Attracting Private Investments For Infrastructure Development
Posted in Finance Articles, Total Reads: 3108
, Published on 10 December 2011
Infrastructure sector fuels the economic growth of a country and an emerging country like India needs the Infrastructure sector to play a pivotal role by increasing the productivity of labor and capital, reducing the costs of production and raising profitability, production, income and employment. Building roads to connect different parts of the country, developing ports to enhance trade, developing airports for speedier access to different parts to the country, upgrading the existing railways network and integrating telecommunication with IT will allow the Indian economy to grow at a healthy rate.
Impediment to developing Infrastructure in India and the way around:
Project Feasibility: Infrastructure projects are characterized by huge capital requirements and long payback periods. Lenders need to have utmost confidence in the project’s success for them to commit large funds for long periods. A proper feasibility analysis could go a long way in enhancing the confidence of the project’s sponsors. Feasibility analysis should include technical feasibility analysis to see that the processes involved are optimized, all environmental factors have been considered and future expansion plans are accommodated. Social impact of the project needs to be carefully studied and all parties concerned should be taken into confidence before embarking on the project. India has seen many projects getting delayed or not getting completing at all since the social impact was not taken into consideration.
Economic Viability: The project should include a study on the economic viability of the project which ensures that the project’s expected net present value is positive considering a factor of safety. Proper study of the economic viability requires a very good understanding of the cost and demand drivers and quantifying them.
Creditworthiness: The amount of debt a project can raise and the cost at which this debt is raised is hugely influenced by its creditworthiness. Creditworthiness should be improved by pledges from the sponsors and third parties benefitting from the project. The contractual agreement between the various stakeholders should ensure debt repayment and servicing to provide adequate security to support the project’s financing arrangements.
Project Risk Identification and Mitigation: Lenders will not agree to fund projects unless they are convinced that the project will be a successful one and a viable going concern. It is impossible for a project to have a proven track record before it is completed and has operated successfully for a certain amount of time. So the lenders will require to be protected against certain basic risks. Some of the important risks that need to be identified and mitigated for are completion risk, technological risk, economic risk, financial risk, raw material risk, currency risk, political risk, environmental risk and force majeure risk.
The public sector stakeholders i.e. the state and central government bodies involved in the project can play a huge role in mitigating most of these risks in the Indian context. They should ensure that the project does not get delayed for want of approvals and clearances from the government bodies unless such clearances are not allowed as per the laws and regulations. Political rivalry between parties should not be allowed to come in the way of success of such projects. An example is the Dabhol Power Project which got caught in the political swamp when the Congress Party lost control of the Maharashtra State Government in March 1995 elections. Policies and regulations regarding infrastructure projects should be formulated in clear terms removing all ambiguity which could cause any kind of hindrance in the future.
Financing the Infrastructure Projects:
As mentioned earlier, Infrastructure projects require huge capital investments and have a long payback period which means that the investors have to remain invested for a long period of time. Most of the infrastructure projects today are project financed by creating a legally independent project company financed with nonrecourse debt (and equity) for the purpose of financing investment in a single-purpose capital asset. It is becoming increasingly clear that government alone cannot fund the infrastructure projects entirely and private investment needs to play a vital role. But the large funds, long payback period, uncertainty about the future cash flows and various other risks mentioned earlier puts off private investors away from infrastructure projects.
The Eleventh five year plan estimates that private investment needs to constitute 30% of the total investments into infrastructure in India. For this to happen, the government needs to make it clear to the investors that there is no inherent conflict between regulation and development. The government needs to relax the various regulations concerned with investments in infrastructure and also provide financial incentives such as tax holidays to attract the investors towards infrastructure projects. The government has taken several steps in this direction such as allowing 100% FDI in most of Infrastructure sector projects and making investments in infrastructure bonds as tax free. It needs to take several other measures to make Infrastructure sector attractive to private investors such as relaxing statutory reserve requirements for banks to raise long term bonds, giving income tax incentives, providing directed credit to Infrastructure projects, giving negative license fee in case the social benefits are high but private investors are unwilling to come in due to low rate of return and attracting foreign equity.
The risks inherent in the infrastructure projects make it imperative that the required funds could not be raised through equity alone. So capital has to be raised through debt as well which means that the development of bond markets is very important. The need of the hour is long term bonds which could be raised for a tenure matching that of the project. But, Indian bond market is nearly nonexistent and the government needs to develop the market where such long term bonds could be traded. The government could provide initial guidance in the form of partial guarantee.
Thus problems in infrastructure financing in India are basically structural in nature and could be solved with regulatory relaxations and structural reforms to attract the private investors.