BackIndia opens the funding tap for infrastructure projects
MintAsia examines the government's key initiatives to rev up the infrastructure engine, snagged by bureaucratic red tape and financial constraints
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Mumbai: Statistics don’t always tell the story. In this case, though, they give you a fairly clear outline of it.
Consider this. More than ₹ 6 trillion ($100 billion) worth of projects in India had been stalled as of 31 March 2014, according to the Centre for Monitoring Indian Economy Pvt. Ltd (CMIE), a Mumbai-based independent think tank. At least ₹ 1.8 trillion of these were road projects stuck for lack of land and environmental clearances, said Nitin Gadkari, minister for road transport and highways in the newly elected National Democratic Alliance (NDA) government.
Half of all restructured loans in the Indian banking system, or almost ₹ 1.2 trillion, were in sectors like infrastructure including power, and iron and steel, according to data from the corporate debt restructuring (CDR) cell.
And investment in infrastructure had slipped to just about 5% of gross domestic product (GDP)—half of what India needs if it aspires to move back to near double-digit growth rates, estimates rating agency Crisil Ltd.
India needs to invest $1 trillion in infrastructure, including roads, ports, airports and power plants, in the current Five-Year Plan (2012-17), according to the Planning Commission.
No surprise then that revival of the infrastructure sector has emerged as one of the top priorities of the Bharatiya Janata Party-led NDA government, which came to power by winning a majority in the April-May general election on the promise of reviving economic growth that slumped to sub-5% for two consecutive years.
“The task before me today is very challenging because we need to revive growth, particularly in manufacturing and infrastructure to raise adequate resources for our developmental needs…," finance minister Arun Jaitley said in his budget speech on 10 July.
Jaitley went on to outline nearly ₹ 60,000 crore in direct infrastructure investments, spread across sectors like roads and ports, and backed that up with announcements intended to attract more private financing into the sector at a time when the government’s ability to spend heavily is restricted by the state of its own finances.
For fiscal 2015, the government has projected a fiscal deficit of 4.1% of GDP, compared with 4.5% in the previous year—a projection that analysts have described as too optimistic.
“Till the fiscal situation improves, the government cannot spend heavily on its own. It’s only once the government starts to reduce its revenue deficit by cutting spending on items like subsidies can they redirect some of that money towards capital expenditure," said Sanjeev Prasad, senior executive director and co-head of Kotak Institutional Equities.
In recognition of near-term public spending constraints, efforts to smoothen the flow of private capital into the sector have taken centrestage. In the past month, the government, the Reserve Bank of India (RBI) and the capital market regulator Securities and Exchange Board of India (Sebi) have announced a series of steps intended to encourage banks to lend to the infrastructure sector, and attract investors to contribute to the equity of such firms.
“The direct project announcements and objectives are significant, but Fitch believes that it is the measures to ease funding that are particularly noteworthy and will be critical for driving the new investment cycle," said R. Muralidharan, director-corporates, Fitch Ratings, in a note on 14 July.
The lack of a well-developed and deep corporate bond market has meant that most of India’s infrastructure development has been bankrolled by domestic lenders.
At last count (December 2013), infrastructure loans accounted for 14.7% of total advances by commercial banks, according to RBI data.
Bank financing
But bank lending to infrastructure comes with inherent problems such as a mismatch between the tenor of deposits that banks can raise and the duration of the loans required for long-gestation, capital-intensive infrastructure projects. Banks in India can typically raise deposits of up to five years whereas infrastructure projects need long-term loans of 10-15 years and beyond, which banks find tough to advance.
“In the initial stages, banks were mostly lending for up to seven years. Gradually that got extended to 10 years; but beyond that is difficult for banks currently," said Parthasarathi Mukherjee, group executive, corporate relationship Group, Axis Bank Ltd.
The limited tenor of loans available means that companies borrowing money to develop infrastructure projects have to crunch their repayments over a shorter period of time, which, in turn, puts pressure on their ability to generate positive cash flows from the project in the initial years.
