Prior to 2004-05, the government undertook almost all infrastructure projects and gave out contracts. The contractors, relatively small in scale and size at that time, needed working capital-type of funding to fulfil those contracts. Infrastructure projects were broken into packages, for which contractors could secure bank credit. Project financing was also moving away from development financial institutions (DFIs), most of which had withered away in 2004-05. Yet there were some banks that had a legacy of project financing, but massive infrastructure projects were not available at that time.
Push to PPPs
It was in the late 2000s when a lot of ideas about public-private partnerships (PPPs) started crystallising. It was realised that given the scale of ambition and need, government funding alone would not suffice to construct the projects in hand. Over the years, the private sector also developed and was able to take on and fund bigger projects, provided there were arrangements for them in place. Further, it was acknowledged that the risk could be shared with the government as the private sector was willing to take risks because of the payoff. It was during this period that concession agreements were finalised and a lot of push was given to PPPs. It also meant that more financing was required and banks stepped in promptly to fill the vacuum left by DFIs.
The ground realities
The above philosophy worked well at that point of time because banks had capital to deploy, and they felt that there was something that would give returns. So the model concession agreements appeared to represent a good way of securing receivables. However, on the ground, projects started getting stalled for a variety of reasons such as land acquisition and local opposition. Subsequently, even as projects neared the completion stage, there was a lack of toll revenues due to inaccurate traffic estimates. The issue of asset-liability mismatch on the banks’ side got the attention it did not get previously. This mismatch started becoming more prominent because a bank funded a project for a period of three to four years, hoping to get out when the project became operational. However, delays led to non-commissioning of projects on time, which led to delays of three or more years, resulting in the issue of mismatch.
Escape routes were available for the commissioned projects, while deep-pocket players were not available to buy out under-construction projects. As the asset-liability mismatch problem started intensifying, corporate debt restructuring (CDR) schemes, which allowed restructuring of financing, suddenly had a sunset clause. In 2013, it was declared that no more CDRs would be available. In addition, around this time, Basel III requirements also kicked in. A lot of divergent ideas were coming together, almost creating a perfect storm.
A fundamental reset was required, which happened with the present government coming in. There was a shift from the PPP model to the hybrid annuity model (HAM). HAM changed the realm of this shelf. It took away many of the commercial and operational risks. Fundamentally, with this change in risk sharing, it became easier to finance infrastructure projects. However, what remained was the challenge of asset-liability mismatch, which got accentuated by the lack of capital. Today, very few banks are financing infrastructure. About 10-15 years ago, banks were falling over themselves to lend to such customers. Today, the entire market has shifted from being a buyers’ or borrowers’ market to a lenders’ or sellers’ market. Clearly, there is now a consensus that projects need to be implemented on time with funding that is matched to liability profiles and a different approach to risk sharing.
The new era of infrastructure financing is not looking at 100 per cent financing from lenders. Lending activities are now taking place on both sides – financing the concessioning authority as well as financing the contractors. In the past, there was no need to finance the concessioning authority. However, big-ticket funding for the concessioning authority is going to matter now. Therefore, more concessioning authorities will be needed due to a concentration risk or a single-party exposure risk. Simultaneously, there is a need to think of non-bank finance for construction. Today, the bond market is only available for operational projects. What are the instruments that need to come into play for investors who are willing to take risk? Project finance still does not have a clear answer on what, other than bank finance, is going to provide the initial impetus. So, this is going to be a big area of work for everybody in the next few months.
For this generation of bankers, an entire project being funded by debt without recourse becomes difficult to justify. That is why HAM becomes suitable in the future because even without recourse, the exposure is limited and somewhat mitigated. There are three sources of funds – grant, equity and debt. Anything purely based on equity and debt without recourse is going to be problematic.
There may be instances where an airport project might be viable even on a build-operate-transfer basis because of a clear understanding that user fee will be there and right-of-way (RoW) issues will not arise and revenue projections are realistic.
Potential funding avenues
There are new models and new ways of doing business. More importantly, new players have entered the market. So, private equity and start-ups, which have the ability to take risk, are the kind of entities that will have to be looked at, provided we have established credibility on project execution. Also, establishing credibility on project execution in terms of timelines and quality is going to be the key.
The concessioning authority can push for delivery, but delivering it on time, by the appointed date, is of utmost importance. It is critical to ensure that authorities do not give an appointed date which is too early, hoping that things will work out. Rather than delaying a project after giving the appointed date, it is better to delay the appointed date so that critical issues have been taken into account and resolved. This is what IIFCL has constantly been advocating with concessioning authorities.
NIIF and sovereign wealth funds
Typically, a sovereign wealth fund or the National Investment and Infrastructure Fund (NIIF) always comes in with an investment horizon. If these funds are looking at a short investment horizon, then they will invest in the stalled or operational projects. The risk appetite varies from fund to fund. There should be a diverse mix of funds, some that are interested in investing in stalled or operational projects and some that are willing to wait for five to seven years, but would prefer to exit after seven to eight years.
Sector performance and challenges
The road sector has done quite well. There is also potential in sectors such as metro rail, airports, railways, water supply and municipal waste. The power sector will take a while, but sooner or later, it will come back. However, the mix of thermal and renewables is still unclear. There is less confidence in hydro projects, given their long gestation periods and other challenges.
Role of IIFCL
IIFCL was set up as a gap filler, and not as an institution that would continually take the lead in terms of structuring and appraising projects. IIFCL was supposed to be the final piece in the whole puzzle and it was believed that with its arrival, financial closures would happen. Hence, no need was felt for a mandate for appraisal, design and so on. IIFCL began to make sure that no project suffered from last-mile finance. This, therefore, explains the kind of structure that the scheme for financing viable infrastructure projects through IIFCL has been laid down.
As more banks become retail-focused, in effect, very few institutions are available to undertake appraisals and project financing. Therefore, IIFCL has to start taking the lead in terms of appraisals, getting approvals and building partnerships with other lenders. To move into this role, it may require some changes in terms of the operating mandate. As an institution, it needs to take into account what the government thinks we should be doing, how the market dynamics are changing, and what the comfort level of partners is on the lending side.
Going forward, similar institutions on the lines of IIFCL can be set up and this need not be government-driven. Today, the private sector in India is big enough to take on this role. Seven to ten years ago, non-banking financial companies were minuscule in terms of size. Today, they are growing and are even bigger than many private banks. As the retail funding space starts getting crowded, there will be opportunities in financing infrastructure projects.
This perspective is based on Indian Infrastructure’s conversation with Pankaj Jain, Managing Director, India Infrastructure Finance Company Limited