Interview with Praveen Sethia:“Appropriate risk allocation is the key to success for PPPs”

Over the past few years, India’s infrastructure financing landscape has witnessed improvements, primarily driven by the expanding role of global funds and the increasing uptake of new investment vehicles such as infrastructure investment trusts (InvITs). The infrastructure sector has attracted significant attention from institutional investors. In an interview with Indian Infrastructure, Praveen Sethia, founder and director, Infrastructure Advisors Private Limited, spoke about financing and bidding trends, experience with InvITs, and the overall challenges and outlook…

What is the current infrastructure financing scenario in India? How has it changed over the past few years?

The overall infrastructure financing scenario is favourable, with active involvement of financial institutions such as banks and development financial institutions (DFIs), particularly the National Bank for Financing Infrastructure and Development. Some of the DFIs have also ex­pa­n­ded their sector base. As compared to the past five years, the current scenario is stable and the appetite has also increased.

In a noteworthy development, lenders are currently seeking bankable opportunities in em­erging sectors such as mine development and operation as well as coal. For example, Im­perial APGCL Power Limited successfully obtained se­ni­or secured debt for the coal sector.

What has been the experience with InvITs? What are the challenges that remain unaddressed? Which new sectors can explore these products?

InvITs have witnessed a surge in activity, with the recent issuance from the Cube Highways InvIT raising approximately $630 million in fun­ding from various sources, including British Col­umbia Investment and Mubadala. Mean­whi­le, the National Highways Authority of India (NHAI) launched its InvIT issuance amounting to Rs 14.3 billion last year, with the Canada Pe­n­sion Plan Investment Board and Ontario Tea­chers’ Pension Plan Board appointed as anch­or investors. Furthermore, the Nexus Select Trust’s Rs 32 billion real estate investment tr­ust (REIT), which is India’s maiden retail assets-led REIT, successfully closed with a total subscription of 5.74 times.

The biggest challenge in concession agreement-based transactions is obtaining approval for change in ownership, which may take three months to six months with required and consistent follow-ups. For instance, in case of NHAI projects, a key challenge is that the seller of the project is required to waive even legitimate claims, which is not an encouraging aspect. This apart, despite its apparent simplicity, the hy­brid annuity model (HAM) presents its own accounting-related complexities.

With regard to InvITs and REITs, as part of the Budget 2023-24, it was proposed to tax in­come distributed by business trusts in the form of debt repayments at the hands of unitholders. Thus, investment entities will have to modify and restructure their distribution methods as debt repayment may incur the maximum tax rate. However, in one of the amendments to the Finance Bill 2023, it has been proposed to tax only a portion of the amount after deducting the cost of acquisition of units at the time of sale of units.

Despite various asset classes exploring REIT/InvIT structures, sectors such as real es­ta­te, roads, renewable energy and power with consistent cash-yielding assets will continue to dominate the market.

What is the land acquisition, permissions and risk allocation scenario in infrastructure projects?

Appropriate risk allocation is the key to success for public-private partnerships (PPPs). In the case of skewed risk allocation, either investors lose interest, or risk premium goes up substantially in terms of return expectation from the project both for equity and debt providers, thus making projects unviable to a certain extent. Although some sectors have achieved a certain level of maturity in terms of risk allocation, it has been observed that in some transactions, the risk allocation is imbalanced.

Within the realm of land and permissions, environment and forest clearances are the mo­st critical requirements. Although the pro­cess of environmental and forest clearances has been effectively streamlined, the acquisition of land remains a complex and challenging issue. This is particularly true for central government projects, which rely on the cooperation of the local administration and state governmen­ts. Land acquisition often becomes a major cause for project delays and subsequent financial  repercussions.

What are the measures required for improving the quality of infrastructure PPPs? Are recent trends of aggressive bidding a cause for concern for the quality of construction and services?

Infrastructure Advisors has observed a significant improvement in the standard of infrastructure compared to its previous state. User-facing infrastructure such as roads and railways has also enhanced significantly. The improvement in road quality, expansion of the road network, and the introduction of highways and access-controlled highways have collectively contributed to reduced travel time. The implementation of FASTag has also resulted in significant time saving for commuters, ranging from 5 minutes to 20 minutes per 60 km travelled.

In the road sector, the quality of the road surface is a crucial factor. Road sa­fety is a matter of concern owing to substandard de­sign, deficient craftsmanship, and in­ade­qu­ate supervision on the one hand and poor im­plementation of traffic regulations on the oth­er. The need of the hour is the establishment of a specialised task force, akin to the Railway Protection Force, to oversee the digital policing of highways and the enforcement of traffic regulations.

The recent bidding patterns within HAM pro­jects are a matter of concern, both in the construction and operational phases. It would be advisable for NHAI to consider dedicated allocation of funds for operational expenses within the financial model presented to them.

What is the level of institutional investor interest in the infrastructure sector? What additional steps can be taken to attract more overseas capital?

The infrastructure sector has attracted considerable interest from institutional investors. In addition, mergers and acquisitions (M&As) ha­ve been observed in roads and other infrastr­ucture sectors. Despite the keen interest exhibited by investor classes in infrastructure sectors, there is a reluctance to take on under-construction risks. This is mainly due to the uncertainties associated with these sectors, particularly at the operational level.

Several measures could be implemented to ensure adherence to contractual provisions by project authorities and to provide clarity on taxation, including direct and indirect taxes.

What are the emerging M&A trends in the infrastructure space? How have these valuations changed?

In the road sector, which sees a significant amount of activity, the trend of M&As is quite encouraging. The delineation of responsibilities between developers and investors throughout the asset life cycle is becoming increasingly evident. Developers are not inclined to retain assets until maturity due to the lack of economic viability. Further, dollars have the potential to generate a higher return for developers rather than holding on to infrastructure assets.

Due to Covid-19, the valuation was negatively impacted by a reduction in the benchmark interest rate. However, the recent an­n­ouncements of deals in the pipeline indicate a positive trend. HG Infra has entered into a transaction with KKR for four HAM projects while Ashoka Buildcon has confirmed a transaction with Sekura. As per industry reports, PNC Infratech has received interest for its 12 HAM offerings.

What are the challenges and opportunities in greenfield project financing in India?

Lender interest in greenfield projects depends on a variety of factors, including risk allocation in underlying transactions, terms of the conce­ssion agreement, credibility of the project au­thority, financing arrangement for the project, bid viability and credibility of the special purpose vehicle sponsor for the project. The interest of lenders is fairly divided. PSU lenders’ offerings are more prevalent compared to private sector lender offerings.

In terms of opportunities for lenders, the op­ening up of the infrastructure sector presents a moderately positive outlook. However, some new sectors have experienced initial te­e­thing problems. In the case of aggressive bi­d­ding, lenders may be required to exercise caution, resulting in more stringent approval criteria.

What are the infrastructure financing challenges? What is the outlook?

Infrastructure Advisors maintains an optimistic outlook on the infrastructure sector. India, as a nation, has highly favourable pros­pects for collaboration in the infrastructure domain. How­ev­er, lenders take a significant amount of time to fully understand a new sector or transaction structure format, which may pose challenges.