During the past three to four years, the government’s programmes and push to the infrastructure sector have started bearing fruit with some pick-up in financing activity. Infrastructure investment trusts (InvITs) have started gaining wider acceptance among investors, the Insolvency and Bankruptcy Code (IBC) has put the spotlight on defaulters, operational assets are finding takers, and bank lending has picked up, albeit with caution. While non-banking financial companies (NBFCs) are in the grey zone due to liquidity challenges, steps taken by the central bank to provide them some comfort will revive lending. Opportunities emanating from sectors such as roads and renewable energy will be key in attracting foreign capital…
What is the current perspective of investors/ lenders on infrastructure financing?
The past few years have seen a reshaping of the Indian infrastructure landscape. Asset ownership is undergoing a change, the government is facilitating newer ideas, large programmes are under way and long-term global capital is gradually emerging as a key component in infrastructure financing. Leading institutional investors, including pension funds and sovereign wealth funds, have made large investments in the highways, airports and renewable energy sectors. This change in the cast of characters has not happened overnight and is really a result of structural shifts in the economy as well as deliberate efforts by the authorities in debottlenecking infrastructure sectors and creating enabling financing models.
Public-private partnerships (PPPs) in infrastructure have a history of almost two decades. The country saw rapid growth of PPP projects in highways, energy, ports and airports during 2005-12 with healthy inflows of domestic and global capital. Some of these projects suffered from aggressive underwriting of risks and overleveraging, which was further exacerbated by regulatory issues as the framework was still maturing. While several good projects were built, some companies and banks/NBFCs got into financial distress.
The infrastructure sector is now undergoing a transformation in the way investors/financiers assess project opportunities. Financiers have understandably become more diligent about fundamental aspects of projects such as availability of land, grant of regulatory approvals, availability of equity capital with the project sponsors, presence of a professional management team, etc. Well-structured projects with a robust economic rationale and backed by strong sponsors do not have any problem in raising the required financing.
Of late, lenders/investors have become cautious towards the sector owing to the inherent issues with infrastructure projects. Amidst this scenario, the renewable energy sector is witnessing some action, though competitive power tariffs in the sector have become a major point of contention for financing. Roads is another sector where some funding activity is taking place, and the award of the third bundle of toll-operate-transfer (TOT) projects is expected to add to the project pipeline. Meanwhile, banks/ investors are also looking to invest in city gas distribution (CGD) and airport projects.
In India, infrastructure financing, which is predominantly dependent on banks and NBFCs, has been passing through a difficult phase in the past few years. Stressed advances (gross non-performing advances and restructured standard advances) to the infrastructure sector have been one of the highest amongst sectors, thus making banks extremely conservative in offering new credit to the sector. Lenders, in some cases, have insisted on higher as well as upfront equity infusion, particularly in the case of smaller players and developers with leveraged balance sheets. Hence, bank credit to the infrastructure sector remained almost stagnant during the three years till 2017-18.
The government and regulators have taken measures to improve the availability of funds to the infrastructure sector. However, there are some green shoots of recovery as recent data indicates that stressed advances in the sector that peaked at about 23 per cent in March 2018, declined to about 18 per cent in March 2019. Outstanding bank credit to the infrastructure sector also witnessed an increase in 2018-19, after being weak for three years prior. As of March 2019, banks had an exposure of Rs 10.6 trillion to the infrastructure sector as compared to Rs 8.9 trillion as of March 2018, a year-on-year growth of about 18.5 per cent.
Which alternative funding sources have worked in the recent past? What are the steps that must be taken to help tap these sources more successfully?
Over the past five to six years, India has increasingly started tapping alternative sources for funding its infrastructure projects. Given the challenges faced by traditional infrastructure financiers, there has been an acute need for fresh sources of capital. New financing mechanisms such as InvlTs and infrastructure debt funds (IDFs) and use of newer PPP models (including the hybrid annuity model [HAM] and TOT) have attracted a fresh class of investors and led to increased activity in the infrastructure sector. Each of these structures is tackling a different aspect of infrastructure development and financing.
InvITs have been designed with the objective of inviting relatively passive capital into lower-risk operational assets through a tax-efficient and liquid instrument that can provide stable cash yields. The instrument has helped in unlocking tied-up capital of original project developers for reinvestment into new ventures. There have been four InvIT issuances till date across the road and power transmission sectors, and have attracted some of the leading global infrastructure and pension funds. The regulators have been quite responsive to investor feedback on the product and have made suitable amendments to the original regulations and these have further increased overall interest.
IDFs are specialised debt financing vehicles that enhance long-term debt flows into operating infrastructure projects and supplement bank finance. IDFs in an NBFC format have done moderately well with their aggregate asset base touching over $3 billion. With their specialised industry expertise as well as regulatory benefits, IDFs are able to supplement bank finance and also, at times, provide banks with a takeout option. The fact that they have been able to attract new financial investors into their ownership structure indicates the potential of this financing product in the days to come.
Banks have been the primary financiers of the infrastructure sector in India. Alternative funding mechanisms have not been yielding the desired level of participation in greenfield infrastructure projects. That said, InvITs can be looked at for those projects that have reached a certain level of maturity. Projects with stable cash flows and a proven track record can be transferred to an InvIT and may also garner interest from IDFs. There are a handful of infrastructure-focused NBFCs in the market, and many of them are facing liquidity constraints. Therefore, bank credit is expected to remain the mainstay for infrastructure financing.
NBFCs have played an important role in infrastructure financing in the past alongside banks. Corporate bonds also have an important role in refinancing debt of operational projects and have allowed larger corporates to raise debt capital. Of the alternative capital avenues, InvITs are the most promising vehicle. The instrument has gained traction recently with fundraising by two InvITs – the Oriental Infra Trust and the India Infrastructure Trust. InvITs can help channelise long-term patient capital into the infrastructure sector and help the developer unlock capital from operational assets and these funds can then be deployed in new projects. InvITs can help reduce both debt and equity capital requirements for the infrastructure sector.
