The economy is going through unprecedented times. The impact of the COVID-19 pandemic on the infrastructure sector, particularly transport, has been severe. Construction activity has slowed down, albeit for a short period of time. On the financing front, developers are facing a liquidity and credit crunch. However, the measures that have been taken by the government, including moratorium on interest payments and extension of project timelines, are intended to provide them some comfort. There are a number of potential assets up for acquisition in the next one to two years. Importantly, foreign investors do not look at the infrastructure sector from a short-term opportunistic lens and the COVID-19 outbreak has not changed their long-term investment strategy for the country.
The impact of COVID-19 is short term in nature. Though the pandemic has disrupted activities, it will not have a long-lasting effect. With structural reforms announced by the government such as the Electricity (Amendment) Bill, 2020, and the soon-to-be-announced amendments to the National Tariff Policy, 2016, India will become an attractive investment destination from a long-term perspective. Foreign investors focusing on yield play will be attracted to the stable return regime on offer. The issue of rate cut transmission still persists but this will not change the strategy of investors. Investment-friendly regulations introduced in the past few years and the focus on ease of doing business have persuaded foreign developers to look at India as a strategic investment destination.
Investors entering the Indian market with a short-term horizon in view will face difficult times in the wake of the COVID-19 outbreak. However, investors pouring funds into the infrastructure sector will stay put due to the long-term nature of the investment. Further, they understand the various risks associated with the current economic environment.
With regard to the aviation sector, which has been hit hard by the COVID-19 pandemic, airport operators have lost 80-90 per cent of their revenues. Economic regulations too are not very helpful as demand for air travel is extremely low. Commercial establishments will also take time to open up. This situation is expected to continue during the next one-two quarters. Nonetheless, as India has a huge domestic aviation market, the outlook for the sector continues to be positive. In fact, foreign developers, including Zurich Airport International AG, are looking at developing a portfolio in India in a planned manner. The focus is on enhancing non-aeronautical revenues and returns on investment in real estate assets in the long run. The government’s airport privatisation move is fairly encouraging for foreign investors as well as developers. Going forward, there needs to be a collaborative and coordinated effort across countries for global recovery of the aviation industry. A piecemeal approach will not work.
Pension funds bullish on infrastructure
Pension funds and sovereign wealth funds make geographical investments from a long-term perspective. Their investment decisions do not get impacted by events such as a virus outbreak, however widespread, as they look at infrastructure investments from a long-term lens. Most countries are coming out of the first wave of the pandemic. Economic activities have recommenced. However, due to fear of a second wave, investors do not have short-term visibility.
The pandemic has given the government an opportunity to take bold decisions. Welcoming the reforms for various sectors announced under the economic package, institutional investors are cautiously optimistic with respect to India as an investment destination. However, a lot depends on the execution of these policy measures. Further, although the policy measures have long-term benefits for the infrastructure sector, the stress on government finances cannot be ignored. The resulting impact on inflation and current account deficit will play a crucial role in determining how the country emerges from the crisis.
New sectors are being looked at by investors including ports and logistics, transmission, renewable energy, roads and airports. Post-COVID-19 too, investors will continue to look at opportunities in these sectors unless there are structural changes. The infrastructure sector presents numerous opportunities for asset acquisitions. For instance, the road sector offers a healthy pipeline of over 200 operational projects. In addition, over 100 hybrid annuity model (HAM)-based projects are expected to be operationalised in the next couple of years. Acquisition opportunities in the renewable energy sector are also aplenty. Eventually, there will be consolidation in this sector too.
Shrouds of uncertainty in deal making
Both developers and investors are waiting for asset valuations to become reasonable. Asset values and norms for cost of equity are expected to change. The spread between cost of debt and cost of equity will also change. Risk premiums will depend on fiscal measures. Thus, multiple factors will be taken into consideration for calculating valuations. Further, deals will be based on different valuation methods. Developers with a strong liquidity position will be able to sail through this tough time. However, there will be rating downgrades for entities with poor liquidity.
Despite the encouraging announcements for the infrastructure sector, a few issues still remain. Chinese investments look hazy at the moment. Besides, force majeure is being invoked by many players. Implementing agencies are yet to clarify their stance on whether force majeure is non-political or political. Developers and investors want COVID-19 to be treated as a political event. Renegotiation clauses in public-private partnership projects are also being examined. Regulatory authorities are expected to act after deliberations with the industry and government. For instance, the National Highways Authority of India (NHAI) is stretched for funds and the possibility of COVID-19 being treated as a political event is bleak. There is still lack of clarity on this issue. NHAI is willing to conduct deliberations with both investors and developers to carve out a mutually agreeable path.
InvITs to remain attractive
Infrastructure investment trusts (InvITs) have raised Rs 545 billion from investors so far. The majority of the issuances were in 2019-20 and the bulk of the fundraising via InvITs has been through the private placement route. Foreign pension funds and global asset management companies are the key investors in this instrument.
Transportation infrastructure has been severely affected by the pandemic. The impact on volumes and consequently on cash flows has been severe. However, the long-term fundamentals remain strong. There will be high divergence in valuations (ask price versus bid price). Sponsors in need of liquidity may thus compromise on valuation. Besides this, deals will be on a slow lane in 2020-21.
In the next five years, fundraising through InvITs is estimated at Rs 2 trillion (Rs 800 billion in the next one year). A lot will depend on the regulatory and tax regime, and uncertainty due to COVID-19 will delay InvITs in the pipeline. Assets in the road, telecom fibre, power transmission and generation segments have been put up on the block. NHAI’s and Power Grid Corporation of India Limited’s (Powergrid) InvITs will be the most watched, given the size and track record of projects.
The current scenario notwithstanding, some sectors offer asset acquisition opportunities. The renewable energy sector has been replete with merger and acquisition (M&A) activity. As per ICRA, the sector has put 3,607 MW of assets on the block. The road sector has been another favoured investment avenue for investors. Waiting for the valuations and pricing to correct, the medium- to long-term M&A environment is expected to be healthy for the infrastructure space.
Government capex has been impacted due to expenditure on the health sector and reform measures. As a result, there will be extremely limited headroom for infrastructure expenditure in the ongoing fiscal year. Thus, the funding of the National Infrastructure Pipeline will face severe constraints. There is confidence in the strong leadership at the centre. The economic reforms as part of the stimulus package are bold decisions, though execution remains a matter of concern. In the long run, these reforms are expected to ensure stability of investments in the infrastructure space.
Based on a panel discussion among Daniel Bircher, Chief Executive Officer (CEO), Zurich Airport International AG; RajeshwarBurla, Vice President, Corporate Ratings, ICRA; AnjanDasgupta, Partner, DSK Legal; PushkarKulkarni, Senior Principal, Infrastructure, CPP Investments; and ShivanandNimbargi, Managing Director and CEO, Ayana Renewable Power Private Limited, at a recent India Infrastructure webinar