Infrastructure Financing in India – Issues and Way forward (Part 2)

Contd. from Part 1….

Ok so PPP comes into the picture as the knight in shining armour saving the government from various perplexities and presenting itself as a decent solution to most of the problems. Then what is the issue now? What is it that is now going wrong! Actually, it’s quite a few things. And brace yourselves, the list is pretty long.

• The projects are not viable in the way that the quality of planning and engineering design has been found to be poor. In many cases, projects are beyond scope, contract’s terms and conditions are not standardised adding to frictional cost interaction. Also, the pre tendering phase of approvals takes forever to get over given the number of entities involved in the process.
• Construction phase have been found to lag way behind the decided schedule mainly due to overruns and dispute settlements like land acquisition delays, weak risk management techniques in place, lack of engineering skills adding to cost and time lag, etc.
• To better manage the risk arising from the construction and management of the infra project, the private company mostly executes the project via an SPV (special purpose vehicle). The impact of having an SPV of a company or its subsidiary run the project is that they do not have recourse to their parent company after initial capital has been provided and since the SPV does not have any credit history or a strong balance sheet, it impacts its ability to secure capital from outside.
• The scale of investment is extremely large and the one who has to invest has to be prepared for a very long horizon for the project to repay its debts and provide return on its equity. For many financial institutions, especially banks, their ability to finance in very long term and illiquid assets is limited due to their asset liability mismatch. Which means that banks mainly source their financing from their commercial deposits which have a tenure of 3-5 years. But the tenure of financing an infra project is 20-25 years. So to be able to provide a loan for such a long time is no easy job. Also, it adds to a bank’s liquidity risk.
• The non-recourse nature of financing the loan, as well as the unique issues entailing every project present a complex picture for the financial institutions and hence calls for great appraisal skills sets which may not be available with them yet. Also lacking in terms of skills sets is the treasury skills of the banks capable of financing these large sized loans as such skills can be useful in the risk management part where the risks arising out of such projects can be hedged is the market with the purchase of instruments having negative correlations with the risky events of the project.
• Many banks are reaching exposure limits to infra related borrowers as Indian banks are relatively small. Pension funds and insurance companies are well suited due to the long term nature of the funds available with them but they can only invest in projects with almost nil chances of default (highly rated projects of ratings AAA or AA only) which may not be the case with many of them. External commercial borrowings can be one option but till now they have constrained by caps on cost and interest rates.

 

The list can go on. But is enough for getting the entire picture so let’s just stop here and discuss on what has already been mentioned. Some of these problems are pretty complex and are being dealt with till date since inception and we are yet to have a convincing solution to them. But it will only be wise is we try and understand what’s the take of our regulatory body RBI on these issues. Some of the points explained in various speeches delivered by RBI executives over the years on these issues have been explained below:

RBI’s Opinion

• The budgetary support provided by the government of India to Infrastructure financing accounts for 45 % of the total infrastructure spending.
• Commercial banks happen to be the second largest source of finance for infrastructure. Commercial banks and in particular, the public sector banks have largely supported infrastructure requirements. The share of bank finance to infrastructure in gross bank credit has increased from 1.63% in 2001 to 13.37% in 2013.
• The gross NPA and restructured standard advances for the infrastructure sector has increased considerably and evidence suggests that a substantial portion of it is due to non-adherence to the basic appraisal standards by the bank.
• Also, creation of separate asset classification for Infrastructure projects due to rising NPAs is not seen in a positive light because of the understanding that the reason for NPAs is non-performing administration which extends to not just bank management but includes policy makers, bureaucracy, etc. and the focus should then lie on improvement of project appraisal techniques, accountability, post-disbursal supervision, etc. which is at the moment more impressionistic than information based.
• On tightening of the provision requirements upon restructuring of advances, the understanding is that provision does not mean losses and that banks should maintain provision accounts for other standard safe assets as well. Instead of restructuring only those projects which are about to turn non-performing, banks can also provide provisions to those projects which have already been marked as non-performing if some push from bank can improve the project’s state-of-affairs. Also, on restructuring, banks cut down the rate of interests charged on the loans to a great extent whereas restructuring only comes into the picture when project has become riskier than ever. It would mean that the initial rate of interest charged by the banks are arbitrary and not calculated as per the risk profile of the bank since it can make do with greatly reduced rates for a highly risky project.
• In case of asset-liability mismatch issue, bank is of the opinion that almost all banks rely on retail deposits of the tenure 1-5 years maximum to fund their advance portfolio (lending business). So the way the mismatch is managed in case of other standard loan products of tenure 8-10 years should be the same way the assets of longer duration need to be managed in the current scenario. From a long term strategy perspective, investing in the development of long tenure fixed rate product, interbank interest rate swap market for hedging interest rate risk and thus in short inculcating appropriate treasury skills may prove beneficial for the overall development of infrastructure financing.
• The idea of take out financing has been initiated and is on track wherein funds have been launched to refinance the infrastructure projects after the completion of the project upto a pre decided level and the stabilization of operations have been achieved in them. It will help the banks to exit the project in a shorter tenure and will help the project with fresh volume of lending for the completion of the project.
• Efforts are being made to resolve the issues around financing via ECB route but the understanding with RBI is that for effective management of financing these projects, ECB route may not prove to be any more beneficial than the other methods already present in the market. Motivations like arbitrage opportunities because of exchange rate differential cannot be preferred if the positions are hedged as the cost of hedging takes away the advantage. The only way a firm can potentially earn by borrowing in overseas markets is by gambling on the exchange rate and then retaining an unhedged forex exposure which of course is something which RBI does not want to encourage.

