Bond Market Update: Recent trends and developments in infrastructure financing

Recent trends and developments in infrastructure financing

As per the Economic Survey 2018-19, India needs to spend 7-8 per cent of its gross domestic product (GDP) on infrastructure annually (about $200 billion). How­ever, actual investments are limited and constitute only 50-55 per cent of the said expenditure. Capital requirements in other sectors of the economy – cement, steel, and oil and gas – continue to be large. While banks have been the traditional source of finance for Indian corporates, capital markets have been playing an active role in recent years. The size of the total credit market is about Rs 150 trillion. Cor­porate bonds account for about 27 per cent of this. Yet India’s corporate bond market size is small (about 16 per cent of GDP) in comparison to other Asian countries (Malaysia about 46 per cent, South Korea about 73 per cent, China about 56 per cent and Thailand about 47 per cent).

A look at the re­cent trends in bond financing for infrastructure, the experience with green and masala bonds, the key issues and challenges faced, and the steps needed to strengthen the bond market…

Infrastructure bond issuances

Infrastructure bonds have acco­un­ted for about 25 per cent of issuances in the overall corporate bond markets (cumulative issuance of Rs 8.3 trillion during 2016-17 to the first half of 2021-22). Public sector entities, such as the National Hi­gh­ways Authority of India (NHAI), NTPC Limited, the National Hydro­electric Power Corporation and Power Grid Corporation of India account for al­most 50 per cent of infrastr­ucture bond iss­ua­n­ces, whereas private sector issuances are well diversified across issuers and sectors. The in­crease in private sector issuances in 2020-21 was driven by large issuances from Re­li­ance Jio. Defaults by a large infrastructure fin­ance company and even the ring-fenced special purpose vehicles (SPVs) increased the risk aversion of investors towards the sector.

During 2016-17 to 2018-19, yields were inc­reasing, which kept investors away from long-te­nor issuances from the infrastructure sector. In ad­dition, issuances from the road sector dec­lin­ed as private sector was affected significantly af­ter the default of Infrastructure Le­asing & Fin­ancial Services. Increase in refinancing ac­tivity encouraged issuances during 2019-20, whi­ch further went up after yields crashed post-Co­vid. Going forward, concerns with rising yields could reduce the investor appetite for long-tenor bo­nds from the infrastructure sector in 2021-22.

During recent years, more than 90 per cent of issuances have been from NHAI in the road sector. Moreover, traffic risk and sponsor risk co­ntinue to be key reasons for risk aversion on part of investors. Issuances from the private sector are relatively better in the power sector, accounting for 50-55 per cent of issuances. The encouraging factors include presence of relatively st­rong sponsors, cross-default structures across various SPVs, transmission lines and relatively few operational risks. The renewable energy sector accounted for around 40 per cent of the overall issuances from the power sector.

Green bonds and masala bonds

During 2015-21 year to date (YTD), India’s cumulative green bond issuance is estimated at $12.5 billion with issue of about $3.5 billion in 2021 YTD. Domestic banks and lending institutions have been large issuers in the past; however, developers are now incrementally ap­proa­ching the green bond market directly. During 2021 YTD, the prominent issuers included JSW Hydro, Hero Future Energies, and Continuum Green En­e­r­gy. Meanwhile, the steep de­p­reciation of the Indi­an rupee and high vola­tility in exchange rates ha­ve reduced in­vestors’ interest in masala bonds. Ov­erall, the enormous liquidity surplus in the do­mestic markets and benign bond yields have re­duced reliance on external commercial borrowing.

Key challenges and the way ahead

Some of the key issues and challenges are inc­reasing preference for high quality papers (AAA/AA accounts for about 85 per cent of the market by volume of debt), lack of broad-based bo­rrowers (the financial sector accounts for th­ree­-fourths of issuances), and delays in the ban­k­ruptcy process, although there has been some improvement. In addition, there is limited secondary market trading, which is affecting liqui­dity, and limited retail appetite. Moreover, there are stringent limits for foreign portfolio investors.

Going ahead, for credit en­hancement of bo­n­ds, guarante­es should be unconditional and ir­r­evocable, and cover the entire pro­mised payme­nts. There is a need for a well-defined payment me­ch­anism, such that a trustee can invoke the guarantee at le­ast a day prior to the due date.

Based on a presentation by K. Ravichandran, Executive Vice-President and Deputy Chief Operating Officer, ICRA Limited, at the India Infrastructure Forum