Infrastructure projects typically include large capital outlay, higher investment risk, and longer gestation periods. Given the upfront capital requirement during the initial construction stage, lenders to such projects are particularly focused on revenue generation potential based on a detailed analysis of commercial, environmental, regulatory, engineering, and financial aspects that would govern the implementation of the project, as well as a comprehensive examination of the construction, operational, political, environmental or legal risks that can adversely impact the project. Any adverse consequence down the lane will, quite obviously, lead to delays and cost overruns which will eventually manifest in the form of reduced financial returns to the project financiers.
This has, more often than not, been the story of Indian infrastructure projects which are plagued by cost overruns from delayed approvals, land acquisition concerns and overambitious usage projections, in addition to a host of other challenges. As a result, fewer financiers are ready to line up even as calls rise for more infrastructure development.
To ensure sufficient and timely availability of capital for the government's ambitious infrastructure development plan, there is a clear need for new financing protocols that alleviate some of the investor concerns and provide relief to this sector. Some of the potential measures that can be considered are discussed in this article.
Development Finance Institutions
These are specialised institutions supported by the Government for providing project finance and typically balance commercial lending norms with responsibility for development. Historically, the first development finance institution o be set up was the Industrial Finance Corporation of India or IFCI, followed by ICICI, IDBI, National Housing Bank, NABARD, EXIM Bank, IREDA, SIDBI, REC, and PFC. Recently, the Government has hinted at the setting up of a new DFI aimed at providing long-term-finance for social and economic infrastructure sector projects. Reports indicate that the structure of this proposed DFI could either be such that it is promoted by the government or it functions like the private sector with the government holding not more than 49% equity. Practically speaking, a private DFI with minority shareholding of the government would likely prove more effective than a government-controlled institution.
Rationalising Bank Guarantee Requirements Recently, the Ministry of New and Renewable Energy has permitted bidders to furnish letters of undertaking issued by IREDA, PFC, REC, etc., instead of bank guarantees as part of the bid process for renewable energy projects. The margin cost for issuance of these bank guarantees could be reduced, particularly in light of the exposure to the infrastructure sector, enabling lenders and bidders to better utilise these funds. This would reduce the cost associated with the bidding process, albeit marginally, but is indeed a positive step. This could be a precedent for other infrastructure sectors where the cost of bid security is a percentage of the total project cost and could ease the level of doing business for companies engaged in the sector while reducing the financial burden on lenders.
Rationalised Credit Guarantee Mechanisms
Credit guarantee mechanisms need to be made attractive to secure financing by NBFCs and DFIs. Intermediaries could guarantee repayment obligations through the issuance of guarantees, which would reduce the uncertainty of repayment, and correspondingly lenders' balance sheets would not be adversely affected. This would also be an opportune time to introduce new products such as credit enhancement and bond insurance, which enable sub-investment grade corporates or municipal corporations in accessing financing.
A Simplified ECB Regulatory Regime
The external commercial borrowing regulatory regime at times acts as a hindrance to getting access to comparatively cheaper finance, and relaxations can be provided to make foreign funding more accessible. For instance, guidelines for ECB's provide certain restrictions on the end-use ECB, such as refinancing of existing domestic debt. These could be revisited, to enable refinancing of domestic debt, where prohibited, resulting in access to greater availability of money for the infrastructure sector.
Clear Investment Incentives
The government needs to make investments in the infrastructure sector more lucrative and provide tangible incentives, such as granting tax holidays. While the Union Budget for FY21 provided such tax exemptions to sovereign wealth funds, this could be extended to other investors. Any such exemption would result in lower project costs, which would benefit lenders by freeing up their lending capacity.
Promoting Alternate Sources of Investment
It is worthwhile to mention the potential involvement of life insurance companies and pension funds, who have a significant corpus, in infrastructure financing. These institutional investors are well-positioned to address the longer-term capital requirements of this sector. For insurance companies, there is a limit they can invest in the infrastructure sector. The limits can be increased since they have access to long-term funds, which is ideal for long gestation projects. Another source of infrastructure financing has been infrastructure investment trusts or InvITs. Since they utilise investor funds in the sector and typically have a longer tenure, not only do they fit in with the requirements but also enable individual investors, foreign investors, and insurance companies to subscribe to units of the InvIT. In addition, they also provide a better governance mechanism and being mandated to invest a greater percentage in operational assets, thereby deleveraging risks associated during construction stages.
Reinvigorating The HAM Model
The Hybrid Annuity Model, which garnered interest from the private sector in PPP projects due to part sharing of the capital cost by the government, has somewhat fizzled out, needs to be revived, and introduced for sectors other than highways. Since there is capital support by the government, the financing requirement from the private sector is proportionately reduced. This model has also stood the test of bankability and is unlikely to face much resistance from lenders.
Increased VGF Support
The viability gap funding for infrastructure projects has also been proposed to be increased, especially for social infrastructure projects – which are considered financially unviable but essential for social services. This is a welcome step by the government as part of the Atmanirbhar Bharat Abhiyan, assuming part-funding of such projects.
Heightened Risk Management Protocols
Since infrastructure projects require a greater degree of risk analysis, commercial banks are not properly equipped to undertake thorough diligence and invest over the long term and lenders would need to improve their governance and risk management capabilities. This would entail amongst others, undertaking a detailed technical, financial, and legal due diligence prior to lending to infrastructure projects. If the debt repayment obligations of a borrower appear to be at risk, lenders can audit and inspect specific aspects at the very first instance, instead of waiting till the loan is on the verge of being classified as a non-performing asset.
Conclusion
Even as non-banking financial companies and the bond market have emerged as a significant source of infrastructure finance, a majority of lending still comes from commercial banks. However, commercial bank financing suffers from an inherent conflict with regards to asset-liability mismatch – while infrastructure funding requires long-term capital, most of the funds from these commercial banks come from short-term deposits – which distorts and adversely impacts the appetite for such investment. Currently, lenders appear to be in a risk-averse mode and are hesitant in lending to the infrastructure sector.
Apart from the current market conditions, attempts by various state governments to re-open contracts have instilled apprehension, which have been amplified by additional factors such as delays by the government in fulfillment of its obligations related to land acquisition and obtaining clearances. These have manifested in larger collateral requests from sponsors thereby significantly raising the cost of financing or raising debt for infrastructure projects.
In this context, there can be no debating the need for specific measures to alleviate the financing concerns in the infrastructure sector. The core requirement pertains to finding a mechanism that balances the long-term capital requirement of infrastructure projects with the short-term capital available with traditional lenders. Steps such as incentives to project lenders, rationalised collateral requirements, sovereign support to social infrastructure will help the government push infrastructure development in a continuous, sustained manner.
Originally published by BloombergQuint
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
