With the country facing an annual infrastructure financing shortage of Rs 2 trillion, lending needs to move beyond traditional bank credit. Further, as banks are stepping back, tapping alternative financing instruments has become a necessity rather than a matter of choice. Apart from raising funds from the bond market, there is a need to further increase monetisation of assets as well.
India’s regulatory environment has improved considerably in the past few years. Structural reforms, along with the presence of strong institutions, have placed the country in a good position. With regard to infrastructure, in the 1950s, the sector was considered lumpy with long gestation projects. However, infrastructure should be a generational issue – the generation which is using infrastructure should end up paying for it as well. The legacy of deferring upfront cost payments to the next generation and reaping the benefits of assets at a very low price should be done away with. Meanwhile, the role of the regulators is also critical. The regulators for infrastructure should protect not only the investor but also the consumer. One way to do this is by strengthening the capacity of regulators so that they are more empowered to
protect the interest of consumers. Further, regulators must create a framework for takeout financing to address the rising construction risks associated with infrastructure projects. The government is best equipped to mitigate early- stage project risks and secure all approvals. The private sector too must deepen its project development capabilities.
Steps to deepen the bond market
In the past three to four years, the bond market has not developed much, despite the uptick in issuances. The vagaries of the bond market still exist. There has been acceptance of bonds as a source of finance by infrastructure developers due to advantages such as long tenors, arbitrage between bond market and banks, lower interest rates, etc. However, investors have expressed reservations with respect to the corporate bond market. Around Rs 30 trillion of the overall bond market is covered by corporate bonds. Secondary trading is a key issue. Therefore, a market making mechanism for deepening the bond market is the need of the hour. Also, greenfield financing must be left to banks and the bond market must be tapped for financing operating assets. Tax-free bonds, which generally have a maturity of 10, 15 or 20 years, are best suited for infrastructure projects. States too must tap the bond market for smart city and other infrastructure projects. Pooled municipal finance is one route that can be considered. Meanwhile, diversification of the investor base is a very important measure for pushing corporates towards the bond market. To ensure this, a long-term yield curve for the country which is the closest proxy to the sovereign yield curve must be plotted. Once this is in place, issuers can price their issuances against this yield curve. The availability of a sovereign-backed long-term yield curve will attract pension and insurance funds.
The Infrastructure Leasing and Financial Services (IL&FS) crisis, in which the group defaulted on its bond payments multiple times, was a seismic event for the Indian financial system. In such a scenario, the market corrects itself. In addition, the regulations have also been tightened to avert another crisis. All these have a prolonged impact on the momentum of the market. Therefore, it is not necessary to over-correct the market.
Increasing role of IDFs and InvITs
While intermediary instruments such as infrastructure debt funds (IDFs) and infrastructure investment trusts (InvITs) are available, these need to be spaced appropriately so that they can be tested properly. IDFs are available in two forms – the mutual fund (MF) route and the non-banking financial company (NBFC) route. IDF-NBFCs have fared better vis-à-vis IDF-MFs as there is lower appetite for the latter in the market, despite that fact that the instrument is more flexible. Six months prior to the IL&FS default, the IDF market was growing at a fast pace. Post the IL&FS crisis, growth of the wholesale debt market for infrastructure
entities has been sluggish. In the NBFC space, credit quality has not come into question. It is a liquidity challenge that NBFCs are facing as an aftermath of the IL&FS default. However, the scenario will improve in the near future as long-term investors are willing to invest in infrastructure projects.
In the past two years, about Rs 200 billion of equity capital was raised for operating infrastructure projects. The Securities and Exchange Board of India (SEBI) has played an instrumental role in setting up robust guidelines and introducing amendments for InvITs. The product has a lot of potential to become a crucial source of finance for operating projects. Having said that, different regulators have a different stance on InvITs, thereby making it difficult for InvITs to borrow funds. Thus, there is a need for alignment and coordination among the regulators such as SEBI, the Reserve Bank of India, the Insurance Regulatory and Development Authority of India, and the Pension Fund Regulatory and Development Authority so that the target of raising Rs 2 trillion for government projects via InvITs is met.
Outlook
The reality is that the bond market has made some progress, IDFs are doing well and InvITs have taken off. Going forward, alternative sources of financing will continue with this momentum. Meanwhile, the sanctity of infrastructure projects housed under special purpose vehicles (SPVs) should be maintained. In case of group insolvency, cash flows of SPVs should be ring-fenced and insulated to prevent loss of confidence in the refinancing market.