Australia’s infrastructure deficit and China’s investment appetite: the perfect match?

"THE HEROES ARE THE PRACTICAL PEOPLE WHO RECOGNISE CURRENT TASKS"

(Chinese proverb)

识时务者为俊杰

The Treasurer, Joe Hockey, and Trade and Investment Minister, Andrew Robb, are in Beijing for the first annual strategic economic dialogue with their Chinese counterparts and the free trade agreement is top of the agenda.

Two challenges for Mr Hockey and Mr Robb are to convince the Chinese that Australia is more than a quarry and provide a solution to cut through the impasse on State Owned Enterprise (SOE) investment in Australia.

In answer to the first challenge a wise approach would be to build upon Prime Minister Tony Abbott’s successful visit in April and focus on the potential for Chinese investment in infrastructure.

Australia’s lack of infrastructure is a growing risk to our prosperity. The so-called 'infrastructure deficit' is real and well documented. Higher domestic saving, surging investment at the macro level and healthy federal balance sheets have not been translated into infrastructure investment needed to position us for the next phase of economic growth.

Infrastructure Partnerships Australia estimates that an additional $770 billion, or about half of Australia’s current GDP, is needed to close the gap over the next decade. It’s an ocean of money that’s needed and it simply cannot come from higher taxes.

While Australia has been chronically failing to invest in infrastructure, China has been engaged in unprecedented infrastructure construction. Since 1992 the nation has ploughed over 8.5% of its annual GDP into nation-building projects – far exceeding any other country’s expenditure.

Meanwhile, China has a war chest of foreign exchange reserves, some $3.8 trillion, that it finds difficult to dispense. The Chinese Government is looking to invest its reserves away from US Treasury debt and into higher returning investments.

With its appetite for investment and deep experience in infrastructure, China can and should be an important investor in Australian infrastructure.

China already has a track record of investing in overseas infrastructure including in the US and UK. China Investment Corporation (CIC) holds a 10% stake in London’s Heathrow Airport and a 9% stake in the company that controls the UK’s largest water and sewage company.

In the US, CIC has a minority stake in EIG Global Energy Partners, an asset manager that invests in energy and resources related infrastructure and a 17% stake in the American power company AES.

Part of the Australia-China model could be a Government sponsored proposal for co-investment by CIC and the Future Fund. Pre-qualified infrastructure assets in Australia and China might be tipped into a co-owned fund. The model could leverage Joe Hockey’s proposal to treat as “special” new infrastructure projects that will increase productive capacity in the Australian economy.

Infrastructure Australia could be responsible for identifying pre-qualified assets - likely to be projects where the relevant State/Territory and the Commonwealth have agreed that the project is productive infrastructure. As a sign of the Government’s commitment pre-qualified investments could also be backed by usage guarantees from Government where relevant (for example toll roads and rail).

Last year the Future Fund formed a $US300m co-investment company with the Boston-based Berkshire Property. The company invests alongside a fund launched last year by the group. A similar model could be used for a CIC-Future Fund partnership.

It now seems certain that Australia will offer China a similar FTA deal that it gave Japan and South Korea on foreign investment. The new deal increases the foreign investment scrutiny threshold from $248 million to $1.08 billion for a private entity. The quid pro quo is likely to be increased Australian access to areas like financial services, banking, education, health and aged care, as well as the perennial issue of improving our agricultural sector’s access to China’s burgeoning middle class.

In Things of today, accomplished today we suggested a different solution to one of the sticking points in negotiation being the rules for investments by Chinese SOEs entities. We proposed a new “fast track” model for non-sensitive investments by Chinese SOEs below, say $750 million, based on an agreed set of behavioural undertakings for SOEs. The model fits well with Treasurer Hockey’s comments that the government is willing to move on its approach to mandatory review of investments from SOEs.

The principle of a fast track model could also apply to investments in pre-qualified infrastructure assets by the CIC/Future Fund (with no monetary threshold applicable). Undertakings specific to investment in pre-qualified infrastructure assets might include compliance with the Santiago Principles (in the case of passive investments) and commitments to use Australian asset managers and a predominantly Australian management team.

The overall picture is enhanced by the Australia and China agreeing to boost offshore market development of the Renminbi (RMB). Australia is at the forefront of countries working with China to support international use of the RMB. Only last month we saw the announcement of the ASX-Bank of China Renminbi Settlement Service.

Today just 4% of settlements in China are in RMB (and 1% of those involving an Australian counterpart); the Chinese government plans to increase this proportion to 15% by 2015. This will encourage capable and credible Chinese enterprises to invest in Australia and participate in infrastructure construction.

In January of this year, the Chairman and CEO of CIC, Mr Ding Xuedong, stated that CIC was shifting its focus away from the energy sector towards investments in infrastructure in both developed and emerging markets. CIC is actively being courted by a number of countries to invest in infrastructure.

Australia is not alone in its need for infrastructure investment and needs to reinvent itself as being open to Chinese investment in spaces other than energy and resources (see Australia 'open' to more Chinese investment (Financial Times)). If we are to attract Chinese investment into local projects a key point of differentiation is a must – skin in the game from the Australian government coupled with a fast track process may be that differentiator!