Japan's main public sector sources of support for the country's policy and infrastructure goals are the Japan Bank for International Cooperation (JBIC) and the Nippon Export and Investment Insurance (NEXI), for exporters, and the Development Bank of Japan (DBJ), for domestic projects. The three public finance institutions face markedly different challenges as reforms of Japan's political and economic systems continue apace.

Prime minister Junichiro Koizumi's reforms to Japan's government affiliated financing institutions promised a big shake-up in the way JBIC and DBJ did business. At present, the two are part of the Japanese government, serve public policy objectives, and are funded through low-cost loans and subsidies via the Fiscal Investment and Loan Program (FILP). METI, the Ministry of Economy Trade and Industry, of which NEXI is a part, provides 100% of NEXI's capital, and reinsures 90% of its commitments.

The main, and probably least controversial, reform is to separate the international financial activities of JBIC, which include project, export and corporate finance, from its overseas direct assistance (ODA) functions. The two have only been combined since 2000, and while ODA has likely been a useful cover for export-tied business in the past, the two spheres encompass very different objectives.

Koizumi, however, has consistently said that he wants to rationalise the lending activities of the main public finance institutions into one organisation and privatise them where feasible. The proposals have sparked a furious lobbying exercise from the Ministry of Finance, the larger Japanese corporations, and those foreign governments for which JBIC has become a major source of project funding.

JBIC is likely to continue as a going concern, stripped of many of its responsibilities, although its leadership and funding remain an open question. A recent study from Mitsuhiro Fukao, president of the Japan Center for Economic Research, has suggested that JBIC loses money on its yen lending, although the picture for dollar loans is more encouraging, since the bank is, even allowing for a project finance risk premium, benefiting from a currency carry trade between yen and dollars.

While the most likely scenario for JBIC would be to retain a measure of structural independence within a larger institution, its funding issue would remain. Koizumi's more high profile initiative – the privatization of the Post Bank – would hit JBIC's sources of funding hard. The FILP uses government pension funds and postal savings to fund public banks, and privatization would dry up this source. JBIC alone might be able to survive using government guaranteed international bond debt and retained interest, but its future is far from decided.

Big-ticket blow-out

Despite the uncertainty over JBIC, competition among European banks and UK and US firms for Japanese export business is intense. In a typical export financing, JBIC puts up 60% of the required total, with commercial banks providing the remaining 40% and NEXI insuring 95% of this debt for commercial risks and 97.5% of it for political risks. NEXI worked with JBIC on deals such as Thailand's BLCP and Saudi Arabia's Rabigh, and alone on CVRD's Sossego project in Brazil.

Rabigh is a useful illustration of the boom in Japanese business. According to Jamal Al-Rammah, Saudi Aramco's director of project finance development, the project cements the increased role of Japanese partners in Aramco's infrastructure process, and augurs well for Aramco's next round of projects, which require up to $50 billion in new investment.

Saudi is an important market for Japan. The Asian competition for oil resources has become even more urgent with the increased effort by Chinese producers for oil reserves in Africa. In Angola, five Chinese banks are supporting CNOOC and Sonangol's block 18 transaction, and in Nigeria, China is likely to play a role in financing refinery upgrades.

In this context, JBIC and NEXI will likely have to continue to write large cheques to support the larger oil, gas and petrochemicals deals. Sakhalin II for instance, is likely to strain the Japanese export finance market as never before, although several Western export credit agencies will also contribute.

The end of the affair?

Securing natural resources is a key policy goal of the Japanese government and one that will likely remain largely immune to the vagaries of electoral politics or commercial lobbying.

Less so are independent water and power projects (IWPPs), an area in which JBIC and NEXI have expanded their presence substantially. Japanese contractors, through a combination of cheap financing and the ability to work with trading arms to supply them with raw materials, have become key players in Gulf Cooperation Council (GCC) IWPP business and most of the forthcoming projects in Saudi Arabia are under JBIC's scrutiny for lending.

However, according to sources at JBIC, it is looking to review its participation in some Middle East project sectors in the face of the extremely tight pricing being peddled by commercial banks to the region. As part of this review, it could decide to reduce the proportion of a project's debt that it will supply, in return for taking on greater types of project risk, although the bank has yet to make any formal decision.

There are a number of alternative explanations for the number of, and individual scale of GCC deals under consideration by JBIC. The most cynical is that JBIC is looking to bulk up its loan book in the face of upheavals at the agency – in effect boost its reason for being. The main problem with this theory is that JBIC is understood to be looking to find ways of reducing its foreign exposure. As part of this process, the bank might sell part of its loan book to commercial lenders or other public agencies.

But that solution in itself raises problems and several of them start with the fact that so many JBIC deals have been struck in competitive markets. Finding willing private buyers of the debt – outside of a heavily structured securitization with heavy credit enhancement – will be a difficult task and other ECAs and development finance institutions have no immediate need to take on such exposures.

