Infrastructure development in India requires about $1 trillion worth of investments in the coming years. However, attracting funds of this magnitude is a major challenge, owing to persistent sector-specific problems. In the past, issues pertaining to land acquisition and securing of regulatory clearances, along with poorly structured projects, have not only led to the locking of capital, but have also made investors wary of extending fresh financing to the sector.
Meanwhile, the quality of infrastructure is as important as the quantity. It is imperative to create an environment to attract funds for the creation of high quality infrastructure in a timely manner. To achieve this, private sector participation will have a crucial role to play. However, private participation will hinge on incentive systems and the policy landscape. With respect to project execution, new models have been introduced. However, these are yet to be tested by time.
India Infrastructure Finance Company Limited (IIFCL) held a summit on January 5, 2017 to mark 11 years of its existence. Presented below are the highlights of the sessions on “Strategies Towards Qualitative Infrastructure for Emerging India”, and “Infrastructure Project Financing: Issues, Challenges and the Way Forward”…
Current perspective on infrastructure financing
- In recent years, investment growth has been slow, especially in the infrastructure sector. The country’s gross capital formation was expected to touch 9 per cent of the GDP by the end of the Twelfth Five Year Plan (ending March 31, 2017). However, the World Bank has recently cut the growth forecast for the country and the plan period is expected to close at a GDP growth of 7 per cent.
- An increase in both public and private investment has become imperative for the revival of the infrastructure sector. Private sector enthusiasm towards and participation in the sector is currently at an all-time low due to sector-specific issues. In the power sector, for instance, private investments in greenfield generation projects have remained subdued. The distribution segment too has failed to attract funding. The proportion of budget funding to the sector has also been declining over the years. Such a scenario has highlighted the need for the development of off-budget financing vehicles such as multilateral aid, bonds, etc. The need is further underscored by the constrained flow of bank credit towards the space, owing to the high level of stressed assets.
- The infrastructure sector requires both primary and secondary financing. While secondary sources of finance are available, the problem lies with the lack of availability of the former. While investors are willing to park funds in operational assets, they are refraining from assuming construction risks in the case of new projects. A case in point is the recent deal between Fairfax Financial Holdings and Bengaluru International Airport Limited wherein the private equity player will acquire a 33 per cent stake in the airport. In contrast, the Navi Mumbai International Airport, currently under bidding, has failed to attract investor interest due to inordinate delays. In general, a clear trend is that a number of equity players are looking to acquire stakes in operational projects being offered by stressed infrastructure developers.
- At present, there is limited appetite for financing infrastructure projects, especially from insurance and pension funds, the reason being regulatory hurdles such as stipulated exposure norms. In addition, there has been no participation from the Employees’ Provident Fund Organisation. Infrastructure debt funds (IDFs) have come forward, but have extended only limited contribution in comparison to the funds required for infrastructure development. Asset managers, a segment that is growing significantly on the global platform, have also stayed away from putting funds in the country’s infrastructure sector.
- The key difficulties in financing infrastructure projects include inordinate delays in securing requisite approvals (that significantly disturb project economics), policy gaps and ambiguous clauses in concession agreements that give rise to arbitration. Apart from financing issues, another area of concern is the quality of infrastructure that is being created. There needs to be a focus on enforcing accountability (which, in turn, will create an appropriate incentive system) on the part of the promoter/concessionaire for ensuring a specified level of service delivery.
- Meanwhile, the industry stands divided on the relevance of public-private partnerships (PPPs) for infrastructure creation. Often, the revival of the infrastructure sector is confused with the revival of the PPP model. The country needs quality infrastructure, which may not necessarily be PPP based. A number of PPP projects have failed due to shortcomings in the concession agreement. However, some PPP projects have also been extremely successful. While some industry experts are of the view that the government should jettison the model, others opine that the model has been carefully thought through and just lacks the right regulatory environment for effective functioning. Another point of contention is the stage at which the PPP model should be implemented – whether it should be adopted during the construction stage or in the pre-construction phase.
