances of the rules of the game changing midway through.”

For many years the ADB has used a funds model to try to attract investment. The bank has been active in private equity since 1983, and today has 40 current funds, covering about 400 individual portfolio companies, with around $720 million of total current commitments.

Again, the ADB is held to a 25% limit on fund participation, but funds are one area where the catalytic effect of the ADB is easily measured. “If we look across the entire portfolio since 1983, we see that for every one dollar we have put into a fund, approximately eight is raised elsewhere,” explains Robert van Zwieten, director of the private sector capital markets division at the ADB. “That’s a huge effect and amplifies the impact we could have with our own resources.

“It’s far beyond what we ourselves could muster. The multiplier effect continues as funds then take minority equity stakes in portfolio companies.”

For much of the decade the focus was exposure to the SME and infrastructure sectors. “Those are widely seen to be a huge source of employment, and jobs are a conduit for poverty reduction,” says van Zwieten. From 2007 the department’s view broadened, with more activity in areas such as microfinance, clean energy and water, and socially responsible investing, as well as an increasing focus on frontier markets “where private equity is nascent or non-existent.”

The change of focus brought a shift in approach too: in clean energy the bank struggled to find suitable investable funds in late 2007, so stepped up to incubate some itself. That process entailed an RFP process that attracted 19 bids, five of which were accepted, and today they are “only just coming to the starting line, due to the harsh fundraising climate for such novel funds in 2008 and 2009.”

Hopefully these funds will, in time, be free-standing. One fund manager the ADB has long backed approached van Zwieten recently saying they hoped to start a fourth fund, and raise $700 million through it. “These follow on funds are getting a lot of mainstream institutional investors coming to the fore, which is exactly how it should be – but if they can do that, there’s no role for us,” van Zwieten says. The ADB’s own capital is better deployed in those that have yet to develop such traction.

The global financial crisis required decisive thinking from regulators, governments and institutions worldwide, but none more so than the World Bank, IMF and the World Bank’s finance arm, the International Finance Corporation (IFC). A decade ago, these groups were instrumental in trying to turn around Asian economies during the financial crisis there, and they were widely criticised for some of the measures they took. This time around, how did they do?

The headlines fell to the IMF by dint of the enormous sums involved, and the public nature of their announcement. In April, when the G20 group of leaders spoke of committing $1.1 trillion to combat the financial crisis, the bulk of it – $750 billion – was pledged to be delivered through the IMF, representing a trebling of its lendable resources. The institution’s emphasis appeared to be on building its power to act: as Andrew Tweedie, the director of the IMF’s finance department, put it in the IMF’s own in-house magazine, the IMF built bilateral borrowing arrangements “to strengthen its lending war chest to combat the ongoing global economic crisis”.

The IMF approach had some interesting elements, particularly the $250 billion allocation of a reserve asset called Special Drawing Rights. In July the IMF’s executive board approved a framework for the issuance of IMF notes to member countries and their central banks, as a method of raising funds and – the IMF says – providing members with a secure investment. Additionally it has expanded credit agreements, increased concessional lending to very poor countries, brought forward a review of the fund’s country quotas, and is considering revising its own investment mandate with a limited sale of gold holdings to create an endowment to generate income.

But one could argue most of the interesting things about the IMF, chiefly reform, are still to come and not yet really up for review. Instead, when it comes to individual, technical programmes, many of the most interesting policy initiatives relevant to financial markets came out of the IFC, part of the World Bank group. All told, its programmes designed to help private enterprises cope with the crisis are expected to involve more than US$30 billion of financing over the next three years – not all of it from the IFC, but in combination with funds mobilized from governments and other financial institutions. That is in some sense the point of the IFC: not to put a vast balance sheet on the line in isolation, but to use it to draw in other sources of funds.

From that perspective, the most obvious cause for alarm at the outset of the financial crisis was trade. Trade is, as the IFC has frequently said over the last year, “the lifeblood of the global economy”, and it was immediately under threat. As capital moved towards lower-risk assets, it left emerging markets, with trade finance lines being cut in some of the areas that needed it most.

The IFC already had a Global Trade Finance Program, basically a one-off guarantee facility which did not deploy funds for trade but did provide support in the form of guarantees in order to make sure emerging market trade transactions would still go through. So its first step was natural: it doubled the size of this programme, from US$1.5 billion to US$3 billion, in December 2008. But something strange happened.