 

Some of the opinions held by RBI has been quite an eye opener for me as most of the times because of higher access to media, we get swayed by the opinions held by banks and other private sector companies involved in the infrastructure lending and borrowing process, once in a while going back to the understanding of the regulators while making a certain policy decision may be a wise idea to consider.

 

However, no matter how much we get into the discussion of which side is wrong and which one is right, one thing is very clear for everyone involved as well as the general public and it is this that we need better and improved infrastructure at any cost and no matter how difficult it looks like to bring in reforms and make the policies work, it has to be attempted if any progress is to be made in this area which quite obviously is the need of the hour. And thus we go on to discuss what are the steps which have been taken in recent past to better deal with the issues surrounding the infra sector and what has been the progress made so far because of the reforms that have been brought in.

 

Progress made so far:

 

• A CAG report states that several hectares of land acquired for special economic zones (SEZ) for public purpose were later sold off or used for other purposes. Among the groups that diverted land acquired for SEZs are Reliance Industries and Essar Steel, according to the audit report. In a report submitted to Parliament last week, CAG said the SEZs of Essar Steel in Hazira and Reliance in Jamnagar in Gujarat de-notified an area of 247.522 ha and 708.13 ha respectively, and allotted them to ineligible (DTA – domestic tariff area) units.
• Raising doubts on the fairness of allotment of government land to some top corporates for special economic zones (SEZs), the comptroller and auditor general (CAG) has said that 47 files related to them have gone missing in the commerce ministry and were not made available to the audit team despite requests.The auditor has published names of all the 47 SEZ developers who were allocated concessional government land at important locations in different cities whose files the commerce ministry has refused to share for scrutiny. The CAG audit report on performance of SEZs was recently tabled in Parliament and will now be taken up for discussion by the public accounts committee (PAC).
• After CAG picked holes in the special economic zone (SEZ) policy and questioned the underutilisation of vast tracts of land by developers, a study commissioned by the Department of Commerce has recommended going easy on new SEZ approvals. Instead, it wants to turn the focus on operationalising existing SEZs – just about half the SEZs with all approvals have at least one functional export unit inside them.
• To revive stalled plans and help banks tide over mounting bad loans, the RBI has eased norms for structuring of existing long-term project loans to infrastructure and core industries. The new guideline widens the scope of 5:25 scheme by including existing standard long-term project loans worth over Rs 500 crore to be flexibly structured and refinanced. The banks can flexibly structure the existing project loans to infrastructure and core industries projects with the option to periodically refinance them. The 5:25 scheme envisages banks to refinance or sell out their long-term project loans after every five years so that both the borrower and well as the lender doesn’t face much of an issue. For banks to avail such a facility, the loan tenor cannot be more than 25 years. The refinance may be taken up by the same lender or a set of new lenders, or combination of both, or by issue of corporate bond as refinancing debt facility. Such refinancing may repeat till the end of the fresh loan amortisation schedule.
• In a decision to speed up transfer of land for implementation of metro rail projects, the Union Cabinet has decided that once such a project is approved, all ministries would give operating rights on the relevant land sought by the metro rail company immediately.
  The decision will help avoid time and cost overruns. The proposal is to restrict ministries, departments or PSUs of the central government from asking for land in exchange for land required for the implementation of such projects.
• As many as 295 infrastructure sector projects worth Rs 150 crore or more are delayed with total cost overrun of Rs 1,01,436 crore.The original cost of the 295 delayed projects is Rs 5,48,838 crore and anticipated cost is Rs 6,50,274 crore, thus leading to a total cost overrun of Rs 1,01,436 crore.
• The National Highways Authority of India has received 167 bids for the proposed Rs 4,500-crore eastern peripheral expressway, in what could be a sign of revival of private sector interest in road projects. The proposed 135 km, six-lane expressway, which will connect Uttar Pradesh and Haryana bypassing the national capital, had no takers when bids were called in 2013 for it to be taken up on build-operate-transfer mode.
• The World Bank (WB) has offered to fund existing industrial infrastructure as well as creation of new infrastructure for micro, small and medium enterprises in Uttar Pradesh. Three sub-regional growth centres on Eastern Dedicated Freight Corridor (EDFC) have been identified by the global bank to make each industrial cluster economically viable.
