Infrastructure Financing – Constraints and Way forward for New India
India is sixth largest economy in the world with USD 2.26 trillion Gross Domestic Product (2016), and retained its position of being world’s fastest growing economy. Development aspirations of India are manifold and infrastructure development makes the base pillar of it. Infrastructure investment, thereby holds key role in accelerating the economic growth. It has been observed that more than public investments, currently private investments hold major potential in meeting up rising infrastructure development requirements. Nonetheless, Foreign Direct Investments in highway, rail, port and telecom projects in India attract attention world-wide. However, India ranked 81st out of 140 nations in Global Competitiveness Index[i] for Infrastructure and 23rd in Global Infrastructure Investment Attractiveness Index 2016[ii].
There are several issues and shortcomings that add to the financing challenges and deter the commercial viability of investment projects in infrastructure in India. Addressing these hurdles becomes indispensable to improve infrastructure in India in order to meet out the development needs of the hour. Infrastructure development forms the core element of UN Sustainable Development Goals[iii]. Furthermore, infrastructure sector is the promising sector in terms of creating huge employment opportunities to engage the bulge in the population pyramid of India. One percent increase in infrastructure investment as of GDP is estimated to generate 3.4million jobs in short-term[iv].
Infrastructure Investment – India on the Globe
When internationally USD 2.5 trillion is invested per year in infrastructure services comprising transportation, power, telecom and ports, accounting to around 7-10% of GDP in boom years, India on the contrary, invested around 3% of GDP in infrastructure till late 1990s. Challenges in Infrastructure development “were not the central focus of policy until mid-1991 economic reforms”[v]. In order to keep pace with growth and development aspirations, investments in infrastructure required a substantial impetus, and it was in late 1990s that private investments in infrastructure stepped up, popularly in form of Public Private Partnership (PPP). In the period 1992-2013, when China recorded 8.6% of GDP investment in infrastructure, India in the same period recorded 4.9% of GDP investment in infrastructure[vi].
According to Aracadis report on ‘Global Infrastructure Investment Attractiveness Index (GIII)’ 2016, Singapore retained the top rank for a third consecutive time, followed by Qatar and UAE. India on the rank chart stood 23rd, while China secured a stable rank at 17th. In Asia Pacific zone, despite its slow growth rate, China still leads the charts for infrastructure investment, owing to its attractive business environment. India, in the same zone has improved two places between 2014 and 2017, given to the Chinese slowdown and India’s consistent growth story in the past decade, even during the recent global recession.
Falling Investments in Infrastructure
Government plays an imperative role by way of addressing the challenges in infrastructure financing. Government has made significant contribution in infrastructure investment so far till 12th five year plan. However, public investment in infrastructure as a percentage of GDP has been almost static during these 5-year plan periods. It was 3.9% of GDP during 10th five-year plan, 4.4% of GDP during 11th five year plan, and 3.5% of GDP under 12th five year plan[vii]. There is wide dependence on private investments for infrastructure development in India. As per 12th five year plan, 51% sources of debt financing identified were domestic commercial banks, 27% were NBFCs and 15% were ECBs. So far domestic commercial banks have driven debt financing in infrastructure sector, followed by specialised NBFCs including insurance companies.
Besides raising capital through IPO/FPO, India, in past decade has witnessed several private equity infrastructure funds (PE) coming up to raise capital. PE investments in India in Infrastructure (excluding telecom), was USD 2176 million in 2011, which went down to USD 688 million in 2013, and gradually increased to USD 1435 million in 2015[viii]. Considering, PPP investments in India for infrastructure are continuously shrinking and reached a 10-year low in 2015, as per World Bank. Then, Foreign Direct Investments in infrastructure projects in India was some 0.1% of GDP, which shot up to 0.8%-0.9% of GDP between 2008 and 2010, however, declined to 0.4% of GDP in 2014[ix].
Constraints in India
Rising Fiscal deficit has been one of the major reason behind fall in public investment in infrastructure in India. Rising fiscal deficits push up the cost of debt for public funding. Furthermore, currency exposure and its management, when India follows floating exchange rate calls for uncertainties in currency market. Then, price stability also impacts investments in India. Continued Inflationary trends hinder investment prospects. Despite high saving rates in India, debt markets for corporate sector is still underdeveloped. Thereby, debt funding for infrastructure financing for private players involves low profitability and long term debts.
