Infrastructure Debt Funds- An Option Or The Only Choice

Posted in Finance Articles, Total Reads: 3350 , Published on 24 June 2012

The debt market in India opened up after the liberalization of the Indian Economy in 1990 and thus introduced the auction system of government securities. It opened up the secondary market and allowed treasury bills, commercial papers, certificates of deposits, short Non-convertible debentures, options and other derivative instruments to be openly traded over the stock exchange.

Corporate paper became a part of it in late 1990’s. Even today, government securities are the one that constitute the majority of the trade. In 2010-2011, government and corporate sector mobilized US $ 175,856 million, out of which 74.32% of the resources were raised by the government.

The Indian GDP growth on an average has been 7% for last five years. According to a survey, India needs to create 100 million jobs in next 10 years, which is equivalent to the total present jobs in the US. To sustain such a growth rate, infrastructural development is of paramount importance and is indispensable to the growth and development of an economy.

The Model Infrastructure debt fund is a latest entry into the market. The infrastructure debt funds are liable to raise money from the market and lend it to the companies working in the infrastructural sector as defined by the Ministry of Finance, India.

According to the guidelines of government of India, Infrastructural Debt Funds can be raised in two forms

a) It can be raised in the form of mutual funds, which will be monitored by SEBI

b) Or it can be formed as a NBFC which will solely work in the debt segment for infrastructural companies and will be monitored by RBI

The mutual funds will invest at least 90% of its assets in the debt securities of the infrastructure companies, the rest of the 10% can be invested in the equities of the companies working in infrastructure sector. The mutual fund can be of any size. There is no absolute limit defined on the size. However, it can lend only up to 30% of the total fund amount. This can go up to 50% with consent from the board of trustees. This percentage is applicable at the scheme as wells as the Mutual Fund level. For example, if a Mutual fund issues two schemes of 100 crore and 200 crore, then the total loan amount that can be borrowed should satisfy the following conditions: -

i) loan amount from scheme 1 < 30% of 100 crore
ii) loan amount from scheme 2 < 30% of 200 crore
iii) loan amount from scheme 1 + scheme 2 < 30% of (100+200) crore.

The mutual funds and NBFC’s follow certain guidelines and the comparison between the two is as shown below: -

Mutual funds can raise funds through Units traded over the stock exchanges (BSE and NSE) in India. Each unit will be of 10 lakhs each, with a minimum investment of 1 crore. A fund scheme should have a minimum of 5 investors where in 1 investor will be a strategic investor which will have to invest a minimum of 25 Crores and its investment will be limited to 50% of the total net assets of the scheme. Thus the minimum value of the scheme is 50 crore.

NBFC's will be formed by a memorandum signed between the government and the sponsors. The sponsors can be multilateral banks, HNI's, domestic and foreign institutional investors specially the insurance and pension funds. The NBFC should have a minimum net assets of 300 Crores with a tier 1 equity of 150 crore. The NBFC's can raise resources through the issue of either rupee or dollar denominated bonds of minimum 5-year maturity, which would be tradable among equivalent investors.

Mutual funds schemes can lend directly to PPP and Non PPP projects. The financing can be both balance sheet finance as well as the project finance.

NBFC's will lend only to the projects based on PPP model. The loan would be provided to the projects that have been completed and have been in the operational phase for the duration of at least 1 year. The loan amount can be used for re-financing the existing loan from the banks.

In case of direct lending, the security arrangement for the loans will be similar to the loans provided as in the case of normal bank loans. The security can also be arranged in the form of securitized loan where in a borrower can issue bonds to which the AMC will subscribe over the counter.

Under the PPP model, the public authority has to provide for a compulsory buy-out guarantee in case of a termination of the project. The lending would be restricted to projects that have been awarded through competitive price bidding. It would cover rail, road, airport, port projects.

In Mutual Funds, the risk will be borne by the investors.

The credit risk will be borne by the AMC i.e. the NBFC in this case.