• The Government of India has de-licensed the material handling equipment industry and has allowed 100 per cent FDI under the direct route. It has also given approval to some financial institutions to raise money through tax-free bonds. In the interim budget 2014-15, excise duty was cut by two per cent.
• The private sector’s share has expanded across key infrastructure segments, ranging from roads and communications to power and airports. Of the total planned infrastructure investments worth US$ 1 trillion during the 12th Five-Year Plan, the share of the private sector is estimated to be 47 per cent, up from 25 per cent during the 10th Five-Year Plan.
• India’s Planning Commission has projected an investment of US$ 1 trillion for the infrastructure sector during the 12th Five-Year Plan (2012-17).
• The Kerala State Cabinet approved a scheme for raising funds from the financial markets for infrastructure development. Funds will be mobilised for immediate, medium-term, and long-term requirements. A bill discounting system will be introduced to pay arrears, totalling around Rs.2,000 crore, to public works contractors. Instead of cash, the contractors will be issued ‘I Owe You’ instruments with irrevocable government guarantee. These could be discounted through banks. When the banks present the instrument to treasury, indication will be given as to when the payment could be drawn.
• The Karnataka government is setting up a special purpose vehicle (SPV) to develop infrastructure at tourist destinations across the state under the public-private partnership (PPP). The state cabinet approved the proposal of the tourism department to set up the SPV for tourism infrastructure development at an estimated cost of Rs.14,737 crore. 1,468 acres of land has been identified at tourist spots across the state for the projects under PPP.
• The central government has sanctioned Rs.21,350 crore for infrastructure development in the port and road sector in West Bengal
• Because of some strong projects developed in India in the last 5-10 years to boast upon, 6 Indian infrastructure projects are included in KPMG’s latest study – ‘Infrastructure 100: World Markets Report.‘ The list is incorporated based on 4 major factors, namely: mature International markets; economic powerhouses; smaller established markets; and emerging markets. They are:
  1. Delhi Metro
  2. Gujarat International Finance Tec City (GIFT)
  3. Interceptor sewage system
  4. Mundra Ultra Mega Power Plant (Mundra UMPP)
  5. Narmada canal solar
  6. Yamuna Expressway
• In the offing is the plan of redevelopment of Anand Vihar and Bijwasan railway stations as world-class infrastructure and integration of 34 metro stations into a multi-modal transportion. These decisions were approved by the DDA’s planning body UTTIPEC recently.
• The state government is all set to roll out the Rajasthan Urban Infrastructure Development Project (RUIDP) phase III with Asian Development Bank (ABD) to improve the infrastructure in six cities.In this regard, the state government has already approved the project of approximately Rs 3,660 crore. The total programme size would be US $610 million (Rs 3,660 crore). Rs 3,000 crore will be assisted by the ADB and state will have to bear the share of Rs 660 cr. In phase III, the government will improve the water distribution network, sewerage system, drainage in Sriganganagar, Hanumangarh, Jhunjhunu, Pali, Tonk and Bhilwara. DPRs and bid documents for three projects town Sriganganagar, Pali and Tonk is being prepared.

Road Ahead

So far we have been able to discuss various points of views and have also been able to review various efforts being made by the government as well as RBI to revive the sector and put it in the path of growth and development. So what is it that we may look forward to in future basis what we have in hand currently. Given the high rate of urbanization in India and a burgeoning middle class, development of infrastructure related facilities has to be in the top priority list for the government as well as the regulators. A lot of that can be seen from the way policies and efforts are being made in this sector. Also, development would mean some of the power shifting in the hands of the lower middle class as well which would mean another reason for a push in the infra sector.

The public sector is expected to continue to play an important role in building infrastructure. However, the resources needed are much larger than the public sector can provide and public investment will therefore have to be supplemented by private sector investments, in Public Private Partnership (PPP) mode. However, there is prevalence of another opinion which is that a large chunk of revenue expenditure is interest payments on past government borrowing. If the interest payment problem can be solved, there will no longer be a fiscal deficit problem and the government will have money to spend on capital expenditure or infrastructure. So, the only solution to the debt overhang of earlier borrowing is disinvestments that can be used to retire public debt and then use the money from the budget to heavily invest in Infrastructure projects.

