In order to be competitive with other global economies in terms of infrastructure development, lending in India needs to move beyond the traditional bank credit. The need to supplement public investment with private capital is particularly salient as it is not feasible for only government-owned institutions to drive the overall infrastructure investment requirements.
Alternative financing for infrastructure projects typically comes into play when banks cannot be approached. The financing environment varies for pre-construction and post-construction stages. Barring banks, there is no alternative funding source for the pre-construction project stage. However, numerous financing options exist for the post-construction phase as it is risk-free.
Alternative sources of financing are situationally applicable. For instance, in situations where regulations of the Reserve Bank of India (RBI) restrict bank financing, alternative funding sources are necessary. Banks may also find it challenging to participate in the immediate takeover of assets and to fund subcontractors for the same assets for which they initially funded the main contractor.
Holistically, there has been an acceptance of bonds as a source of finance by infrastructure developers, owing to certain advantages such as long tenors, arbitrage between the bond market and banks and lower interest rates. The bond market has been extremely volatile in recent months, making it favourable for issuing long-term bonds. Additionally, there have been numerous issuances in the five-year bracket.
Furthermore, RBI increased interest rates by 200 basis points in May 2022, resulting in elevated bond prices. Following this, in November 2022, the Kotak Mahindra Bank raised Rs 15 billion ($183.46 million) through infrastructure bonds, with a seven-year maturity and an annual coupon rate of 7.63 per cent, while the certificate of deposit rate on the same day was 7.6 per cent. Apart from this, mutual funds, banks, sovereign wealth funds, provident funds and insurance companies appear to have a strong appetite for longer-tenor paper, which may be caused by the market being at the fag end of the rate hiking cycle.
Overall, due to the high cost, credit-enhanced bonds have not been widely successful, although it is anticipated that these products will make a comeback in the market with a larger role as a result of the increased number of participants entering the bond market.
Infrastructure debt funds
Infrastructure debt funds (IDFs) have made a commendable start moving towards their objective of providing securitisation for India’s infrastructure projects. IDFs are available through two routes – the mutual fund route and the non-banking financial company (NBFC) route. Despite the many obstacles encountered, the size of the IDF-NBFC industry as of December 2022, stands at approximately Rs 400 billion. Going forward, the IDF-NBFC structure is projected to expand and will complement other available sources of financing, such as the infrastructure investment trust (InvIT).
As IDFs operate with very narrow margins and the landed cost of dollars on a fully hedged basis in the Indian market is higher than the rupee cost of funds, the offshore market remains untapped. IDFs have not had many policy changes. However, more flexibility in terms of operations is desired.
Within the private sector, the experience of infrastructure finance companies (IFC)-NBFCs (NBFCs) has not been particularly positive. Until five years back, assets managed by private sector IFCs NBFCs were approximately Rs 1.5 trillion. The current value has decreased to Rs 200 billion. Nevertheless, the public sector includes Power Finance Corporation Limited (PFC), Rural Electrification Corporation Limited (REC) and Indian Renewable Energy Development Agency Limited, with the government also bringing in the National Bank for Financing Infrastructure and Development (NaBFID).
In terms of incremental asset growth, NIIF Infrastructure Finance Limited (NIIF IFL) was rated fifth in the country, with the State Bank of India ranking first. In the road sector, NIIF IFL signed over 28 tripartite agreements with public and private sector lenders as well as foreign lenders. The current portfolio of NIIF IFL consists primarily of solar and wind energy projects. Airports and the water sector have also been a focal point. Additionally, data centres are being targeted.
Despite the RBI’s rate hike, loan rates have remained persistently competitive. The loan market has provided a favourable climate for borrowers by giving them the option of choosing between bond and loan markets.
Considering the bank lending experience within the road sector, traditionally, banks have provided financing for public-private partnership road projects, as neither the bond market nor IDFs bear the construction risk. The hybrid annuity model (HAM) was introduced with a government guarantee and it has presented banks with a more secure lending environment. In addition to this, HAM projects also feature a floating interest rate.
The Indian corporate sector is in top form. The bond market has made progress, IDFs are doing well and InvITs have also taken off. The wholesale credit space has shifted towards alternative investment fund (AIF) structures as the risk of an asset becoming a non-performing asset is eliminated. Going forward, alternative sources of financing will continue with this momentum.
AIFs can be tapped for meeting funding requirements. Deals in which a holding company is borrowing from the alternative market and using funds as equity for a project are also becoming prevalent. This is an ideal precursor to equity, prior to a company’s formal fund raise. However, the current AIF market is not particularly robust.
In light of the market’s progress over the past four to five years, a favourable environment can be expected moving forward. Additionally, innovative structures, with the option of distressed asset revival, are an upside that can be anticipated. However, a protracted period of inactivity in the bond market is expected if the RBI raises interest rates by another 25 basis points.
NIIF IFL has initiated disintermediation in order to attract various classes of investors for infrastructure projects. The division of the tenor among mutual funds, provident funds and sovereign wealth funds make it a sound investment. Further, the company is striving to develop an energy shortfall insurance product for wind power. Wind power fluctuation makes it riskier for lenders. With an accessible insurance premium, the insurance product will cover these fluctuations.
Sovereign wealth funds and pension funds investing in Indian InvITs have been enjoying double-digit returns. Due to regulations, the participation of retail investors in InvITs has been limited, but this is expected to change in the near future.
Based on a panel discussion among Jyoti Prakash Gadia, Managing Director (MD), Resurgent India; Sujata Guhathakurta, Senior Executive Vice-President and Business Head, Debt Capital Markets, Kotak Mahindra Bank; Suvek Nambiar, MD and CEO, India Infradebt; Shiva Rajaraman, CEO, NIIF Infrastructure Finance Limited; and Rohan Suryavanshi, Head Strategy and Planning, Dilip Buildcon Limited, at a recent India Infrastructure conference