The government of India has also taken several other initiatives. For example

a) Incorporation of Special purpose vehicles like IIFCL in 2006. IIFCL will provide financial assistance up to 20% of the total project costs both through direct lending and through refinancing banks and financial institutions as a Takeout finance.

b) The AMC’s will not be taxed on their margin money and the withholding tax on interest payments for foreign investors will be 5%, instead of 20%.

c) Indian investors under the tax saving schemes can purchase Rs 20,000 of bonds.

An option or the only choice The Government of India has initiated this new product with a vision of building strong infrastructural facilities in the nation. Before, analyzing the utilities of this product, let us see what all options are available in the market for raising debt.

  • External Commercial Borrowings (ECB)
  • Foreign Currency Convertible Bonds (FCCBs)
  • Preference shares (i.e. non-convertible, optionally convertible or partially convertible)
  • Foreign Currency Exchangeable Bond (FCEB)
  • Indian bond Market
  • Loans from Indian Banks
  • Equity Market

The cost of debt raised through foreign banks is much less, than the cost of debt raised from the Indian banks. The loans from foreign market are available for longer tenure and hence the need for hedging the interest rate and foreign currency risk.

Borrowing from foreign market makes sense when the summation of cost of foreign currency debt and hedging cost is less than the cost of INR debt. Apart from this, there are other aspects that makes raising debt from the Indian market a viable option, i.e.

a) Asset Liability Mismatch: - In case of foreign currency debt, the asset side of the balance sheet shows cash in INR, whereas the creditors account in liabilities side, presents the same in foreign currency.

b) Stringent environmental guidelines enforced by foreign investors

However, some companies are bound to raise debt from the foreign debt market, the prime reason being that these big organizations have already reached the exposure limits for some of the major Indian banks. Reserve Bank of India has also laid tighter norms for Indian banks under Basel III international accounting standards that were conceived after the 2008 credit crisis to strengthen the lenders capital base and improve their ability to withstand shocks. Key points of Basel III guidelines:

a) Commercial Banks operating in India has to maintain the minimum total capital of 9% of the total risk weighted assets as against the 8%, prescribed by the Basel III guidelines.

b) According to the RBI, the common equity should be atleast 5.5% as against the international standards of 4.5%.

c) Tier I capital that is 6% in Basel II, rises to 7% under Basel III guidelines.

These guidelines are expected to be in place by 2018. So, are Infrastructure Debt Funds an option or the only choice in the long term?

If there is no increase in the exposure limits of the banks or the organizations which have already raised up to the maximum amount do not repay, we can expect that the IDF’s will be the only source of raising home currency debt in future.

4. Conclusion The present situation of Infrastructure Debt funds does not look too good. In 2009, government launched nine infra related infrastructure debt funds with an aim of raising 20,000 crore. However, until now, only three infra related funds have been able to raise money. SREI venture capital raised $ 13 million and $20 million and SBI Macquarie infrastructure Management raised $1.2 billion.

Presently IIFCL, IDBI, IDFC have filed a paper with SBI for the approval of their schemes. Though most of the fund management companies have knowledge about the benefits for their investors. However, they are still not clear about what will be offered to the borrowers. There are several questions, which are still unanswered. For example

  • What are the benefits of a loan from schemes based on IDF's as compared to direct loans from banks?
  • What are the guidelines specified for the moratorium period?
  • What guidelines will be followed in case the project is terminated?
  • What kind of Security arrangement is required for the loans?
  • What interest rates would be charged from the borrowers?

I believe, as the product will mature over the time, investors would get confident of returns and companies will borrow from IDF’s not because it will be a lucrative option but some of the big organizations will have no option other than this. At present, the AMC’s will have to induce confidence among the investors and clearly explain the borrower’s side of this model. Until then, the IDF’s overall picture seems to be gloomy and uncertain.

This article has been authored by Manish Khattar from IIM Rohtak.



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