- Partial credit guarantees form a crucial element in stepping up the rating of bonds to increase investor participation. While banks have been allowed to provide partial credit guarantees, they have not exercised the option due to a large backlog of stressed assets and the guidelines for the accounting treatment of such guarantees. There are stipulated timelines regarding the treatment of a default (which would eventually lead to a rise in non-performing loans) even if the delay is of a single day. It is due to this reason that banks have stayed away from increasing such type of credit exposure.
- With regard to the quality of infrastructure, the focus should shift from the engineering, procurement and construction (EPC) mode, currently the most prevalent, to the accountability and service delivery mode. This is possible only with the active participation of private players. Even within the EPC model, the defect liability period should be increased from the current six-seven months to seven years for the model to deliver quality assets. Wherever possible, the hybrid annuity model (HAM) should be adopted instead of the EPC model as there is better risk mitigation for the concessionaire on the revenue side. Another possibility that should be explored is the closed-loop model.
- Certain confidence building measures should be undertaken by the government to revive private sector interest in the infrastructure sector. This could be done by revising the risk allocation as has been done under HAM. The Kelkar Committee has listed various recommendations for the PPP model. However, the government has not been proactive in implementing these recommendations.
- A good policy framework, a transparent regulatory landscape and appropriate project management skills are crucial for ensuring the creation of affordable and quality infrastructure. Successful project implementation is largely the outcome of a correct execution model and sound policies which ensure its financing. Thus, a balanced institutional approach and a level playing field are required to ensure the development of quality infrastructure.
- Service-level agreements (SLAs) should be set and suitable processes must be put in place to ensure that these are met. At present, the problem is that the SLAs are not set. In cases where they are, their implementation is not properly monitored. However, if such issues are overcome, then a high level of service can be assured. A case in point is Delhi airport, where one of the SLAs is that the baggage from a flight that has landed must reach the baggage collection belt within eight minutes. Meanwhile, in order to improve the service delivery mechanism, community participation such as that of self-help groups must be fostered for the desired results.
- With respect to the types of financing instruments, new sources such as masala bonds look promising. In addition, a vibrant onshore bond market will also prove beneficial for tapping long-term funds for financing infrastructure projects. A key learning has been that the bond financing of infrastructure projects must not be carried out without underwriters. Besides, there is a need for churning capital in a secondary market. In this regard, there must be effective market making.
- Grey areas in concession agreements need to be addressed, as ambiguity wards off the interest of potential investors/financiers, especially foreign ones. Once there is greater clarity, it will aid in structuring projects better, and this will eventually lead to timely infrastructure creation.
- While it is appreciated that new models such as toll-operate-transfer (TOT) and HAM are coming up, the inherent risks (such as traffic risk, most of which is borne by the concessionaire) must be minimised by incorporating key learnings from countries that have done so. Such steps may also attract interest from offshore financiers.
- Learnings from global markets need to be incorporated in designing new financing in-struments. At present, some investment vehicles are unable to attract investor interest as they are not aligned with the expected return profiles. Real estate investment trusts, for instance, are finding few takers as it is an equity-like structure offering debt-like returns. Instead, the mechanism to devise an investment vehicle must be the other way around: the investor class must be clearly identified and should be consulted prior to designing the investment vehicle, so that there is a ready market.
- With a slew of measures announced by the government and the Reserve Bank of India (RBI), the enabling environment for project finance is in place. Most of the issues have been addressed, such as those pertaining to loan tenors (addressed through the introduction of the 5/25 scheme), among others. Interest rates too have declined. However, the focus must now be on better project structuring.
- The outlook appears bright for the infrastructure sector, particularly for segments such as urban infrastructure. Going forward, it is necessary that the reliance on budgetary sources for securing funds for infrastructure projects declines. Besides, it is yet to be seen how instruments such as the National Infrastructure Investment Fund (NIIF) and infrastructure investment trusts (InvITs) will contribute towards meeting the funding requirement. With respect to the choice of execution model, industry experts believe that the choice must be made based on its cost effectiveness and practicality.