On the other hand, PPP investment model has reached its “trough in the capex cycle”[x]. Furthermore, it is known that in India, since developers largely have limited capital, they tie up with financial investors to form Private Equity Infrastructure funds (PE). But capital markets with poor exit norms are deterring the private players to take up investment in infrastructure. India has an underdeveloped bond market, featuring liquidity crunch, high cost debts, and fluctuating interest rates, with ceiling limits on foreign investments in certain sectors. External Commercial Borrowing (ECB) in this context, has made affordable infrastructure finance accessible.
Recent developments and reforms on regulatory framework related to Taxation, such as Dividend Distribution Tax, Minimum Alternate Tax to foreign companies under New Companies Act, deductions under IT Act u/s 80 IA, introduction of GST and GAAR rules, are indeed encouraging, but their compliance procedures have created uncertainties amongst the investors. Complex rules and interpretation of compliance procedures discourages investment. Furthermore, restricted land acquisition rules, and new PPP models coming up, have created perceived apprehension amongst the investor fraternity. Comprehending and meeting compliances, procedures and regulations deters interests of investor in taking up long-term risk projects in infrastructure.
Rising Gross Non-Performing Assets (GNPAs) of domestic commercial banks, which was INR 6 trillion as on March 2016, has subdued the risk taking capacity of domestic banking sector. Infrastructure projects, in this context, are executed by Special Purpose Vehicles, which neither have a credit history nor a balance sheets. Indian financial market, apprehensive due to rising GNPAs, discourages debt financing to these SPVs. Then, since banks lend loans at floating rates, entire project span is subject to interest rate fluctuations, restricting the viability of the project in the long run. Scope of External Commercial Borrowing (ECB), in order to curb the monetary expansion effects of capital inflows from outside, has been regulated and restricted by RBI. In January 2015, it was reported that ECB applications worth USD 2billion were pending for approval, most of it include housing and infrastructure finance[xi].
Lastly, there are sectoral challenges that deter investment in projects pertaining to infrastructure[xii]. Transportation projects, particularly highway projects have to largely depend on collaterals due to inadequate bandwidth to undertake project appraisals and structuring. Furthermore, under-performing assets impact portfolio returns, and the sector is facing growing debt levels due to delay in commissioning of projects. Moreover, they suffer lack of clarity on repayment on project termination, and face limited confidence in availing funds under new funding models such as Hybrid Annuities due to backlog of previous projects. Port development projects struggle with shorter debt tenures and project concession periods. All of these challenges altogether limit infrastructure finance in these sectors in India.
Similarly, infrastructure financing for power and energy sector faces certain challenges. For instance, financial constraints of Discoms working under accumulated losses of around INR3.8 trillion[xiii], has indeed been deterring investment environment in power sector until UDAY scheme came for rescue. Then, renewable energy sector is a new and buoyant sector for investments presently. Whenever a new sector is opened for investment, aggressive bidding follows. Government on the other hand undertakes reverse bidding for effective low tariffs. This aggressive bidding phase often calls speculative instinctive quotes, beyond project viability in long term. Analysis of project viability in this context is significant so as to ensure reasonable returns to investors in this sector.
Overcoming Barriers and Innovating finance options
At first, it is important to mitigate risks in financing infrastructure. Frequent changes in policies, government actions and industry norms adversely impact investment appeal. Firstly, clarity on legislations and simplified policy for regulatory authorities for easy compliances is important to mitigate with regards to infrastructure financing. Second, maintaining fiscal discipline is very crucial for state to build a better investment market in the long-term. This helps minimising business risks involved for investors arising out of high/fluctuating cost of debt/finance, inflation or currency fluctuations. Following FRBM rules, most states have been conservative spenders emphasizing fiscal prudence. However, of late certain states have opted to break fiscal conservatism in order to boost economic activities, particularly infrastructure financing[xiv].
Then, optimum risk allocation and cushion throughout the project investment phase, viz. development, construction, operation and termination phase is important. Most risk is perceived during development and construction phase. So besides, availing adequate funds in this phase, it is also important to ease and simplify the regulatory compliances to build on risk taking potential of the investors. These compliances include, permitting processes, environment permits, land acquisition, contract negotiations, taxation, collaterals, and other permits. Instruments that enable bankability of projects, should be prioritised and incentivised.
