The National Investment and Infrastructure Fund (NIIF) has the potential to become a major vehicle for channelling domestic and foreign long-term capital into the infrastructure sector. There are sizeable opportunities in the Indian infrastructure space with many operational projects in the road, port and energy sectors which would be of interest to long-term investors like sovereign wealth funds (SWFs) and pension funds (PFs). These investors have an appetite for long-term investments with stable cash flows/returns and a favourable risk profile, criteria which many operational infrastructure projects would meet. Nevertheless, there could be risks arising from adverse foreign exchange movements, offtake/counterparty credit risks, inadequate periodic maintenance undertaken on assets and disputes that take a long time to be resolved. However, steps taken to strengthen and accelerate the arbitration process could help reduce investment risks. With the NIIF investing in operational projects, capital deployed by developers in these projects can be freed up and used for the development of new public-private partnership (PPP) projects.
Background
Keeping in mind the long-term capital requirements of the infrastructure sector, the NIIF was created by the Government of India in December 2015 on the concept of an SWF. Structured as a Category II Alternative Investment Fund registered with the Securities and Exchange Board of India, the NIIF is targeting a corpus of Rs 400 billion, of which the government will contribute 49 per cent and the rest will be raised from foreign and domestic strategic investors, also called anchor partners. In Budget 2016-17, the government made an allocation of Rs 40 billion towards the NIIF and given the fiscal constraints, it may have to work within this for the time being. Nevertheless, the government has shown interest in increasing the corpus, should it be required.
The NIIF will be able to invest its funds in multiple ways – either directly into infrastructure projects and/or infrastructure finance companies or by creating sub-funds under it. The sub-fund structure could also attract additional sector-specific equity investments from investors and will be amenable to leveraging by raising debt.
The NIIF entered into discussions with various prospective investors including SWFs as anchor partners. MoUs have been signed with the Qatar Investment Authority (Qatar), RUSNANO OJSC (Russia) and the Abu Dhabi Investment Authority (UAE). In the power sector, two funds under the NIIF are being explored – a renewable energy fund and a stressed power asset fund. The renewable energy fund is likely to garner $2 billion.
Investment opportunities in the infrastructure space
India has undertaken a large-scale infrastructure development programme, part of which has been in the PPP mode. The Twelfth Five Year Plan had envisaged an investment of $1 trillion in infrastructure during the 2012-17 period. Currently there are close to 2,000 completed/operational infrastructure projects with a project cost of Rs 7.5 trillion, while another 3,500 projects at an estimated cost of Rs 20.8 trillion are under implementation.
Nearly half the operational infrastructure assets are owned by the government while the remaining have been developed either on a PPP model or by the private sector (mainly in the energy sector). Many of these projects now have an established track record of operations and
stable cash flows to attract investors. In the national highways segment alone, there are 77 operational projects covering 5,000 km length at an estimated project cost of $5 billion with the government, which it is looking to monetise through the toll-operate-toll (TOT) mode.
The highway sector in the country has also established a track record in the PPP space and has many completed projects, both in the build-operate-transfer (BOT) (annuity) and BOT (toll) modes, which would be of interest to long-term investors. Moreover, in the next three to five years, another 5,000 km of PPP projects are likely to achieve completion, thereby sizeably expanding investment opportunities for the NIIF.
Some of these projects have already been acquired by investors, including global players and funds such as Brookfield Asset Management, the Canada Pension Plan Investment Board, Cube Highways and Infrastructure Private Limited, the Macquarie Group, etc., either directly or through investments in project holding companies. As per an ICRA study, stake sale has taken place in 23 highway projects, with an aggregate project cost of Rs 115 billion, over the past three years. Further, some of these investors have also invested in project holding companies. Since these funds will have to provide an exit to their investors, these assets could also be available to the NIIF after six to eight years, provided the residual concession period is attractive for NIIF investors. Barring a few projects which became operational in the early 2000s, the majority of the operational projects have a residual concession period of 15-20 years considering the general concession period of 20-25 years. For long-term investors like SWFs/PFs, operational highway projects would be of greater interest due to their favourable risk profile as compared to under-construction projects.
Several projects based on the hybrid annuity model (HAM) have been awarded by the National Highways Authority of India (NHAI) recently. NHAI will fund as much as 40 per cent of the project cost in HAM projects during their construction phase. These projects could generate interest among some NIIF investors even during the construction phase as they are perceived to be less risky once the right of way (RoW) and statutory clearances are in place.
