India needs to invest around Rs 50 trillion over the next five years (2018-22) to build infrastructure. The funds are expected to be spent across key sectors such as power, highways, railways, urban infrastructure, ports and airports. The projected investment requirement factors an average annual GDP of 7 per cent with a simultaneous increase in the flow of private investments.
However, infrastructure spending as a percentage of GDP has come down in the past couple of years. During the past five years, nominal GDP grew by over 67 per cent. Over the same time period, outstanding bank credit increased by 63 per cent, while outstanding corporate bonds increased by over 117 per cent (from Rs 12.6 trillion to Rs 27.4 trillion). Equity funding was over Rs 6.2 trillion. As a result of increased financing from the capital market in recent years, the share of bank loans disbursed to the commercial sector declined from 56 per cent in 2011 to 38 per cent in 2017, while non-bank sources of credit such as commercial papers, corporate bonds and external commercial borrowings increased from 44 per cent to 62 per cent.
Although the performance of the capital market in India has been impressive, its role in infrastructure financing has been rather limited. The three broad reasons for this are higher risk perception during the project implementation stage, weak arbitration and dispute resolution mechanism, and relatively nascent stage of the corporate bond market.
A vibrant capital market (both equity and bond) plays a crucial role in facilitating fund mobilisation for sustaining a country’s economic growth momentum. Given the stress on the banking sector, the role of the corporate bond market has now become even more important. In this context, fiscal year 2016-17 can be marked as a watershed year as the funds raised from the corporate bond market touched an all-time high of Rs 6.7 trillion, surpassing the amount of bank credit disbursed during the same year. The exemplary performance of the bond market in 2016-17 is, to some extent, attributable to the Reserve Bank of India (RBI) mandating asset quality review by banks in 2015-16.
In view of the larger complementary role that the debt market has to play alongside bank credit for financing economic activities, several policy measures have been taken by the government and regulators to develop the corporate bond market. These include a framework for allowing banks to provide partial credit enhancement for improving the creditworthiness of corporate bonds, information repositories developed by exchanges and depositories to provide consolidated information on primary issuances and secondary market trades in corporate bonds, electronic book building mechanism for providing enhanced transparency in issuance of debt securities on a private placement basis, and enhanced standards for credit rating agencies for timely monitoring of the credit quality of bonds.
While these policy measures have helped in deepening the corporate bond market, in comparison to other countries, India still has a long way to go. For instance, the outstanding corporate bond to GDP ratio in the US and China is about 96 per cent and 54 per cent, respectively. In comparison, for India, this ratio stood at only around 18 per cent.
Alternative investment instruments for infrastructure financing
Alternative investment funds (AIFs) serve as an effective source of alternative financing for infrastructure. Over 80 AIFs have been registered with the Securities and Exchange Board of India (SEBI) for investing in infrastructure and real estate. Seven infrastructure investment trusts (InvITs) and two real estate investment trusts (REITs) have been registered with SEBI so far. Three of the registered InvITs have already issued and listed more than Rs 100 billion units. Recently, one REIT has filed the necessary documents with SEBI to make an offering of more than Rs 50 billion units.
With respect to municipal bonds, an active municipal bond market would help municipalities to finance a part of their requirement through the financial market. Pursuant to SEBI’s municipal bond framework of 2015 which was further amended in 2017, two municipal corporations – of Pune and Greater Hyderabad – together raised Rs 4 billion through the issuance of municipal bonds during 2017-18. Further, another three municipal corporations – of Indore, Greater Hyderabad and Bhopal – have together raised Rs 4.7 billion so far.
Issues and challenges
While the Indian corporate market has transformed itself into a vibrant one for debt instruments compared to what it was a decade ago, there is still a long way to go. On the supply side, corporates, non-banking finance companies and housing finance companies are the major class of issuers tapping the corporate bond market in India. These three groups account for 40 per cent, 25 per cent and 21 per cent, respectively, of the outstanding corporate bonds. In terms of tenor, most of the corporate bond issuances are between two and five years. In the absence of adequate liquidity in the secondary corporate bond market, long-term investors such as insurance and retirement funds adopt the buy-and-hold approach. Others such as mutual funds and banks/foreign investors mostly invest in tenors of up to five years, generally in instruments issued by the most frequent issuers.
On the demand side, institutional investors dominate the corporate bond market. For instance, on the subscription side, corporates, banks/financial institutions, mutual funds, trusts and foreign portfolio investors constitute the major class of investors (97 per cent share in the outstanding corporate bonds) in India. Retail investors hold only about 3 per cent of the outstanding issuances.
With respect to municipal bonds, the key issues constraining municipalities in using these bonds as a significant source of financing inc-
lude lack of expertise in raising funds from the market, poor quality of accounting and management hampering due diligence by investors, procedural delays in approvals, lack of creditworthiness to access the market, and slow progress in building confidence and creditability for a traditionally loss-making organisation.
A take on the future
Enabling capital markets to play an important role in funding infrastructure projects, which typically require long-term financing, is still, in some way, work in progress. With a view to addressing the constraints of the corporate bond market, some measures have been introduced, while others are on the anvil. RBI has laid down the large exposure framework, aimed at limiting/ capping banks’ lending and their exposure to large corporate entities. This is expected to nudge large corporates to tap the corporate bond market for raising debt, though the efficacy of the framework is yet to be tested. Further, SEBI is working on operationalising the Budget 2018-19 announcements which mandate large corporates to raise 25 per cent of their financing needs from the corporate bond market. The securities regulator is also examining enhancing the framework for “on tap” bond issuances by corporates.
According to private developers, the key points that need to be considered with respect to financing of infrastructure projects include well-written contracts, clearly defined risks and responsibilities of both the government and private players, effective contract enforcement and integrated planning. Further, as per developers, while the responsibility of creation of infrastructure can rest with government authorities, its operations and management can be given to the private sector. In a nutshell, capacity creation (in terms of implementation of projects) is not the issue, but efficacious contract enforcement is.
Based on a panel discussion among P.R. Jaishankar, Chief General Manager, Human Resources, IIFCL; Ajay Tyagi, Chairman, SEBI; Sujoy Bose, Managing Director and Chief Executive Officer (CEO), National Investment and Infrastructure Fund; Shailesh Pathak, CEO, L&T IDPL; Suresh Goyal, India Head, Macquarie Infrastructure and Real Assets; and Keshav Varma, Chairman, Sabarmati River Front Development Corporation Limited, at a recent NITI Aayog conference