Credit FAQ:

How "Abenomics" And Japan's First Private Airport Concession Mark The Beginning Of The End For Self-Financing The Nation's Public Infrastructure
Primary Credit Analyst: Kumiko Kakimoto, Tokyo (81) 3-4550-8705; kumiko.kakimoto@standardandpoors.com

Table Of Contents
Frequently Asked Questions

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Credit FAQ:

How "Abenomics" And Japan's First Private Airport Concession Mark The Beginning Of The End For Self-Financing The Nation's Public Infrastructure
Recent policy changes in Japan could transform the way major infrastructure operators, as well as some government-related entities (GREs) and local and regional governments (LRGs), fund their activities. Japan's government launched the "third arrow" of "Abenomics"--its "Japan Revitalization Strategy"--in June 2013. As a follow-up, it established a Private Finance Initiative Promotion Organization tasked with opening a prospective 10 trillion to 12 trillion market for public-private partnerships (PPPs) and private finance initiatives (PFIs) in the next decade. The first test of this shift from debt issuance to project-based finance will be a government tender of a private concession to operate an airport in west Japan. LRGs will need to play a leading role if the government is to succeed with this new project, in our view. However, we see challenges ahead for investors seeking to assess airport concessions in Japan.

Frequently Asked Questions

What are the key points of the "Japan Revitalization Strategy?
This new growth strategy is the last but most important of the "three arrows" in Prime Minister Shinzo Abe's "Abenomics" policy agenda. The first two are aggressive monetary policy and flexible fiscal policy. The strategy includes wider proposals to reignite economic expansion in Japan, which has suffered low growth and deflation for the past 20 years. The strategy foresees economic expansion in a variety of industries, such as medical services, higher education, airports, and ports and harbors.

Why improve infrastructure, particularly airports and ports and harbors?

The strategy's primary focus is airports and ports and harbors, along with other infrastructure facilities such as toll roads and mass transportation. The reason provided is "to facilitate movement of human talent and goods on a global scale." We believe the plan's authors expect cross-border trade and financial activities, particularly with growing areas of Asia, to be Japan's main engine of future economic growth. The strategy might also signal government recognition that the end is approaching for a growth trajectory dependent on organic, internal "locomotives" of the national economy such as major manufacturers. Historically, LRGs or GREs operated basic infrastructure in Japan, financing the enormous investment costs in the domestic market essentially through either bank borrowings or bond issuances. We regard Japan's finance markets as deep and well-matured, backed by considerable domestic household savings. So far, LRGs or GREs have funded themselves. As a consequence, they carry sizable infrastructure assets and liabilities on their balance sheets. One of the strategy's conclusions, as we see it, is that rising maintenance costs expose a need for new sources of financing. As the nation's population continues to age, we believe it is inevitable that citizens will begin to withdraw their financial assets

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Credit FAQ: How "Abenomics" And Japan's First Private Airport Concession Mark The Beginning Of The End For Self-Financing The Nation's Public Infrastructure

from the market, indeed at some point prior to the strategy's 10-year horizon, making it harder for LRE or GRE operators to sufficiently fund new opportunities. As a result, we believe the strategy marks the beginning of the end of self-financing in Japan's public infrastructure sectors. In its place, we expect to see alternative financing schemes such as PPPs, in which the government contracts one or more private entities to provide a public service or project, and PFIs, in which the government encourages private funding of public facilities under its Act on Promotion of Private Finance Initiatives. If operating assets will not provide a sufficient return to attract private operators, we believe current operators have to choose either to cover rising maintenance costs, which may increase their financial burden, or to discard the assets. This may be a difficult political choice. However, we expect this predicament to drive the streamlining of Japanese LRG and GREs' generally debt-ridden assets. For example, Tokyo Metropolitan Government plans to use the PPP model to fund major facilities for the 2020 Summer Olympics, including athletes' accommodation. Private sector management (concessions) is a highlight of the strategy, and we expect these concessions to become important to financing in Japan in the wake of the plan's release. The first concession offered to the private sector will be for joint operation of Kansai and Osaka's international airports. Subsequently, we believe Japan will follow other countries, such as Australia, the United States, and many in Western Europe that have utilized PPPs and PFIs,

Do you think an airport concession scheme will work in Japan?

Concessions are new to Japan's capital market. Given current business conditions for airports in Japan, whether a concession deal could succeed depends on political initiatives, particularly in our view the efforts of the related LRGs to curb the influence of local stakeholders with vested interests. Even if a concession is trialed, we believe investors tempted to put funds into Japanese airports will likely need time to get comfortable with the concession model, because predicting future performance generally requires a measurable track record. Unstable regulatory regimes create uncertainties for long-term investors, particularly as these assets typically are more indebted than other industrial corporations. Currently, the central government and LRGs that own airports meet most of their financing needs from among domestic investors, who indirectly finance Japan's airports as a result. Domestic investors do not directly invest in airports in Japan except in very limited circumstances; operators issued fixed income instruments for three international airports--Narita, Kansai, and Chubu. A concession scheme would need to offer sufficient value to encourage investors to redirect a portion of their portfolio from government paper to a concession. Furthermore, we see three challenges for investors wanting to evaluate the creditworthiness of an airport concession in Japan. First, we believe investors need a more clear and precise understanding of regulations governing airports in Japan. From our credit perspective, the strength and predictability of the regulatory framework governing the airports is the key. This applies to airports operated by concession, and it would be important for the regulatory framework to ensure that rates are predictable and required investments can earn an adequate economic return. Until recently, Japanese airport regulations have mostly put a higher priority on airport safety than on operational and managerial efficiency, in our view. We believe the revised Japanese PFI law gives a concession operator a framework designed to be predictable and under which it can enter a long-term funding agreement with investors. However, we

