Infrastructure development plays a pivotal role in propelling the economy towards sustainable growth, job creation and poverty reduction, leading to social and economic transformation, increasing cost competitiveness, and providing an impetus to the country’s trade and economic activity. This is highlighted by a Reserve Bank of India (RBI) working paper, which states that the peak multiplier of capital outlay can reach up to 3.5 times, indicating that every Re 1 invested in capital expenditure can generate Rs 3.5 of GDP. This statistic highlights the significance of infrastructure in propelling the economy towards sustainable growth, job creation and poverty reduction, leading to social and economic transformation, increased cost competitiveness, and an overall boost to the country’s trade and economic activity.
India’s nominal GDP is likely to reach $3.65 trillion by the end of 2023-24, and the country aims to become a $5 trillion and $40 trillion economy by 2025 and 2047 respectively. According to the Economic Survey 2021-22, realising the vision of a $5 trillion economy would require infrastructure investments of approximately $1.4 trillion. To facilitate this, the government is spearheading the National Infrastructure Plan (NIP) with investments across 8,900 diverse projects.
Historically, India has relied on the government for financing infrastructure projects. However, this changed in the late 1990s when commercial banks were permitted to pursue long-term project finance. Since then, banks have played a fundamental role in funding infrastructure projects, with the total bank credit to the infrastructure sector at around $150 billion as of June 30, 2023.
Given the growth-oriented outlook for the infrastructure sector, several new measures are being implemented to increase long-term infrastructure financing. These include the development of the municipal bonds market, and the establishment of a new dedicated credit enhancement NBFC to improve the credit risk profile of infrastructure companies.
Over time, non-banking financial companies (NBFCs), foreign commercial lenders and developmental institutions have become active in the lending space, while new equity funding is flowing in from multinational corporates, pension funds and sovereign wealth funds. However, the growth in credit has not kept pace with the demand, with prudential guidelines requiring lenders to keep an eye on asset-liability mismatches and sectoral/counterparty exposure limits.
Considering the magnitude of the funding requirements under the NIP and the stretched nature of government finances, the NIP financing plan envisages a mix of government and private funding, along with innovative solutions.
Key milestones in infrastructure financing and new sources of financing
- The public-private partnership (PPP) model was introduced in 1997 with the aim of fostering government and private sector collaboration for financing, developing and operating infrastructure facilities.
- In 2006, India Infrastructure Finance Company Limited (IIFCL) was established as a wholly owned government company, aiming to promote lending to PPP projects. Over the years, IIFCL has facilitated lending/investing in infrastructure investment trusts (InvITs), refinancing of bank/financial institution loans, takeout financing, credit enhancement with support from the Asian Development Bank (ADB), and investment in infrastructure project bonds.
- In 2010, NBFC-IFCs (infrastructure finance companies) were introduced vide an amendment to RBI’s NBFC directions of 2007. Over the years, NBFC-IFCs and banks have supplemented each other in accelerating infrastructure credit.
- In 2012, NBFC-IDFs (infrastructure debt funds) were permitted. These essentially act as vehicles for refinancing the existing debt of infrastructure companies (with at least one year of operation), thereby creating fresh headroom for banks to lend to infrastructure projects.
- In 2014, InvITs were introduced by the Securities and Exchange Board of India (SEBI). Serving as investment vehicles that can invest in diversified pools of infrastructure assets, InvITs offer infrastructure developers the option to refinance higher-cost infrastructure project loans and also free-up invested capital for reinvestment into new projects. Further, by granting a 100 per cent tax exemption on interest, dividend and capital gains income to sovereign wealth funds (SWFs) and global pension funds, these vehicles have successfully attracted patient capital. Today, InvITs attract a wide array of investors such as retail, high net word individuals, wealth funds, domestic institutional investors, foreign institutional investors, insurance companies and employee pension funds.
