The infrastructure sector has been an attractive destination for sovereign wealth funds (SWFs) and pension funds to invest their capital in the long term for earning stable returns. Infrastructure assets are best suited to the investment strategy of SWFs and pension funds as these investors have adequate capital, a long-term investment horizon and the risk taking capacity needed for financing big-ticket infrastructure projects. Emerging markets with high economic growth rates and favourable demographics are at the front and centre for attracting investments in infrastructure.
India: Plethora of opportunities
India’s fast growing economy coupled with the consumption profile of its large young population has been a particularly appealing feature for SWFs and pension funds worldwide. These fundamentals are often in direct contrast to the slow growing and ageing developed nations and thus countries like India offer an exciting opportunity not only to diversify risk but also to gain outsized returns in the future. India’s young population constitutes 70 per cent of the overall population and thus will be able to sustain consumption for a long period of time. This demographic strength is further aided by rising urbanisation and increasing income which will continue to fuel consumption growth in the foreseeable future. Infrastructure is seen as a critical enabler for rationalising production and lowering production costs to make Indian products competitive globally. Quality infrastructure is also important in improving the standard of living of the population.
The infrastructure sector is often considered a proxy for the quality of governance in a country. This is because infrastructure projects rely heavily on government expenditure and thus government stability. The steadiness of the tax regime is also of particular importance to long-term investors like SWFs and pension funds. Hence, India is in an advantageous position due to its relatively stable government (as compared to some other emerging markets) and its favourable attitude towards institutional investors. For instance, to promote its infrastructure development plans, the government introduced an income tax exemption for investments by SWFs and pension funds. As per the new rule, income in the form of dividend, interest and capital gains arising from investments made by SWFs and pension funds in specified infrastructure activities shall be exempt from income tax. This includes investments made in the units of infrastructure investment trusts (InvITs), debt or shares of companies engaged in specified infrastructure activities and units of Categories 1 and 2 alternate investment funds, which have invested 100 per cent of their funds in companies engaged in infrastructure activities. The exemption is subject to the condition that the investments are made after April 1, 2020 and before March 31, 2024 and held for a period of three years. This new tax law was recently used to grant tax-free status to Abu Dhabi’s Sovereign Wealth Fund, MIC Redwood 1 RSC Limited, in order to expedite foreign investment in India’s priority areas during the Covid-19 pandemic. MIC Redwood thus became the first foreign SWF that has been notified and granted 100 per cent income tax exemption for long-term investments to be made in the specified priority sectors in India.
Brownfield leads the way
The investment preference of SWFs and pension funds is towards operational projects generating predictable cash flows rather than greenfield projects, due to the underlying risks in such projects. In India, these funds find the transport and renewable energy sectors to be the most attractive. They have invested in the infrastructure space through direct acquisition of assets, participation in InvITs or through co-investment strategies.
Going forward, SWFs and pension funds expect regulatory policy that will encourage investment in the transmission, port, airport, gas pipeline and railway sectors. The transmission sector has a low risk profile and generates a stable return over a long period of time, and thus has generated a significant amount of interest among foreign SWFs and pension funds. However, there is a lack of availability of brownfield transmission projects which hinders investment in the sector. Another problem is the declining number of developers of new transmission lines, thereby reducing the possibility of meaningful collaboration for greenfield projects. One possible solution to this problem is the divestment of existing brownfield transmission lines by the government. For instance, the central government has authorised Power Gird Corporation of India Limited to monetise some of its transmission lines through an InvIT in order to meet its disinvestment targets as well as capitalise on investor demand in this space. Further, sectors such as ports, airports and gas pipelines also face a lack of inventory with regard to existing brownfield projects, leading to lower investments in these sectors as compared to the demand for such assets globally.
The underlying strength of the infrastructure sector was highlighted during the early days of the Covid-19 pandemic, when most of the emerging markets were grappling with equity outflows but India received a string of investments in its infrastructure-related companies. For instance, Jio Platforms Limited raised funds from three SWFs from the Middle East. The Mubadala Investment Company, the Abu Dhabi Investment Authority (ADIA) and the Public Investment Fund of Saudi Arabia invested a total of nearly Rs 261 billion in the company, signifying the immense trust these foreign investors place in the growth story of India.
Partnering up
The National Investment and Infrastructure Fund (NIIF), which has emerged as a quasi-SWF, has also become a potent platform through which other SWFs and pension funds can channel their investments into the country. For instance, the Canada Pension Plan Investment Board and ADIA are among investors that have made equity capital commitments worth $4.3 billion in the NIIF and have shown interest in investing in the nationwide roll-out of 250 million smart electricity meters through IntelliSmart, a joint venture between the NIIF and state-run Energy Efficiency Services Limited. This investment will not only aid in reducing discom losses but also provide a new way of steering investments from foreign institutional investors in India.
Simplifying procedures
The task force on the National Infrastructure Pipeline (NIP) has suggested that the “procedural aspects” of foreign investment in infrastructure projects by global pension and SWFs be simplified and the bond markets be deepened. It has also included measures such as developing model investment agreements in line with international standards and best practices; consistent, fair and unambiguous enforcement of investment terms; a neutral investor arbitration claims mechanism; and systematic framing of foreign direct investment (FDI)-linked performance conditions to aid FDI inflows into the country. The task force has also recommended the setting up of the Credit Enhancement Guarantee Corporation to be expedited, as this is expected to support growth of the bond market for infrastructure projects.
Need for clarity
Despite the government’s efforts, there are some problems that a number of SWFs and pension funds would like addressed so as to create a more robust investment environment. At the institutional level, the government needs to give considerable attention to the project planning process, to ensure that projects are completed within the stipulated time frame, which is presently unclear due to persistent delays in the conceptualisation process. Another problem is the lack of a proper framework for privatisation in sectors such as gas pipelines and ports, and this could hamper future investments. Thus, there needs to be clarity at the planning stage as well as the development of a proper framework for asset monetisation in order to free up capital.
Given the size of investments in infrastructure projects, even a small delay can lead to a significant erosion in value for the investor. Thus, proper implementation and strong regulatory oversight is critical for the success of any investment made in these projects. Further, in light of the Covid-19 pandemic, there needs to be consistency in policy regarding cash compensations in order to safeguard the equity and debt value of infrastructure investments. For instance, the confusion regarding whether a political force majeure could be invoked led to a significant impact on the revenue collection and cash compensation for a number of road projects, making them unviable for several long-term investors.
Conclusion
The infrastructure sector thus offers an exciting opportunity to long-term investors like SWFs and pension funds to invest in a growing economy. With rising interest in combating climate change through environmental, social and governance investments, many funds can capitalise on the burgeoning renewable energy sector. In addition, investments by SWFs and pension funds brings in the best ethical standards and practices from around the globe, and this will further strengthen the domestic infrastructure sector.