What the need of the hour is that we have to identify our negatives such as high interest rates and inflation as well as the positives, including low labour costs and mineral resources and deal with them in a constructive way to be able to achieve the kind of growth that we as a country require currently. What can be said for sure is that there is a visible change in attitude towards investment especially in the recent times. However, to be able to say something positive with regards to flow of investments may probably take some time.

Infrastructure Financing in India – Issues and Way forward (Part 1)

So here is a blog on the current issues facing Infrastructure financing in India. I know it’s kind of a sharp turn from what I have been writing till now but as I have already mentioned in one of my previous blogs that I am after all a girl from a finance background (and it’s called Mullah ki daud masjid tak).

Lately I have been reading a lot about Infrastructure financing, the sector and what is happening in general around it. Got me to thinking about the various point of views that exist regarding what is the right way forward for the economy as a whole. It’s no brainer that India needs quality infrastructure at its disposal to support any of its developmental agendas. So if the way forward is so clear, what could be the various issues which could be acting as the barriers to a better, cleaner, organised and hence developed India? What are these points of views which are taking forever to sync?

To the ones who have already been following up on what is happening in this regard, my blog may come across as a bit layman as its basically for the ones who are not much into understanding the details of the economy and banking and stuff but if explained in easy bloggish terms may find it interesting and worth taking the pains for.

So the first and foremost question should be what exactly is infrastructure? In most simple terms it’s the basic physical structure that is needed for a society to operate or the structure required for the services and facilities necessary for an economy to function. But in common usage, the term is used to refer to physical structures like roads, bridges, tunnels, water supply, sewers, electrical grids, telecommunications, well you get the point.

But I don’t really want to talk about the infrastructure related issues of the economy. Frankly speaking, that list may go on forever and my time is precious for me. I would like to concentrate on the financing related issues with the infrastructure projects and what’s been taking so much time to get resolved for us to have bearable roads, parks, schools and other such facilities in place. After all, some of us are paying our taxes. Then why!

That takes us towards our second question. What’s financing required for and what is it really? So, that bit comes under the project financing part, which is basically financing a project based upon the projected cash flows of the project rather than the balance sheets of the sponsors/contractors. This is in sharp contrast to financing a car or a home construction (called car loans and home loans respectively) which are sanctioned when it has been confirmed via net worth documents that the owner is rich enough to pay for it. In case of infrastructure projects, the financing is done via PPP (Public-Private Partnerships) mode in India which is primarily a partnership between government and one or more private sector companies. So let’s take the obvious next question – why do we need to finance these projects like this? Why can’t the government pay for them from its own pockets?

The answer is it can’t. Two main reasons: First is that the government does not have the necessary skills or expertise to carry out these projects and the process of hiring experts and suitable engineering firms to do the job is not its cup of tea. Secondly, government is unwilling and incapable of incurring that kind of borrowing and show it in its balance sheet. The first reason is pretty straight forward to understand so let’s go deeper into the second reason. The government’s budgetary balance is a difference between the economy’s revenues and spending. Revenues are basically sourced from taxes. So, if spending is more than revenues, we have a deficit, if it’s less then we have a surplus which of course has never been the case. While some amount of deficit in an economy is seen as a mark of high demand for goods and services and thus shows good business potential, excessive deficit may create problems in terms of risks of default. Spending on infra projects comes under capital spending which is long term in nature as it cannot be renewed within a year’s time. If government does not have the resources to spend on capital expenses, then it needs to borrow funds. The most common method of borrowing is via selling government bonds (They are long term securities that pay a fixed rate of return over a long period until maturity, and are bought by financial institutions looking for a safe return).

Why is capital spending via selling bonds is not such a great idea is because as already discussed, there may be a considerable time-lag between spending and the benefits that arise from that spending, so the decision making has to be from a very long term perspective. But most importantly, excessive borrowing every year results in interest burden. In general sense, what constitutes Governments primary spending list is interest payments, defence expenditure, wages and salaries of govt. employees and various subsidies. This means that even if government doesn’t get involved in any of the activities going forward, it will still have a deficit. In order to finance this deficit, government borrows which then pushes up the interest rates (government sells bonds to banks and thus reduces banks’ surplus cash thus making commercial loans expensive) causing inflation and pushes other private sector investment to the bottom in its priority list. Since, interest burden of the past borrowed funds is already taking away such a huge chunk of the revenues, borrowing further to spend in capital expenditure is not an option for the government currently. Additionally, further borrowing translates into higher credit risk making interest rates being charged to potentially go up north further adding to the burden. Hence, PPP.

In the next sections, I will be talking about the reasons why PPP as an option got surrounded by so many controversies and complexities that despite being a perfect model given the issues with our economy, it was still unable to contribute in the desired way. Till then, happy reading…