Given to recent developments and that the incumbent regime is putting high impetus on spurring growth rates through infrastructural development, several measures have been put in to encourage investments. States/PSUs are taking up new investments in sustainable infrastructure projects through Public Private Alliances. Furthermore, RBI is taking measures to facilitate infrastructure funding by easing lending norms, ECB guidelines and giving scope to emerging options. Promoting alternate and emerging funding options such as, Rupee denominated offshore ‘Masala’ bonds, InvITs, REITS, Sovereign funds, Hybrid models, Special Purpose Vehicles, etc. is lightening the tunnel. Further, it is important to build a dynamic and responsive policy deliberation forum to overcome glitches in these new models of funding. Similarly, development of more new funding options such as auctioning upcoming revenues from infrastructure projects to fund the infrastructure, and more convenient financing options must be encouraged.
Nonetheless, more public guarantees for major infrastructure projects, promoting refinancing options, long term funding and grants, besides dynamic and responsive grievance redressal mechanism is expected to boost infrastructure financing. Lastly, it is important to overcome policy paralysis and inconsistency in policies to boost investors’ confidence. Most reasons that deter investors’ confidence comprise delay in project planning, implementation and payment disbursement. It is important to identify and eliminate points of conflict and delay in processes, besides continuous dialogue to build their trust in Indian markets. Political stability, efficiency in Parliament proceedings and budgetary performance are macro variables that boosts investors’ confidence in country’s markets, while easy land acquisition laws, licensing and other regulatory framework besides, low cost of compliances and simple processes and friendly bureaucracy are micro variables that keep the investors’ morale.
High level Committee under HDFC chairman, Shri Deepak Parekh was set up, that submitted its report in 2014 on infrastructure financing addressing most of the challenges highlighted here, which are under consideration with the Government. In recent years, efforts have been made by Government of India in form of economic and budgetary reforms, coupled with improved foreign policy which has indeed resulted in an upsurge in Foreign Direct Investments in India. There was a significant 23% growth recorded in FDI in FY 2015-16. This even replicated into increase in capital expenditure outlay in infrastructure, at INR 2.2 trillion in FY 2017-18[xv].
[i] World Economic Forum Report (2017). Refer http://www3.weforum.org/docs/GCR2016-2017/05FullReport/TheGlobalCompetitivenessReport2016-2017_FINAL.pdf
[ii] Aracadis, ‘Third Global Infrastructure Investment Attractiveness Index 2016’.
[iii] Goal 9, UN Sustainable Development Goals; Refer http://www.undp.org/content/undp/en/home/sustainable-development-goals/goal-9-industry-innovation-and-infrastructure/targets/
[iv] Mckinsey & Co. (2016), ‘Bridging Global Infrastructure Gaps’.
[v] Ahluwalia M.S., ‘Infrastructure Development Reforms in India’, Planning Commission (Speech), Refer http://planningcommission.gov.in/aboutus/speech/spemsa/new/msa29.pdf
[vi] Ibid 5.
[vii] Deepak Parekh Committee Report 2014, 12th Five Year Plan Vol.1 Report.
[viii] Grand Thornton (2016), ‘The Fourth Wheel 2016’.
[ix] DIPP, FIPB Report (2015). *Infrastructure here includes – Construction, Electricity, Petroleum oil and gas, Real estate.
[xi] Refer http://www.thehindu.com/business/Economy/Reserve-Bank-of-India%E2%80%99s-ECB-norms-two-steps-forward-one-step-back/article14017722.ece
[xii] Refer http://www.ey.com/Publication/vwLUAssets/ey-infrastructure-investment-and-stressed-assets-outlook/$FILE/ey-infrastructure-investment-and-stressed-assets-outlook.pdf
[xiii] Press Release (2015), Ministry of Power, Government of India. Refer http://pib.nic.in/newsite/PrintRelease.aspx?relid=130261
[xiv] Refer http://www.livemint.com/Politics/6md0IVDzvmIkzk9c22oT8J/State-governments-driving-fiscal-expansion-in-India.html
[xv] Refer http://www.livemint.com/Politics/zdmiM68OZXnq2Kg5sMJESI/Budget-2016-Govt-to-spend-Rs218-trillion-on-roads-railway.html
Research Associate, Public Policy Research Centre, New Delhi