In the first step towards tackling that problem, RBI is trying to incentivize the country’s lenders to raise longer-term resources by selling infrastructure bonds that are exempt from regulatory requirements like the cash reserve ratio (the portion of deposits banks are required to park with the central bank, now 4%), the statutory liquidity ratio (the portion of deposits that banks are required to invest in government bonds and approved securities, now 22.5%) and priority sector lending (the proportion of loans that banks are required to channel to sectors such as agriculture and small business units, 40%). The sale of such long-term bonds had been permitted, but few banks had exercised the option, RBI noted while saying that it would minimize certain “regulatory pre-emptions" to nudge banks into raising more long-term resources.
Securities house CLSA estimates banks can potentially lower lending rates to infrastructure projects by 150-200 basis points as a result of the concessions given. One basis point is one-hundredth of a percentage point.
However, “…a key constraint on the extent of exemption will be the amount of long-term bonds that banks can raise; we understand that the annual market size is ₹ 300-400 billion ( ₹ 30,000-40,000 crore), but it can develop over a longer term," said CLSA in a note on 16 July.
To be sure, no one is clear about the amount of money that banks can raise via such long-term bonds and whether there would be enough investors willing to lock in their money for such long periods of time.
“Raising such long-term infrastructure funds would not be easy. The best option would be a retail offering, but retail offerings would not go up to huge amounts. In due course, yes if a thriving market were to develop, then it would be helpful," said Mukherjee of Axis Bank, adding that clarity is needed on whether these bonds can be pledged by the holder to take a loan. “If that were done, it would certainly help," he said.
The onus then would once again be on institutional investors such as insurance funds and pension funds, said Prasad of Kotak Institutional Equities. But even there, issues may crop up.
“This would be unsecured paper, so that may be a problem for pension funds. Insurance companies would probably be the most likely class of investors, provided that the bonds are highly rated, which shouldn’t be a problem since they would be issued by banks," said Prasad.
A more viable model
Along with encouraging banks to borrow longer term funds, the government and the RBI are also trying to convince banks to lend to infrastructure projects for longer periods that match the economic life of the underlying asset.
Detailing a model now being termed as the 5:25 lending model, RBI said on 15 July it has no objection to banks lending to infrastructure for 25 years or more, with periodic refinancing every five-seven years. The refinancing can be done by the existing bank, a new set of banks, or even via the bond markets, said the central bank, even though strict conditions were attached to such lending. Loans that are refinanced or reset in this manner would not be considered as restructured and, hence, would not attract the higher provisioning requirements attached to restructured loans.
The extended repayment period is intended to help reduce the stress on infrastructure companies.
“5/25 is a welcome step as it would allow staggering of loan repayment over a longer period. The scheme has limited the actual extension of period by providing a mandatory tail period which is equally essential," said Parvez Umrigar, co-head of structured investments group at Piramal Enterprises Ltd.
According to Barclays Capital Inc., principal repayment in the case of most infrastructure projects currently gets condensed over a 9-12 year period, which leads to front-loading of repayments for the developers and puts pressure on initial cash flows.
“In the fresh set of guidelines, RBI has allowed an amortization schedule up to 80% of the concession period of the project (normally ranges from 20-30 years, with refinancing every five-seven years), which we believe would lower the initial principal repayment obligation on the asset developer," said Barclays in a 16 July report, adding that the norms are positive for infrastructure developers. “Given the stretched balance sheet position of most of the infrastructure asset developers in India, we believe this is a positive development," Barclays said.
Stretching out the repayment period may make projects more viable, said Nirmal Gangwal, founder and managing director at Brescon Corporate Advisors Pvt. Ltd, one of the leading distressed debt resolution advisors in the country.
“Large infrastructure projects require long-term funding since payback period is also long. Current infrastructure lending of 15 years falls short of real requirements," said Gangwal.
The new structure of lending could also hypothetically help in better pricing of loans given to infrastructure companies over the term of the loan. According to Prasad Koparkar, senior director for industry research at Crisil Research, the interest rate being charged to a developer should decrease as the project becomes operational and starts generating regular cash flows as project risk diminishes over time.