“We thought when we doubled the programme there would be immediate uptake across the markets,” recalls Scott Stevenson, manager of the Global Trade Finance Program at the IFC. “But when we made that increase the immediate uptake was much less than was anticipated.” Banks had pulled back all their own capital, and in Europe they were further constrained by the arrival of Basel 2 with its heavy risk weighting towards emerging market exposure. “It was a convergence of negative effects, but it meant that global liquidity collapsed – not only the interbank market, but liquidity available for trade finance.”

What was needed was not the guarantees, but the pool of funding in the first place. “When we saw the market dry up like that we started fishing around for what we could do,” says Stevenson. “It was not just a drying up of liquidity but the entire secondary market, because the investors who would traditionally be buying up the securitized trade portfolios had put their tails between their legs.” So the IFC’s next step was to build what it calls the Global Trade Liquidity Pool, which among other things was a sort of synthetic secondary market. At that point, the World Bank was estimating that the gap in the liquidity in the system, between what was there and what was needed, was between $200 and $400 billion, clearly beyond the remit of the IFC balance sheet or anyone else’s in isolation. The idea was instead to partner with governments and development institutions to pool resources, and then to get the banks themselves involved: “established international players with footprints in emerging markets, who had liquidity but not the secondary market to churn their portfolio,” Stevenson explains. The banks would create portfolios, the pooled IFC fund would purchase 40% of them, and the banks retain 60%. IFC’s own contribution to the fund was $1 billion, additional donors $3 billion, and the involvement of the international banks is intended to put a further $6 billion to work, making a $10 billion programme.

It took time, but by April the World Bank was able to announce that the UK, Canadian and Dutch governments were all involved, and that the first two lines, of $500 million and $400 million, would go to Standard Chartered Bank and Standard Bank respectively (in Standard Bank’s case as a full loan rather than the 60/40 arrangement, since Standard’s extensive networks in Africa were deemed vital). Since then Citigroup and Rabobank have agreed terms, while Commerzbank and JP Morgan will be next.

The theory of the scheme was widely supported, with criticism instead focusing on the length of time involved to get it running. The IFC funds were put to work at the end of June and the commitment for donor funds is in place, but at the time of IFR’s interviews, in early September, disbursement of the pooled funding had still not taken place, although it may well have done so by the time this article is published. “I think the lesson learned is that in dealing with public sector counterparts, a lot more time is necessary in terms of response,” says Stevenson. While private sector institutions were, he says, the ones who pushed the programme, “from the donor side you do get into the machinations of governments, and that’s the slower part.”

Although the global markets have clearly improved dramatically in the meantime, Stevenson has little doubt the funds will still be necessary. “Because of the advent of the increased capital rules that Basel 2 is demanding, a lot of the major banks are still constrained in terms of what they can do in higher risk countries of the world,” he says. “That really is the focus at IFC as well as other donors. First tier banks are fine and seeing liquidity come back into the market. But second and third tier banks in those countries, for them, liquidity has not returned.” In fact, he has no doubt that additional funding is going to be necessary. “If you look at the overall ability to respond to the shortage in the market, this is – I don’t like to use the term – a drop in the bucket.”

While it would obviously have been preferable to see funds deployed faster, a benefit that may have come from the process is an unprecedented level of cooperation among world bodies. “This was a crisis that was well beyond what anybody would have imagined,” says Jyrki Koskelo, vice president for Europe, Central Asia, Latin America and the Caribbean, and global financial markets and funds, at the IFC. “It forced everybody to work together. Some of these initiatives helped us and the international community to align our interests, and when we worked on that basis the damage was contained a bit more than if the IFC had done anything alone. A lot of it is signaling to the market: this is what happens in a crisis, and this is what had to be done.”

While trade and liquidity were among the most visible problem areas, there was plenty else to worry about too. Another example was microfinance, which in a relatively short time has become absolutely vital. According to Martin Holtmann, who heads microfinance for the IFC, there are believed to be about 140 million households in the world that have access to microfinance credit, and a much larger number who have access to micro savings. Many of these institutions, and the people who borrow from them, faced a double hit within the space of the year, first with the vast food price rises in 2007, and then the financial crisis. Deposit-taking microfinance institutions, excepting some problems in Eastern Europe and particularly Ukraine, came through the crisis largely unscathed and in some cases enhanced by the run on commercial bank deposits. But those that exist chiefly to provide credit faced a serious liquidity crunch. “Take a country like Bosnia,” says Holtmann. “There would normally be commercial banks providing funding to the MFIs [microfinance institutions] but that supply has totally disappeared, creating a liquidity issue. You wouldn’t call it a crunch, because MFIs like any other prudent institutions had secured medium term financing, but eventually you hit the rollover risk, and certainly that’s happening in certain parts of the world.”