In comparison, BOT (toll) projects carry revenue risks linked to toll collected from users. Generally, for a greenfield project, toll revenue estimates are subject to wide variation as has been witnessed in the past, leading to high revenue risks. As per ICRA’s study, in several projects the variation in estimated revenues based on traffic forecast was lower by as much as 60 per cent and on an average, the deviation was 30 per cent on the negative side. In addition to this, there is the added risk of the developer’s inability to complete the project on time and within the stipulated cost. ICRA’s study has shown an average cost escalation of 5 per cent and maximum cost escalations as high as 44 per cent for BOT road projects. Similarly, the mean time overrun witnessed was 12 months, with a maximum time overrun of 36 months. Risk-averse investors like PFs and insurance companies may not find under-construction projects attractive for investments during the implementation stage.
On the other hand, operational toll road projects with an established track record of traffic volumes and toll collections are relatively less risky as the variation in revenue estimates is not very wide in the long term, though there could be some large swings intermittently based on variability in overall economic growth. In general, operational infrastructure projects exhibit a better credit profile as is also reflected by their credit rating distribution. The credit profile undergoes massive change in the case of annuity projects and toll projects with established traffic growth rates on project completion, as execution risk is mitigated.
While operational highway projects provide a significant investment opportunity for the NIIF, there are certain factors that deserve a closer look. There is the risk of termination of the concession agreement which could impact project returns. Further, the termination payment may not be sufficient to match the investments made by the NIIF as the same is linked to NHAI’s estimation of project cost, which is lower by around 40 per cent as compared to the actual cost. Secondly, the ticket size, in the case of highway projects, is lower as project costs typically range between $200 million-$300 million and the project is funded by a debt-equity ratio of more than 2:1. The NIIF will also face competition from dedicated infrastructure funds which would not be very keen to invest in a pool of assets, but would rather invest directly for management control of the assets.
Sizeable opportunities also exist in the fast developing renewable energy sector in India. As of June 2016, India had an installed renewable energy capacity of 44 GW, including 27 GW of wind power and 7.8 GW of solar power. The country is targeting a renewable energy capacity of 175 GW by 2022. Some of the largest wind power projects are the Muppandal wind park (1,500 MW), the Jaisalmer wind park (1,064 MW) and the Brahmanvel wind farm (528 MW). Some of the prominent solar plants are the Charanka solar park (214 MW), the Neemuch solar project (151 MW), the Welspun Phalodhi project (50 MW) and the Adani Bitta project (40 MW). A key risk faced by investors in the power sector is the offtake risk, given the weaker credit profile of the state electricity utilities which are counterparties for power offtake. Initiatives like the Ujwal Discom Assurance Yojana have been taken by the government to improve the financials of these utilities. Still, some more support would be required from the central government in the form of credit enhancements to reduce the counterparty credit risk.
Attracting foreign capital in infrastructure
The NIIF is looking to raise long-term foreign capital and is targeting various SWFs as these funds also seek investments in long-term avenues of 15-20 years. SWFs are one of the largest institutional investors with huge assets under management of close to $7 trillion, of which the top 10 SWFs hold close to $4 trillion.
Many large SWFs have invested in infrastructure projects globally. Infrastructure investments offer long-term stable yields making them an attractive investment option. Furthermore, as SWFs have the ability to withstand longer lock-in periods, they are more suited for infrastructure investment, compared to a private equity fund.
However, attracting capital from SWFs will not be a given for the NIIF because of multiple reasons. First, SWFs prefer mature markets for infrastructure investments due to the lower risk involved in such markets as well as abundant availability of high quality infrastructure assets. Further, SWFs generally invest in large-sized projects (typically over $500 million) which becomes a constraint in emerging markets like India. Second, SWFs based on oil-
producing countries are currently constrained in terms of making new investments, given their government’s lower revenues on account of weak crude oil prices. This would put pressure on these SWFs to distribute funds to the government, rather than make fresh investments. Third, SWFs also face foreign exchange risk and limited long-term currency hedging tools. On the other hand, infrastructure investment in India provides an attractive long-term investment opportunity for SWFs. At a time when it is difficult to find infrastructure assets at reasonable valuation in developed markets, emerging markets, including India, provide ample opportunity.
Conclusion
While there exists ample investment opportunities in the Indian infrastructure sector to attract foreign investors including SWFs, the NIIF would initially focus on acquiring operational projects with established revenue streams. Investment in operational projects by the NIIF will unlock developers’ capital which can then be used to fund new infrastructure projects. While the NIIF cannot leverage on its own, the sub-funds in which it will invest can raise debt. If the NIIF raises Rs 400 billion and invests the entire amount in sub-funds, while these sub-funds leverage up to 1-1.5 times, total funds available for investment will range between Rs 800 billion-Rs 1,000 billion per year. This would unlock sizeable capital for newer projects.
Rohit Dattatray Inamdar, Senior Vice-President, ICRA