Views of Pankaj Jain, Joint Secretary, Department of Financial Services
In the past two-three years, the infrastructure financing landscape has undergone significant changes. Historically, a shift has been made from EPC to build-operate-transfer, and now, new models such as HAM and TOT have been introduced. Projects under HAM are likely to mobilise about Rs 330 billion, while under TOT, about 75 projects are likely to come up. From the perspective of lenders and developers, the shift in execution models is changing the investments required due to a change in the risk matrices, which, in turn, is improving the pricing dynamics. The resulting debt and equity requirements are reduced, which lowers the probability of overleveraging, as has been witnessed in the past.
Meanwhile, there has been a marked improvement in the reduction of stalled projects. In the road sector, for instance, until two-three years ago about 74 projects were stalled, and these have been brought down to only ten at present. This has been the result of measures such as expedited land acquisition, a one-time fund infusion, the rationalisation of compensation, etc. Consequently, capital to the tune of about Rs 1 trillion has been unlocked, and in addition, Rs 70 billion-Rs 90 billion has been unlocked due to the easing of arbitration-related procedures. It is expected that this year, over 10,000 km of road projects will be awarded. In other sectors, such as railways, power and telecommunications, too, the progress is quite encouraging.
Further changes are imminent in the coming years. For instance, RBI’s Large Exposures Framework is likely to be implemented in 2019, which will change group exposure norms, increasing the requirement of Tier I capital on the books of financiers such as banks and other financing institutions. This, in turn, will render lending to infrastructure projects more difficult.
Amidst this, the trend wherein companies are exploring new sources of funds such as masala bonds seems encouraging. Fund raising in the corporate bond market too is increasing. Incremental changes in the bond market are encouraging. Eased norms for investments by foreign portfolio investors, and the introduction of e-book for private placements and market making framework by SEBI are some of the key developments that lend optimism to the segment going forward. Besides, investment vehicles such as InvITs and IDFs are also expected to garner investor interest going forward. In essence, infrastructure financing in the future will come from multiple sources, unlike in the past where banks have been the major financiers. Institutions such as IIFCL will have a key role to play. Measures to set up sector-specific financing institutions also bode well for the sector. The financing terms and structures, however, will be crucially dependent on the type and stage of a project.
Key recent initiatives by IIFCL
- The government has set up the NIIF with the objective of providing funds to commercially viable projects, both greenfield and brownfield, including stalled projects. IIFCL has been appointed investment advisor to NIIF Limited, which is the investment manager for the fund. The NIIF is likely to commence operations via two sub-funds – the roads fund and a green fund. The $2 billion green fund is in advanced stages of development and is being formed in association with the Ministry of New and Renewable Energy. It will provide funds both for old projects looking for refinance as well as new projects. Initially, the fund may not take exposure in greenfield projects.
- IIFCL, along with the Life Insurance Corporation of India, is setting up a credit enhancement fund with an initial paid-up capital of Rs 5 billion. The fund will help enhance the rating of bonds floated by infrastructure companies to facilitate long-term investment. The dedicated fund will be in the form of a special purpose vehicle with IIFCL holding a 20 per cent share. Prior to the setting up of the fund, RBI is expected to bring out a comprehensive regulatory framework for providing credit enhancement to infrastructure projects. While the government is in talks with the Power Finance Corporation to become one of the promoters, it is also keen on roping in international financial institutions.
- Expanding its reach to foreign funds, IIFCL signed a loan agreement with the Japan International Cooperation Agency in March 2016 for a JPY 50 billion line of credit. The financial assistance will be utilised towards the implementation of PPP infrastructure projects, particularly non-fossil fuel power projects.
- IIFCL has also signed an MoU with the Delhi-Mumbai Industrial Corridor Development Corporation (DMICDC) to share expertise and help boost investment opportunities in the industrial space. The financier is considering funding DMICDC projects such as those in the airport, urban public transport, energy, and social and commercial infrastructure sectors. Further, DMICDC will be able to avail of the services of IIFCL subsidiaries such as IIFCL Projects Limited, which specialises in project advisory, loan syndication and financial consultancy services.