So IFC set up a $500 million facility, the Microfinance Enhancement Facility, with the German development bank KfW to support microfinance institutions facing refinancing difficulties. It aims to support more than 100 institutions in up to 40 countries. “The top 150 microfinance institutions in the world account for roughly 70 to 80% of the total supply out there. That’s essentially the group this facility is targeted at,” says Holtmann. At the time of our interview about $140 million of funding had already been approved, mostly in the area covering Eastern Europe and the Balkans, and Latin America. (Perhaps surprisingly, African institutions suffered less in the crisis, partly because they have tended to have more access to deposits, and also because the crisis had less of an impact on African than it did in, for example, Eastern Europe).

As elsewhere, things have already improved, but Holtmann says it is “too early to cry victory.” He sees quasi-commercial investors coming back into the market, but “a creeping up of portfolio at risk – a slow deterioration of loan portfolio quality.” Even so, this is not so bad compared to many retail banks since the default rate on microfinance portfolios is often strikingly low, although he says institutions in Bosnia, Morocco and Ukraine are on the watch list. In some cases, there is a need for capitalization, and part of the IFC’s role is to provide the right instruments for that, whether equity infusions or subordinated debt.  “When the crisis hits you first and foremost need liquidity, you don’t worry so much about solvency,” he says. “In the long run of course you do have to worry about solvency, but the moment you’re illiquid, you’re dead.”

One interesting element of the microfinance response is that the facility is managed externally, by BlueOrchard Finance, responsibility Social Investments and Cyrano Management, all specialist fund managers. This, Holtmann says, increased the capability. “Last  year we did 33 transactions in microfinance. With these fund managers we can triple, quadruple the number of transactions.”

Another vital area requiring a response was infrastructure. “In several countries in the world today which are developing infrastructure projects are funded only partially with a long term debt structure with quite a bit of it based on rollover maturities,” says Koskelo. “When that [the ability to roll over debt] stops, the good infrastructure projects get stopped as well.”

Usha Rao-Monari, senior manager in the infrastructure department at the IFC, recalls: “A number of projects had come to the market for financing and were not getting it, and in a number of other projects preparation was stopping because of fears that they wouldn’t get long term debt.” She recalls from the Asian financial crisis how banks can back away from this capital-intensive, long-term sector; “it ended up becoming what is known as the lost decade for infrastructure in Asia. We did not want to repeat that.”

The response here was the Infrastructure Crisis Facility, which has debt and equity components. The debt side had raised US$2.4 billion when announced in April and Rao-Monari hopes by the annual meeting in Istanbul in October another $700-800 million may be in place. Then on the equity side, $1 billion is targeted; IFC has approval to put in $300 million of its own balance sheet on the equity side and up to $2 billion in loan co-financing. But – once again – as yet, none of it is deployed yet. “We already have a pipeline of projects waiting for it to be set up and we will start putting money up almost instantly,” Rao-Monari says. Her hope is that, when funds finally do get put to work, “it will send such a huge signal to the market we are going to be deluged by projects. There is stable financing available, Mr government representative and Mr private sponsor, so don’t worry about building projects.”

Then there’s agribusiness. During the 2009 financial year IFC invested $2 billion – a record – across agribusiness, through the supply chain from farm to retail, to boost production, increase liquidity and improve logistics, as well as increases access to credit for small farmers.

Elsewhere, the IFC Capitalization Fund was launched with $1 billion of the IFC’s money and $2 billion of Japan’s, through the Japan Bank for International Cooperation, in order to provide additional capital for banks in developing countries, in subordinated loans or equity investments. Here, too, little has been dispersed, although the first investment took place in Paraguay’s Banco Continental, with a US$20 million contribution.

And IFC is also planning a private sector programme to take on and resolve distressed assets.”If you look at the NPL rates in Eastern Europe, there are horrible projections about where they might end,” says Koskelo. “We’ve tried to prepare ourselves for that. We haven’t signed individual NPL platforms yet but we do expect to sign some of the first vehicles for NPL funding soon.”

The capitalization fund in particular is an area that looks like shutting the stable door after the horse has bolted, with the financial environment now much improved, but Koskelo says there is every need for such a facility. “Unfortunately the capitalization needs are pretty much in line with what we expected,” says Koskelo. “There’s a significant uptick of demand today. There was a limited need about six months ago, because the crisis had not yet hit the banking sector properly through NPLs. Today, the pipeline of banks requiring capitalization is unfortunately increasing.”

