Gradual Pickup

Bonds slowly emerging as an alternative route for infrastructure financing

Infrastructure development is currently playing a key role in India’s growth story and hence there is a need to enhance financing options for the sector. Traditionally, banks have been the primary source of funding for infrastructure projects, either directly or indirectly. Such exposure has led to banks hitting their internal exposure ceilings and also slipping on their asset quality (given the increasing non-performing asset levels). Further, the banks’ balance sheets are weighed down by asset liability mismatches due to the long-gestation nature of infrastructure projects. Thus, there is a dire need to explore alternative avenues of funding for such projects. One such source is bond financing.

Traditionally, bonds have not been a popular source of funds for infrastructure companies due to factors such as stamp duty issues, a low investor base, tight liquidity in the secondary market, and a preference for government debt, among others. However, due to the above-

mentioned limitations of bank credit, bond issuances by infrastructure companies are picking up and is being supported by a number of enabling measures recently introduced by the Reserve Bank of India (RBI). Moreover, volatility and weak sentiment in the equity market, and lower costs of debt (due to falling interest rates) have increased public and private bond issuances recently. 

Emergence of masala bonds and green bonds

Masala bonds are rupee-denominated borrowings in the overseas market, which shield an Indian company against currency fluctuations. RBI, in June 2017, imposed a price ceiling on masala bonds and made it mandatory for issuers to sell notes maturing no earlier than five years if they raise more than $50 million. In July, the market regulator halted sales after global holdings of rupee debt hit the limit. The move did not go down well with market participants who argued that these changes would stall the growth of the masala bond market, which was already struggling to gain traction. In order to stimulate activity, RBI, in September, removed masala bonds from the corporate bond investment limit. These bonds will now be treated as external commercial borrowings (as of October 3, 2017), where a borrower just needs to seek RBI approval to sell these securities. While some industry experts feel that waiting for a RBI go-ahead each time can be challenging as companies hit the market at opportune times, others are of the view that companies will have more room to raise funds.

Green bonds are bonds issued to finance green projects, that is, those related to renewable energy, clean transportation and sustainable water management. In the domestic market, climate bonds worth around Rs 89 billion have been issued. Of these, $4.7 billion of bonds have been issued by Indian firms in overseas markets. Encouraged by the Paris climate agreement, emerging economies are tapping the tremendous renewable energy potential. The trend is especially visible in India with companies raising money through green bonds, a new mode of financing that is increasingly gaining popularity. RBI is coming up with green bond guidelines and preparing a framework enabling the issuance of these bonds in large numbers, while the Securities and Exchange Board of India has already issued green bond guidelines. In the absence of a credible infrastructure for these bonds, the United Nations Development Programme is trying to create an ecosystem in India to facilitate the green bond issues.

So far in 2017-18, there have been 10 green and masala bond issuances to the tune of Rs 4,516.93 million.

Barriers

The long-term infrastructure financing market needs natural long-term institutional investors such as pension funds and insurance companies. A significant challenge lies in the credit rating requirement, as cash-rich pension funds and insurers only invest in assets which have a credit rating of AA or above (and A+ with special approval). The delivery risk in the case of infrastructure projects restricts the ability to achieve a high credit rating (lowest investment grade or above). Also, since most infrastructure projects are implemented through special purpose vehicles, they are unable to get a credit rating of AA or higher at the pre-commissioning stage.

A high stamp duty makes bonds an unviable option and encourages the loan market instead. The level and complexity of stamp duty levy does not encourage the development of the bond market.

Third, debt market issuances by corporates are constrained by detailed primary issuance guidelines. In addition, the corporate bond market is a largely private placement driven market. Public issues are difficult, slow, expensive, risky and inflexible with the issue process taking several months compared to other markets where the process only takes a few days.

Outlook

While recent developments in the bond market bode well for the segment, long-pending issues and challenges must be resolved. These include the taxation structure, non-uniform stamp duty, investment norms that inhibit institutional

participation, and the absence of a secondary market. Further, the financing needs of the infrastructure sector are mostly met through bank credit. But with RBI tightening banks’ loan exposure, the sector is likely to face constrained credit flow. Therefore, infrastructure companies will tap the bond market, and many of them are expected to hit the market with partial credit enhancement. With greater issuances, the yield spread between government and corporate bonds is likely to widen a bit.

Also, in the medium to long term, the investor base is expected to expand, particularly after the easing of norms for foreign portfolio investment in corporate bonds. A broad investor base will increase competition within the market, thus lowering the cost of capital as well as systemic risks. Moreover, most of the measures for the corporate bond market introduced recently were based on the recommendations of a report by the H.R. Khan Committee released in August 2016. These will be instrumental in providing the much-needed impetus to the lacklustre bond market and increase liquidity going forward.

Many stand-alone green projects such as those for rooftop solar, energy efficiency and rural water supply still remain unattractive to institutional investors owing to the smaller scale and vast geographical spread. Aggregation and securitisation of such projects could be a welcome move in providing mainstream debt to small-scale green projects. In the case of municipal bonds, these have not taken off in a big way, though there was an issue by the Ahmedabad Municipal Corporation as early as 1998. However, the Smart Cities Mission is expected to reinvigorate the municipal bond market. The Pune Municipal Corporation became the first civic body to tap this route for a water supply project. Further, according to CRISIL, municipal bodies in the country are expected to raise an aggregate of Rs 60 billion through bonds over the next three years on the back of a conducive regulatory and policy environment.

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