Banking on Bonds: Emerging funding avenue for the infrastructure sector

The Indian infrastructure sector has un­der­gone a turnaround over the past few years. The introduction of the National Monetisa­tion Pipeline (NMP) has led to a significant inc­rease in funding opportunities and innovative growth avenues. The infrastructure bond market has gained traction and is poised for further gro­wth. Efforts have been made to improve the perception of risk. Meanwhile, the increased role of central agencies has improv­ed operational performance as well as investor confidence.

The bond market has overcome traditional bottlenecks such as low credit ratings for infrastructure projects and prudential restrictions for pension and insurance funds. As a result, it has witnessed long tenures, a favourable risk pro­file, adequate risk-adjusted returns and im­pro­ved recovery prospects. Furthermore, several prominent worldwide investors, including Bl­a­ck­stone, Brookfield, KKR, the Macquarie Group, CPP Investments and Caisse de dépôt et placement du Québec (CDPQ), have made in­vest­me­nts in the market.

Green bonds

With the launch of its first sovereign green bond (SGB), the centre has established a new route for financing its climate goals and green ambitions. The performance of the first two tranches worth Rs 80 billion each exceeded expectations, with the issuance selling at a yield of five to six basis points lower than the sovereign yield of similar tenure. The issue was oversubscri­bed by four times. The five-year bond was sold to 32 investors and yielded 7.1 per cent while the 10-year bond was sold to 57 investors and yielded 7.29 per cent. This bond issuance is also indicative of a growing policy commitment to increase domestic financing capacity.

Following this, the Indore Municipal Corpo­ration came out with a Rs 2.44 billion ($29.67 million) green bond issue in February 2023 and received an enthusiastic response from inves­tors, raising over Rs 3 billion ($36.69 million).

The government announced its Sovereign Green Bond Framework in October 2022, whi­ch aligned with the Green Bond Principles of the International Capital Market Association. In January 2023, the Insurance Regulatory and Development Authority of India allowed insurers to classify their sovereign green bond purchases as infrastructure investments. This mo­ve was made in an effort to de-concentrate and diversify the infrastructure portfolios of in­sur­e­rs, and participate in environmental, social and governance (ESG) initiatives.

Indian bonds currently offer higher returns than debt instruments in advanced and several emerging economies. As a result, rupee-denominated offshore green bonds could become a potential segment in the near future to attract greater foreign investment. Green bond issuan­c­es are also likely to accelerate as the country inches close to meeting the goals of the 26th UN Climate Change Conference of the Parties.

Moreover, SGBs amounting to Rs 160 billion are proposed to be issued shortly. These bonds will prioritise public sector projects that reduce the carbon intensity of the economy, with the aim of tapping into the growing inves­tor base in this space. Currently, there are se­ve­ral investors that have dedicated funds for investing in green bonds, and the government intends to increase the participation of international investors in the domestic bond market. It is expected that the government’s green bonds will set a precedent and are likely to further open up the local market.

Bank bonds

In 2022-23 (as of January), banks have raised a total of Rs 196 billion through infrastructure bonds. As per ICRA, these issuances will cross an all-time high of Rs 272 billion, surpassing is­suances by Indian lenders such as Axis Bank and HDFC Bank worth Rs 270 in 2021-22. With deposit growth struggling to keep pace with credit growth, marquee banks such as the State Bank of India (SBI) and ICICI Bank have raised sizeable funds by issuing infrastructure bonds.

As of December 2022, ICICI Bank Limited has raised Rs 50 billion through infrastructure bonds to fund projects in sectors such as pow­er and roads. The coupon rate on the seven-year paper was set at 7.63 per cent, about 25 ba­sis points higher than the yield on governme­nt ben­chmark bonds of comparable maturity. The in­fra­structure bonds had a base issue size of Rs 10 billion, with a greenshoe option of Rs 40 billion. The bank’s outstanding infrastructure bond borrowings stood at Rs 408.24 billion as of September 2022, up from Rs 223.14 billion in the previous year. Prior to this, in June 2021, the bank raised Rs 30.01 billion through infrastructure bonds in terms of total asset volume.

In January 2023, the country’s largest le­nder, SBI raised Rs 97.18 billion through the issuance of 15-year (for the first time) infrast­ructure debt bonds with a coupon rate of 7.7 per cent. The investors included mutual funds, pro­vident and pension funds, and insurance companies. Earlier, in December 2022, the ba­nk raised around Rs 100 billion through its maiden bond issue

Over the past several years, tight liquidity conditions have led to higher infrastructure bo­nd issuances by private sector banks. This is likely to continue in the near term. Other private lenders such as Axis Bank and HDFC Bank are expected to adopt this route to mobilise resources for infrastructure funding.

Other major developments

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 Limited (Powergrid) account for almost 50 per cent of the total infrastructure bond issuances.

In the road sector, over 90 per cent of bon­ds during 2022 were issued by NHAI. The success of NHAI’s infrastructure inv­estment trust (InvIT) in raising Rs 15 billion through a public issue has infused confidence in other issuers as well.

Recently, following a market downturn, Adani Enterprises shelved its plan to raise Rs 10 billion ($122 million) through its first-ever public sale of bonds. The newly established in­frastructure financing institution National Bank for Financing Infrastructure Development (NaBFID) is planning a maiden bond issue of Rs 50 billion (approximately $610 million) in the upcoming April-June quarter. It plans to le­ve­r­age the government’s equity capital by issuing Tier 1 and Tier 2 bonds, with a target of raising Rs 3 trillion-Rs 4 trillion. Moreover, un­­der the 2023-24 budget, the centre proposed raising capital spending to Rs 10 trillion, which is expected to support NaBFID’s agenda.

The institution aims to tap pension funds and insurance companies to finance the capital requirements of various sectors, including energy and transmission, airports, ports and urban infrastructure. In December 2022, In­dia’s first-ever “Surety Bond Insurance” was launched by Bajaj Allianz for infrastructure projects. However, the government is yet to actively adopt it as an instrument to mitigate risk and provide long-term value to projects. Appropriate measures could make surety bonds one of the most crucial reforms in the Indian economy, allowing micro, small and medium enterprises unfettered financial access.

In sum

A wider range of financial instruments for infrastructure finance is bound to make the sector even more appealing to investors. The bond market is increasingly considering infrastructure assets as potential investments. Several policy measures, such as equitable risk sharing between developers and authorities, have increased investor confidence in the sector. Ce­­n­tral utilities such as NHAI, the Solar Energy Cor­poration of India, NTPC and Powergrid have ensured consistency in payment cycles, significantly reducing cash flow volatility.

With rising confidence, domestic bond market investors may increase their allocation to infrastructure. In the near future, an increasing number of banks are also likely to issue in­frastructure bonds in an effort to bri­d­ge the gap between credit and deposits.

Furthermore, the NMP plans to recycle ar­ou­nd Rs 6 trillion worth of government infrastructure assets by 2025. Many of these ass­ets will find their way into InvITs and present an investment opportunity for bond markets.

Ishita Gupta and Harman Mangat