Apart from criticism of the time taken to get things moving, NGOs have focused concern on the increased power of the IMF without a change in its policies. Speaking of the IMF funds, Peter Chowla of the Bretton Woods Project noted in August: “This substantial amount of resources may never be provided, and, if it is, may not have the intended positive effect on developing countries. Experience so far demonstrates that the IMF is still imposing damaging pro-cyclical conditions on some borrowers, and that the finance provided to low-income countries will be too small.” Chowla noted that by early July only $100 billion of the $500 billion of new lending that was supposed to come through the IMF had actually been signed off.

At Third World Network, another NGO, Bhumika Mucchala has argued: “At a time when devastating financial and economic crisis is calling into question the governance and policies of all the major institutions that constitute the existing international financial order, the IMF appears to have escaped any such major reevaluation…. The IMF, now financially reinvigorated with a fresh infusion of funds, is still pursuing some of its discrete policies.” Like Chowla, Mucchala wanted to see reforms in lending instruments, conditionality and policies “toward more even-handed and broad-based implementation which better meets the needs of its developing-country members.” Mucchala sees a contrast between loan conditions – for example, advising a reduction in Pakistan’s deficit through lowering public expenditure and removing energy subsidies; or, in Hungary, freezing public sector wages and placing a cap on pension payments – and the rhetoric of officials calling for fiscal stimulus programmes to boost demand and consumption. To this point Mucchala quotes the IMF’s wording in a $532 million loan to Serbia: “Anything less than a tight fiscal stance could… jeopardize the credibility of the programme in the eyes of foreign investors and the Serbian public.”

The charge that the IMF has opportunistically bolstered its own standing through the crisis is occasionally leveled at IFC too. Bretton Woods Project in July noted that the crisis had given the IFC an expanded role “but its methods may leave a bitter taste with civil society.” The NGO argues that the liquidity deals with Standard Chartered and others “likely subsidises their activities in the sector”. Bretton Woods is also uncomfortable with the formation of the IFC Asset Management Company, which will buy shares in emerging markets companies and will initially manage the capitalization fund, as well as a $1 billion private equity fund, with the intention of attracting third party funds such as national pension funds and sovereigns. Bretton Woods is not alone in this: Aldo Caliari from Center of Concern, another NGO, has said: “Access to credit [for developing countries] has traditionally rigged the playing field against developing country companies. Now, instead of fixing those asymmetries, this device will allow foreign investors to help themselves to any company they might have in their sights, bearing little or no risk, courtesy of IFC-provided public money.”

If you want a microcosm of the bad habits global capital got into as the credit crunch hit, go to Brisbane. The story of Brisconnections there has everything you need, and its conclusion – unresolved at the time of writing – will have major ramifications for the way infrastructure is funded in Australia and beyond.

BrisConnections was set up by Macquarie Capital Group and the construction firms Thiess and John Holland to design, build, operate and finance a A$4.9 billion airport toll road in Brisbane, under a 45-year concession awarded by the state of Queensland in May 2008. BrisConnections floated two months later at A$1 a share, lost 60% of its value in a day and by November had hit one tenth of an Australian cent, the lowest possible price on the Australian Securities Exchange. The A$1.2 billion float, underwritten by Macquarie and Deutsche, used an instalment model in which investors paid A$1 up front, with two more payments to come in subsequent years, meaning they remain on the hook for two instalments which will each cost 1,000 times more than the trading value of the stock today.

How did it get to this? There are many components to the BrisConnection story and they all speak to the way infrastructure has become commonly funded in western markets.

The wrong assets for listed markets. When infrastructure first started to make its way to stock market investors, it was typically when a government sold an operational power plant or road: a tangible asset, throwing off consistent cash, and something you could go and see if you felt so inclined. BrisConnections was typical of a trend to list projects that were not yet built. “Listed markets are a natural home for assets when they’re more mature and yielding,” says Lachlan Douglas, director of Principle Advisory Services, which structures private market investments for institutional investors. “They don’t tend to go a good job of being a home for assets going through significant transformation, and there’s no greater transformation than when the thing’s being built.”

Worse, retail investors who in Australia had come to see infrastructure as a safe haven failed to note the difference and thought they were buying a cautious yield play. Nor did they ask where dividends could be coming from when there was no asset yet to generate them: the answer was from borrowings. These things get away in the good times but as BrisConnections was launched at a time of quickly changing attitudes to debt, institutional investors (including Macquarie itself) quickly jumped ship, triggering the share price falls and putting most of the stock into retail hands.

Financial engineering. The source of the dividend was only one example of common financial engineering structures that have since backfired. The most obvious was the instalment method.