- In 2015, the National Investment and Infrastructure Fund (NIIF) was established by the Indian government. Established as the first sovereign wealth fund of India with an initial corpus of $5 billion, NIIF is registered with SEBI as a Category II Alternate Investment Fund and provides long-term capital for infrastructure-related projects. NIIF has attracted investments from SWFs, multilateral institutions and banks, among others.
- In 2016, the Insolvency and Bankruptcy Code was enacted, which provided a timely and effective resolution framework for distressed loans, and in turn, enabled lenders to better manage their capital.
- In addition to the above initiatives, the RBI implemented several reforms to streamline infrastructure funding. These include notification of the “Prudential Framework for Resolution of Stressed Assets”, which facilitates early identification, reporting and time-bound resolution of stressed assets.
- In 2021, the National Bank for Financing Infrastructure and Development was established as a development finance institution. It holds the mandate to lend capital to a mix of greenfield and brownfield projects, while also participating in the monetisation of operational infrastructure assets.
- In 2022, the Sovereign Green Bond (SGB) Framework was introduced, following which the first SGB was launched in January 2023, thereby establishing a new route for financing infrastructure to meet climate goals and green ambitions.
Apart from the aforementioned measures, other milestones and reforms over the years include the liberalisation of foreign direct investment (FDI) regulations, permitting 100 per cent FDI under the automatic route for sectors such as roads, railways, power, ports and construction; liberalisation of external commercial borrowings; establishment of National Asset Reconstruction Company Limited; establishment of GIFT City, an International financial centre that facilitates capital inflows from private and global investors; enhancement of bond markets; and heightened engagement with multilateral institutions such as the World Bank, the Japan International Cooperation Agency and the ADB.
Considering the magnitude of the funding requirements under the NIP and the stretched government finances, the NIP financing plan envisages a mix of government and private funding, along with innovative solutions.
Challenges and solutions for increasing long-term investments
With the benefit of hindsight, greenfield infrastructure development is being pursued by fewer private sector players. The lenders have been at the receiving end of the build-up of stressed infrastructure assets. This is triggering a domino effect, where current players are not able to take on the challenge of meeting all the new infrastructure demands and goals. Even if they attempted to do so, the debt financiers would encounter constraints imposed by prudential norms pertaining to counterparty exposure.
Hence, the public sector has stepped in to take the lead role and will continue to do so in the foreseeable future. To facilitate this, it is imperative that adequate revenues from affordable user charges are generated in a timely manner. Along with this, there is a need for a substantial amount of long-term financing.
Given the growth-oriented outlook for the infrastructure sector, several new measures are being implemented to increase long-term infrastructure financing. These measures include the development of the municipal bonds market, which is critical in the context of rapid urbanisation; and the establishment of a new dedicated credit enhancement NBFC to improve the credit risk profile of infrastructure companies.
Other measures that we collectively need to deliberate upon are:
- Relaxing the restrictions imposed on the exposure of pension funds/insurance funds to unlisted InvIT/REIT assets.
- Tapping the 30 million-strong Indian diaspora (non-resident Indians and persons of Indian origin) through credit-enhanced investment instruments that compete with low-yielding deposits overseas.
- Tapping the rich residents for government-issued equity-risk type investments, designed in a manner similar to schemes such as the US’s EB-5 the UAE’s Golden Visa, with added incentives of priority public services.
- Tapping individual and household deposits through bonds structured like savings accounts, with floating interest coupons linked to rates such as the SBI’s savings account interest rate and providing insurance coverage in a range similar to 2x-3x the level of the Deposit Insurance and Credit Guarantee Corporation’s coverage.
- Allowing a portion of earmarked corporate social responsibility expenditures in infrastructure projects in impoverished areas.
- Inclusion of green and social loans in priority sector lending, and lower capital risk-weights for the same.
- Lowering the threshold for pension funds and insurers for investments in infrastructure expected loss-rated instruments from A/Infra EL 1 to BBB/Infra EL 2.
- Increasing the use of value capture financing to tap into local areas for funding.