Another alternative funding avenue which holds tremendous potential is the National Investment and Infrastructure Fund (NIIF). With the quantum of funds the NIIF aims to garner, it can significantly enhance infrastructure financing. A stable policy regime, speedier arbitration for claims and faster regulatory approvals can help in improving capital inflows to the sector. Steps to further strengthen the corporate bond market can help in garnering funds from this source.
What has been the role of the IBC in the resolution of stressed assets?
In terms of the sheer recovery track record, the IBC seems to be making good progress. As per a CRISIL report, the recovery rate for the 94 cases resolved through the IBC by 2018-19 is 43 per cent, compared with 26.5 per cent through earlier mechanisms. About Rs 700 billion was recovered through the IBC in 2018-19, twice the figure that was recovered through other resolution mechanisms such as the Debt Recovery Tribunal, the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002, etc. The industry hopes and expects that as the legal, financial and borrower ecosystem gets more familiar with the entire IBC process, timelines for the resolution of stressed cases would improve further and thereby provide faster relief.
More importantly, the IBC has been one of the key economic reforms in the country and has brought in a sense of credit discipline amongst borrowers. It is widely expected that this could change the overall credit culture, thus eventually benefiting both lenders and borrowers, and improving the bankability of infrastructure projects.
The IBC has been a landmark initiative for the resolution of stressed assets. Recoveries in the past fiscal year were to the tune of Rs 700 billion with a recovery rate of 43 per cent as per a CRISIL report. There have been several amendments to the code in the recent past based on experience. With the timely resolution of cases under the IBC, the investor community will gain confidence.
With the implementation of the IBC, 2016, the situation has improved, albeit challenges still remain in smooth resolution. Many infrastructure companies that were under financial stress have entered into the corporate insolvency resolution process with a lag, which is likely to result in high haircuts for financial creditors. Nevertheless, the IBC has a very crucial role in stressed asset resolution, as the time-bound resolution of stressed companies is critical. A delay in the resolution process impacts both the asset value as well as the ability of lenders to extend fresh credit. Weak liquidity during the interim period of resolution could result in deterioration in operational performance leading to termination of contracts, penalties, invocation of bank guarantees, etc., which could further increase the financial liability. While the IBC has made significant improvements in asset resolution and has had some successful outcomes, a lot still needs to be achieved, particularly for the infrastructure sector.
What is the sector outlook for the next one-two years?
Clearly, the infrastructure sector is at an interesting juncture today. While the process of resolving past issues continues unabated, new projects (highways, airports, railways, etc.) have gained momentum in parallel. Perhaps one of the most important aspects of the current environment is the tailoring of policies to tackle distinct needs of various stakeholders. Engineering, procurement and construction (EPC) contractors, developers, operators and financial investors have very different risk-return approaches, different strengths and time horizons through which they contemplate their engagements. A continued focus on providing commercial investors with products and opportunities that fit their risk-return paradigm, and a solution orientation to resolve unforeseen issues during projects’ life cycle is a two-pronged approach that can greatly help in making Indian infrastructure projects a preferred destination for international and private capital.
The pipeline of infrastructure projects in some subsectors is thin. However, investments are taking place in the renewable energy sector and will continue. For attracting greater private investments, it must be ensured that contracts are honoured. The road sector is moving at a decent pace. Going forward, CGD will witness continuing investments owing to the government’s push. Further, there lies significant opportunity in the airport sector with the government’s plan of privatisation and modernisation of existing airports. This, coupled with the government initiatives towards “Housing for All” and the development of smart cities, is expected to support growth in the sector.
ICRA sees a significant impetus from the government towards infrastructure development. Budgetary allocations towards key infrastructure segments such as roads and highways, railways, urban infrastructure, water resources, etc. have increased over the past few years and are expected to increase further in the coming years.
The roads and highways sector has shown strong demand supported by policy measures and the introduction of the new hybrid annuity model. The sector is likely to perform well with new projects being taken up under the ongoing Bharatmala Pariyojana. Urban infrastructure, which includes metro rail, has also seen significant awards in the past few years. Further, a number of metro rail projects have been recently approved or are at the approval stage and are likely to be taken up for development in the next one-two years. Railway station development is also an area to look out for as there are ambitious plans involving the upgradation of 400 stations.
In terms of credit profile, many players in the sector still remain highly leveraged and their liquidity pressure is likely to persist in the short term as lenders remain cautious in lending to the infrastructure sector. Their ability to raise funds via a stake sale in subsidiaries, monetisation of assets, or dilution of equity will be key factors in improving liquidity and the capital structure. Asset monetisation can also help in lowering the borrowing levels for infrastructure developers that have operational assets. Many such transactions have taken place in the past few years, particularly in the road sector, with active interest from private equity funds and other long-term investors. InvITs can also help lower the leverage for infrastructure companies with multiple operational projects.
“Financiers have become more diligent about the fundamental aspects of projects. Well-structured projects with a robust economic rationale and backed by strong sponsors do not have any problem in raising the required financing.”
Prasad Gadkari, Head Investment Strategy and Policy, National Investment and Infrastructure Fund
“Projects with stable cash flows and a proven track record can be transferred to an InvIT and may also garner interest from IDFs.”
Vishal Gupta, Senior Vice President, SBI Capital Markets
“While the IBC has made significant improvements in asset resolution and has achieved some successful resolutions, a lot still needs to be achieved particularly for the infrastructure sector.”
Shubham Jain, Senior Vice President and Group Head, Corporate Sector Ratings, ICRA Limited