People buying into the float knew clearly that there would be three separate payments of A$1 each, a year apart, and while the method is unusual it is certainly not unheard of. The problem was that some small investors in the secondary market don’t appear to have realised this and inherited huge obligations when they bought in. One investor spent A$600 on the stock at 0.3 cents per share without realising that doing so committed him to A$400,000 of subsequent instalment payments. Others are up for millions. So it was that a housewife called Fang He found herself becoming the biggest individual shareholder in the company by mistake, followed more recently by a 26-year old Melbourne entrepreneur called Nick Bolton, a lank-haired bohemian figure in designer stubble and a beanie. (The sting in the tale was that Bolton used his shares to launch a series of motions to wind up the company in order to get out of paying the later instalments – then at the last moment sold his voting rights to the contracted builder, Leighton, for A$4.5 million and voted all his shares against the very resolutions he had proposed.)

At the time of writing it was still not clear if Macquarie and Deutsche were going to pursue small investors for the later instalments, suffering the crushing PR of putting people out of their homes by doing so, or wear the costs of the shortfall on the two scheduled A$390 million raisings themselves by taking the vehicle private.

October is going to be a big month for Papua New Guinea. It doesn’t sound much on paper: it’s the deadline for the final investment decision on a liquefied natural gas and pipeline project. But it’s a project that will change the country dramatically – economically and socially. In fact, it’s hard to think of another example anywhere in the world where so much, good and bad, might depend on a single investment decision.

The project in question is known as PNG LNG, and it is an attempt to commercialise undeveloped petroleum and gas resources in the highlands and western provinces of Papua New Guinea. The gas has to go through a 470 kilometre pipeline across rugged terrain to a liquefied natural gas facility 20 kilometres outside Port Moresby, the capital, for liquefaction; once there, about 6.3 million tonnes of LNG product a year will be loaded into tankers to be shipped to offshore gas markets worldwide. ExxonMobil, with its Esso Highlands subsidiary as operator, is the driver of the project with a 41.5% interest; also in there are Australia’s Oil Search (34%) and Santos (17.7%) and Japan’s Nippon Oil (5.4%) among others, with the PNG state expected to join as an equity participant at a later date.

The numbers attached to this project are extraordinary in any context, but particularly so in an economically small country where 85% of the population exists on subsistence agriculture. The development costs are put at between $11 billion and $14 billion, figures confirmed to Euromoney by the Investment Promotion Agency (IPA); once completed in 2013 or early 2014, it is expected to double Papua New Guinea’s approximately $12 billion GDP.

The consortium signed a gas agreement with the Papua New Guinea government in May and has since moved to what is known as the front end engineering and development (FEED) part of the project – a sufficiently big step that many seem to think the project’s development is now a foregone conclusion. “They are spending $400 million on FEED, so it would be silly to spend that kind of money and not have the project go ahead,” says Ivan Pomaleu, who heads the IPA. One foreign banker says he senses “100% certainty among local people that it’s going to happen.” But in truth it won’t be until October that the deal is confirmed. “That’s basically the point where we say yes, no or defer,” says Pomaleu. “That’s the moment when we can say: yep, we have a project; no, we don’t have a project; or we will have a project but not immediately. It’s a big project and we want to be sure.”

So big that those involved tend to use great understatement in describing it. “The scale [financially] will depend on commodity prices but if it doubles our current GDP, that’s quite big,” says Simon Tosali, secretary for the department of treasury. “It will be the biggest project this country has ever undertaken in its 34 years of independence. So it’s going to be quite big.”

The knock-on effects will be varied, and not entirely to the good. An increase in wealth on this scale obviously has enormous potential for budget revenues and the ability to fund badly needed spending on schools, hospitals and roads, among other things. There’s also the demonstration effect to consider: if a project like this is shown to be not only possible but practical then a host of other possibilities come to the surface in this remarkably resource-rich country. But there are real questions about Papua New Guinea’s ability to cope with this sudden influx of money and development. “There is already a strain on all infrastructure: telecoms, security, power, skilled labour,” says one banker. “There are lots of business opportunities but the capability of the local market to provide that support is already sorely tested.” Foreign banks – there are three of note, the Australians Westpac and ANZ and the Malaysian Maybank (Malaysia is the most active foreign nation in Papua New Guinea, particularly in areas like forestry and palm oil) – should stand to do remarkably well out of the development of Papua New Guinea, using their own global or regional networks to help serve the multinational companies who are coming in. But it’s the on the ground presence, from the 7500 construction workers required for PNG LNG, to the hotels and schools they will need and the roads they will drive on and the power for their businesses, to the local accountancy and legal professions, that are really going to be under stress.