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Credit FAQ: How "Abenomics" And Japan's First Private Airport Concession Mark The Beginning Of The End For Self-Financing The Nation's Public Infrastructure

do not believe the strengths of Japan's regulatory framework are well-disclosed to investors. Investors interested in allocating capital to Japan's airports have been able to do so only through a portfolio of government debt instruments. Hence, the primary credit focus for investors has been the governing authorities, either the central government or LRGs. To determine an airport's creditworthiness, our primary focus is the regulatory framework's stability and predictability on a stand-alone basis. However, we observe that market participants tend to regard the likelihood of extraordinary government support for an entity as a proxy for an assessment of the regulatory framework. We, on the other hand, analyze government support in accordance with our GRE criteria (see "Rating Government-Related Entities: Methodology And Assumptions," published Dec. 9, 2010), as we do for Narita International Airport Corp. We view extraordinary government support as specific to a particularly entity rather than systemwide, based on our assessment of an entity's specific role and link to the government. Second, investors must identify the scope of an airport concession in Japan, which could differ from those elsewhere. Japan's first airport concession will assume operation of New Kansai International Airport Co. Ltd. (KIX), which jointly runs Kansai International Airport's and Osaka International Airport's aeronautical operations. We believe the concession will also include activities that nonaeronautical operators currently undertake, such as terminal and cargo operations and transportation. One company controlling both aeronautical and nonaeronautical activities is common around the world, and the government has enacted a law tasking KIX with organizing the nonaeronautical operations to fit the future concession opportunity. However, we are unsure what will be included in a concession for some of the other 28 airports the central government is interested in offering to private operators. This partly relates to the business model for these airports, in our view. Typically, the central government operates basic passenger-related aeronautical services, while LRG-owned entities run other services. Two different operating entities results in the separate handling of each operation. Furthermore, sometimes nonaeronautical companies have multiple private shareholders with minor stakes, wield cross-shareholdings in other nonaeronautical companies, and are heavily influenced by local LRGs through close personnel and political links. In our view, all 28 airports might find it a challenge to generate sufficient economic returns from their aeronautical operations alone. Because the central government runs the airports' aeronautical activities, investors need not care about the economics of these operations at present. At Narita International Airport and in most cases elsewhere on the globe, nonaeronautical activities subsidize aeronautical ones. However, nonaeronautical activities at each of the 28 airports eyed for concessions are under the control of private operators. This lowers investor expectations about the potential economic returns of concession contracts, likely reducing how much the government can charge for them. In our view, the only way to get nonaeronautical activities to subsidize aeronautical ones is through enactment of laws stipulating it, as occurred for Narita and Kansai airports, or through strong political leadership at a local level to streamline and reshape LRG-owned nonaeronautical entities into the foundation of a consolidated aeronautical operator under a future concession. We expect to analyze the credit quality of airport concessions in Japan case by case because special legal frameworks may be applied to individual concessions and local politics can influence the management and organizational

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Credit FAQ: How "Abenomics" And Japan's First Private Airport Concession Mark The Beginning Of The End For Self-Financing The Nation's Public Infrastructure

capability of concession holders. Third, airports in Japan operate in a relatively competitive environment, in our view. Travelers have the option to use the bullet train network, which connects Japan's main four islands via extra-long bridges or tunnels. As bullet train operators continue to extend their coverage, we believe competition between air- and land-based transportation will intensify. We expect credit analysis of an airport concession in Japan to weigh more on examining competition between air and land modes of transport than it would in some other parts of the world.

Does the strategy affect the creditworthiness of GREs and LRGs operating infrastructure in Japan?
The strategy can benefit the long-term credit quality of current major infrastructure operators, particularly those GREs and LRGs burdened with developing and operating major infrastructure around the nation. For example, the strategy calls for using project-based finance to upgrade aging urban toll-road facilities. Generally, we believe shifting ongoing operational risks for these assets to the private sector is a key driver of government policy promoting PPPs, and indeed they will help control maintenance costs for toll roads, water and sewage facilities, and ports and harbors now more than 40 to 50 years old. Airports are younger by comparison, but we believe they tend to bear more operational risks--particularly regional airports. Therefore, shifting operational responsibility for an LRG or GRE to the private sector will also likely improve the credit quality of the LRGs or GREs now running them. Among the facilities that the strategy aims to bring to the attention of potential concession holders, water, sewerage, and subways are the direct responsibility of LRGs. Some toll-road projects are also under the remit of LRGS, through their own GREs. Others mentioned in the strategy are national GRE-operated regional toll roads. We regard well-run maintenance and control of costs for major infrastructure as crucial to controlling the debt of LRGs and GREs, which we consider already more heavily burdened than is standard in other parts of the world. We expect infrastructure owners' use of PPPs to give them more opportunity to achieve sound debt management, which we regard as key to our ratings on these entities. However, we do not expect policy changes for financing public infrastructure to immediately affect our ratings on LRGs and GREs. We believe possible effects on individual ratings will emerge over a longer period than we ordinarily factor into our ratings assessments.
Additional Contact: Thomas Jacquot, Sydney (61) 2-9255-9872; thomas.jacquot@standardandpoors.com

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