Infrastructure debt funds (IDFs) have gained traction in the past four to five years. The instrument has an advantage over bank credit in the sense that IDFs provide longer-tenor loans, typically for 20-22 years, to the infrastructure sector. Unlike banks, IDFs offer fixed rate instruments such as bonds of various tenors, thus eliminating interest rate risks. There are two types of IDFs – in the non-banking financial company (NBFC) format known as IDF-NBFC and in the mutual fund (MF) format known as IDF-MF. IDF-NBFCs have scaled up better than IDF-MFs as there is lower appetite for the latter in the market, despite it being a more flexible instrument. However, given the tightening of systemic interest rates, the incremental cost of funds has gone up for IDF-NBFCs as well.
Current market
At present, there are six IDFs in the country – four IDF-NBFCs (capturing a market share of about 95 per cent) and two IDF-MFs. As of March 2019, the four IDF-NBFCs had an outstanding loan of over Rs 220 billion in operating infrastructure projects. The bulk of this is constituted by the road and renewable energy sectors.
Last year, in October, the National Investment and Infrastructure Fund acquired a close to 59 per cent equity stake in IDFC Infrastructure Finance Limited. The other shareholders are IDFC Limited (30 per cent) and HDFC Bank (11 per cent). As of March 2019, the IDF has a well-diversified loan book of Rs 46.85 billion across various infrastructure sectors such as hospitals, transmission projects, and airport infrastructure projects.
Key challenges
In a falling interest rate regime, it becomes difficult to convince borrowers to opt for fixed rate instruments when floating rate products are available in the market.
The low single-company limit and group exposure limit imposed by the Reserve Bank of India (RBI) on IDFs poses a challenge. Due to small balance sheets, they face limitations in providing total refinancing solutions. Thus, they have to participate in consortiums with other banks and financial institutions.
In the road sector, IDFs can refinance up to 85 per cent of the debt. However, in many cases, the actual debt is almost double the outstanding debt. Therefore, IDFs actually end up refinancing only about 40 per cent of the debt. This creates the need for a non-IDF lender in a road project. Meanwhile, in a public-private partnership project, it is mandatory to enter into a tripartite agreement, which stipulates that in case of termination of the project, IDFs have the first right of termination payment. However, the problem is that many banks are yet to get comfortable with subordinate rights in termination payments. This leads to difficulties in bringing banks on board for co-financing.
With low credit growth and a thin pipeline of infrastructure projects, banks are retaining good operational projects at fine margins. Moreover, banks are unwilling to let go of these assets as they had assumed the risk during the construction phase. Another challenge for the IDF market is the increasing competition in the refinancing market from sources such as bonds and infrastructure investment trusts (InvITs). Post-operationalisation, projects are able to secure higher ratings of AA+/AAA that allow them to access the bond market. Meanwhile, the emergence of InvITs has also widened the pool of financial avenues for developers.
On the liabilities side, limited depth and volatility in debt capital markets pose challenges in raising long-term debt (over five years) in a cost-effective manner. In addition, banks’ marginal cost of funds-based lending rates (and consequently lending rates) have not kept pace with the increase in bond rates, thereby hurting the competitiveness of IDFs. The bond market has been hit by the recent defaults in the NBFC space. The repo rate has been slashed by 135 basis points in the past eight months (since February 2019), and this has not translated into a reduced cost of borrowing in the bond market. Due to these reasons, raising money from this source has become difficult for IDFs.
Recommendations: Supportive measures
IDF-NBFCs should be permitted to lend to PPP projects without a tripartite agreement, subject to lower exposure limits. While the tripartite agreement with the National Highways Authority of India in the road sector is now well established, sectors such as airports do not have model tripartite agreements. Further, signing of tripartite agreements with project authorities can often be a long-drawn and cumbersome process. The above amendment will significantly enhance the ability of IDFs to refinance bank loans in a speedy manner without adding to the portfolio risk.
IDF-NBFCs should be permitted to borrow funds in the form of external commercial borrowings (ECBs). RBI should provide clarification allowing IDF-NBFCs to obtain ECBs via the automatic route. Foreign institutional lenders generally find loans to low-risk operational infrastructure assets to be attractive bets and such an amendment will immensely help in accelerating the flow of the much-needed foreign investment into the infrastructure debt financing market in India.
IDF-NBFCs should be brought at par with housing finance companies (HFCs) with regard to investment by debt schemes of mutual funds. The Securities and Exchange Board of India’s guidelines for debt-oriented mutual fund schemes provide an additional exposure of 15 per cent (over and above the limit of 25 per cent allowed for the financial services sector) for HFCs. At present, IDF-NBFCs need special approval from the Insurance Regulatory Development Authority of India (IRDAI) to become eligible for their bonds to be classified as part of infrastructure investments by insurance companies. Thus, IDF-NBFCs must be treated at par with infrastructure finance companies and HFCs for mobilising investments by insurers in infrastructure bonds.
The government, in consultation with IRDAI, has made it mandatory for insurance companies to invest a minimum 15 per cent of the net premium received in their traditional insurance plans in the infrastructure sector. Similar requirements may be introduced for pension and gratuity plans, unit-linked insurance plans and retirement benefit funds for channelising investments in debt securities issued by IDF-NBFCs.
Currently, pension fund managers accredited with the Pension Fund Regulatory Development Authority can invest only up to 10 per cent of their net worth in a single company and Employee Provident Fund Organisation fund managers can invest only up to 25 per cent of their net worth. However, IRDAI allows insurance companies to invest up to a limit of 20 per cent of their net worth plus outstanding long-term debt in the infrastructure sector. Thus, investment limits for pension and provident funds must be increased in line with IRDAI’s investment guidelines.
In sum
IDF as a financing product has grown in scale over the past few years, albeit at a rate slower than anticipated. In order to accelerate offshore investments into IDFs, the government recently waived the three-year lock-in period on investments made by non-resident Indians in IDFs. The impact of the move though is yet to be seen. The government also allowed IDF-NBFCs to raise funds through shorter tenor bonds and commercial papers from the domestic market to the extent of up to 10 per cent of their total outstanding borrowings. Going forward, with a number of operational road and renewable energy projects becoming eligible for refinancing, the product mix of IDFs will continue to be dominated by the two sectors, with increasing inclusion of conventional power and telecom sector projects as well. As the product’s penetration in the infrastructure sector is still modest, the growth potential is immense. w
Based on presentations by Sadashiv Srinivas Rao, Chief Executive Officer (CEO), NIIF Infrastructure Finance, and Shiva Rajaraman, CEO, L&T Infra Debt Fund, at a recent India Infrastructure conference