“The biggest issue is really the pricing. A structure where you charge a higher rate during construction and a lower rate when the project is operational was never thought of because the idea when the loan was given was that the loan would be held till maturity. That entire issue of resetting the spread over the risk free rate over a period of time has to be addressed," said Koparkar, adding that allowing banks to provide long tenor loans with a strong refinancing/take-out finance mechanism would go a long way in ensuring long-term availability of funding for infrastructure projects.
Attracting equity capital
Aggressive expansion plans, stalled projects and the economic downturn have all, in varying degrees, led to a pile-up of debt on balance sheets of infrastructure developers. The Jaypee group, for instance, had accumulated debt of ₹ 60,000 crore at the end of the last fiscal. Peers GMR Infrastructure Ltd and GVK Power Infrastructure Ltd had debt of ₹ 39,187 crore and ₹ 21,837 crore, respectively.
According to Umrigar, a former managing director of Gammon Infrastructure Projects Ltd, many infrastructure projects in India under the public-private partnership (PPP) route have been mainly funded by banks with real equity in the system being less than 10%.
A pick-up in equity markets has provided some relief; so has the sale of shares to sophisticated investors via so-called qualified institutional placements (QIPs). Yet, there has been a need to open up avenues for equity funding of infrastructure projects.
A possible avenue is infrastructure investment trusts, which at least on paper, can widen the base of investors willing to put money into special purpose vehicles (SPVs) created for the execution of such projects.
On 16 July, the capital market regulator put out draft guidelines for infrastructure investment trusts, after finance minister Jaitley flagged the government’s intention to introduce such a financing option in the budget.
Such trusts can raise funds via the public issue of units and invest in infrastructure projects, either directly or through SPVs. Eighty per cent of the assets of such a trust must be invested in revenue generating projects, while the remaining 20% can be invested in under-construction assets and other investments. A cap of 10% has been placed on investment in under-construction assets.
“Basically, it’s a pooling of certain assets and cash flows and creating a trust which will hold shares of the SPV which holds those assets. But, again, what will be the appetite of the unit holder of the trust will have to be evaluated because the risk will be quite high in some of these structures," said Rahul Prithiani, director–industry research, Crisil Research.
Koparkar added that while such an investment trust will offer investors the benefit of diversification, finding investors who understand the product and are willing to invest in it will be difficult in the beginning.
“I think it will be a gradual process, but it’s a step in the right direction," said Koparkar.
The last mile
The success of the recent efforts to revive infrastructure will eventually depend on how quickly the government can resolve last-mile issues such as clearances for existing projects and allocation of new projects, and that, say analysts and bankers, continues to be the big unknown.
“Things have not changed yet but the government is mindful of the problems. They have met with banks, they have asked for more meetings, and they are trying to resolve the issues. So we are hopeful," said Mukherjee of Axis Bank.
To be sure, attempts are being made. On 29 May, just three days after the administration of Prime Minister Narendra Modi was sworn in, the government announced it will allow online submission of applications for environmental clearances. The idea is to ensure timelines, transparency in application process and real-time monitoring of projects, environment minister Prakash Javadekar said. In late June, the same process was extended for forest clearances needed by infrastructure projects as well.
The government is also attempting to move towards a single-window clearance mechanism for core sector projects such as those in the steel industry.
In the road sector, where a large number of projects are stuck for want of final clearances, road transport and highways minister Gadkari has promised that stalled projects worth ₹ 1.8 trillion would be rolled out by 15 August after removing hindrances in the form of land acquisition and environmental clearances, Press Trust of India reported on 15 July.
Meanwhile the government intends to set up a dispute resolution authority for projects being undertaken via the PPP model, Jaitley said in his budget speech.
“The slowdown in infrastructure has been the result of a combination of factors including administrative issues, business issues and financing issues. All three are important but I would still think that administrative issues and business environment are more critical to resolve as compared to the financing issues," said Koparkar, adding that investment in infrastructure, which was closer to 7-8% in the early part of the decade, has fallen to near 5% of GDP.
“First we have to get the basic policy framework right, from approvals, to allocation of resources, to the process of awarding projects, acquisition of land and labour laws. Once that is in place, the funding will come," added Prasad of Kotak Institutional Equities.
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