Latin plans

Despite the upheaval at Japan's multilateral agencies, competition for Japan Inc's attention is still growing. While Africa has sparked the most recent interest, and Asia, particularly Indonesia, is an increasingly important battleground, parts of Latin America still wish to attract Japan's attention.

Debt from JBIC, much of it carrying direct or indirect guarantees from Petrobras, was a key factor in building out much of Brazil's offshore infrastructure, and was one of the main elements in the exploitation of the Campos offshore deposit. It should be noted that local market debt has also played a role, and that in the interim, Petrobras has gone from a government that is 60% privately owned (of that, half trades as American Depositary Receipts).

According to Kawakami, Petrobras plans on investing over $70 billion over 2006-10, of which roughly $20 billion will come from financing activities. Of this, maybe $500 million to $1 billion a year will come from project finance, a small amount from sale-leasebacks of rigs, and between $1.5 and $3 billion a year from long-term debt, including ECA financings, bonds and commercial bank debt.

Its most recent financing was for a floating production storage and offloading (FPSO) vessel, for which JBIC provided a $126 million direct loan, and commercial banks, led by Mizuho and ING, and including SMBC, CITI and BTMUFJ, provided $84 million. As reserves stretch further away from the Brazilian coast, such FPSO assets will become much more important.

Petrobras has previously intimated that it would look to become less dependent upon Japanese trading companies as partners. However, the next set of infrastructure development looks like providing classic opportunities for Japanese exporters. In particular, Petrobras wants to develop a $2.5 billion, 200,000 barrels per day refinery at Pernambuco and wants to spent $370 million on upgrading the Passadena refinery in Texas, in which it recently acquired a 50% stake.

Green growth

Green energy is also a source of interest for JBIC. Japan has strongly backed the enforcement of the Kyoto Treaty, and Japan Carbon Finance is a $140 million fund dedicated to buying carbon credits produced by eligible renewable energy projects. These carbon credits, which exchange notional emissions reductions for cash from industrialised countries that must reach emissions targets, are often the best way for small renewables projects in emerging markets to raise financing.

JBIC's role is twofold: it can broker credit transactions between producers and the Japanese fund, and it can finance projects based on the revenue streams from those projects. And at present, through its ODA programme, it can lend money directly to a government to build a project, although this function might be affected by any drastic change in the status of JBIC.

JBIC could also, according to Takashi Hongo, director general and special adviser for the Kyoto Mechanism at JBIC, arrange financing for a regional development bank, say the Central American Bank for Economic Integration, to lend on to projects within its footprint.

The approach can be risky since the lender is taking on project risk, as well as the various risks associated with the Kyoto mechanism, including volume risk, certification risk, and the risk of credit prices dropping. The last risk is a very real one – European markets have experienced sharp falls, as countries participating in the mechanism have discovered that they have been better in meeting emissions targets than predicted. As a result, they need to buy fewer credits.

The ins and outs

Predicting the likely shape of the Japanese export/project finance market is difficult. While the lobbying in favour of retaining JBIC and its name has been effective, its product range has yet to be determined. Furthermore, the Development Bank of Japan is to be privatised and officials there have hinted that they are examining the potential for working on overseas transactions – although DBJ is faced with the difficult task of sorting out its balance sheet if it is privatised.

The only real certainty is that few Japanese public finance bankers can rest completely easily in the coming months.

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Public finance, private promoters

DBJ's privatization has the potential to upset Japan's domestic infrastructure market. In many respects this might be a welcome development – DBJ has consistently been the main force for creativity in new infrastructure finance solutions but progress in the country's PFI market has been slow, frustrating the entity.

While JBIC has been offering mezzanine loans for power producers hunting for overseas assets, DBJ has been dangling a similar product under the noses of the country's domestic developers. Its mezzanine finance fund has been active for several years. The fund is best suited to real estate and "box"-type projects – those where construction and operational risk are strongly separated. However, there are some signs that PFI concessions in Japan may incorporate a greater blending of construction and operational risk, in the future.

Japanese local government has not displayed large amounts of creativity in attracting private capital. Bankers hoping for a budget-driven sale of transport assets or concession financing should remember that the list of non-core assets in the hands of local governments, which number assets such as hotels and malls, is long. These would probably be the first targets of a fiscal discipline drive.

The long-awaited PFI market-mover looks like being the Haneda airport financing. Haneda, long-promised, consists of two separate concessions at Tokyo's second airport – one for passengers and one for cargo. The two concessions would upgrade an airport that has primarily serviced the domestic market.

The results of the Haneda tender were a little dispiriting for outside bidders – the existing operator, Japan Airport Terminal, won the passenger terminal and Mitsui won the cargo terminal. The awards, however, will likely involve a hefty slice of debt financing, and some potential for foreign lenders to get involved.