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Infrastructure Financing in India - Exploring Alternatives

Posted in Finance Articles, Total Reads: 11523 , Published on December 02, 2011

Infrastructure – It is the backbone of economic activity in any country, but unfortunately, here India suffers from Osteoporosis. Time and again various policy measures have been taken to boost infrastructure, but no major progress has taken place barring on telecom infrastructure front. To fuel India’s ambitious growth rate and meet distant targets, a major restructuring is required on governance, legal, administrative and financial front. According to Global Competitiveness Report (GCR) 2009-10, India ranks very low at 76 in infrastructure domain.  Also India spends only about 6-7% of its GDP on infrastructure.


Finance is one of the most basic requirements for carrying out infrastructure projects, which are capital intensive and are in risky domains. The low levels of public investment have made India’s physical infrastructure incompatible with large increases in growth. Any further growth will be moderate without adequate investment in social, urban and physical infrastructure.

In 11th 5 Yr plan, 30% of total infra investment is expected to be from private sector & 48.1% of total infra investment is expected to be from Debt sources . This emphasises the need for availability of cheap and easy finance options for private sector.

% Contribution in projected investment in 11th 5-Yr Plan

Challenges in Infra Financing

There a lot of hindrances in achieving easy financing for infra projects in India

1.            Savings not channelized – Although India’s saving rate may be as high as 37%, but almost one-third of savings are in physical assets . Also financial savings are not properly channelized towards infra due to lack of long term savings in form of pension and insurance.

2.            Regulated Earnings – Earnings from projects like power and toll (annuity) may be regulated leading to limited lucrative options for private sector and difficulty for lenders. Also any increase in input cost over the operational life is very difficult to pass on to customers due to political pressures.

3.            Asset-Liability Mismatch – Most of the banks face this issue due to long term nature of infra loans and short term nature of deposits.

4.            Limited Budgetary Resources – With widening fiscal deficit and passing of FRBM act, government has limited resources left to meet the gap in infra financing. Rest of funds have to be met by equity / debt financing from private parties and PSUs.

5.            Underdeveloped Debt Markets - Indian debt market is largely comprised of Government securities, short term and long term bank papers and corporate bonds. The government securities are the largest market and it has expanded to a great amount since 1991. However, the policymakers face many challenges in terms of development of debt markets like

•             Effective market mechanism

•             Robust trading platform

•             Simple listing norms of corporate bonds

•             Development of market for debt securitization

6.            Risk Concentration – In India, many lenders have reached their exposure limits for sector lending and lending to single borrower (15% of capital funds) . This mandates need for better risk diversification and distribution

7.            Regulatory Constraints – There are lot of exposure norms on pension funds, insurance funds and PF funds while investing in infrastructure sector in form of debt or equity. Their traditional preference is to invest in public sector of government securities.


Exploring Alternatives

To overcome these challenges and find a way for easy availability of funds for infra finance, we can explore following alternatives:

1.            Developing domestic bond market, Credit Default Swaps & derivatives

India receives substantial amount of FII investment in debt instruments. But most of this investment is concentrated in government securities and corporate bonds

FII investment limit in infrastructure bonds has been increased from USD 5 billion to USD 25 billion. However investments of only USD 109 million materialized till August, 2011 . This deficit in target investment levels need to be reduced.

Just like a well developed equity market, India needs efficient bond market so that long term debt instruments are available for infrastructure. Currently FIIs can trade Infra bonds only among themselves. Also if credit derivatives are allowed, then FIIs will be encouraged to invest more in these infrastructure bonds due to the presence of credit insurance and better management of credit risk. RBI is in the process of introducing CDS on corporate bonds and unlisted rated infrastructure bonds by Oct 24 2011 . However much progress is sought is this domain like minimizing multiplicity of regulators, removing TDS on corporate bonds, stamp duty uniformity, etc.

2.            Priority sector status to Infra

Hitherto, infrastructure financing doesn’t come under the ambit of priority sector like agriculture, small scale industries, education etc. For every Rs 100 lent to non priority sectors, banks have to lend Rs 140 to priority sectors . Giving priority status will help banks to lend more to this sector.

3.            Take out financing and loan buyouts

One major problem faced by banks while disbursing loans to infrastructure projects is the asset liability mismatch inherent with these projects. Therefore many such projects are denied financing by banks.

One way out from this predicament will be the taking over of loans by institutions like IDFC after the medium term. This will allow banks to finance these projects for a medium term by sharing some of the risks with institutions like IDFC. This reduced risk exposure will allow banks to increase their financing of infrastructure projects.

4.            Rationalizing the cap on institutional investors

Rationalizing the cap on investment in infra bonds by institutional investors like pension funds, PF funds and life insurance companies will lead to more investment in this sector. Currently insurance companies face a cap of 10% of their investible funds for infra sector .

5.            Tax free infrastructure bonds by banks

Currently only NBFCs can float tax free infrastructure bonds. If banks are also allowed to float these bonds, they can raise long-term resources for infrastructure projects, thus reducing the asset liability mismatch.

6.            Fiscal Recommendations

The following fiscal policy medications can allow more funding of infrastructure projects.

1.            Reducing withholding tax

Currently foreign investors pay withholding tax as high as 20% depending on the kind of tax treaty . It increases borrowing cost as the current market practice is to gross up the withholding tax. So this recommendation would reduce the borrowing cost.

2.            Tax treatment on unlisted equity shares

Unlisted equity shares attract larger capital gains tax than listed ones. Currently capital gains on unlisted equity shares are taxed at 20% instead of 10% for listed equity shares. Most private players in the infrastructure sector are not able to raise capital through public issues. Therefore for these players unlisted equity will be their dominant source of equity capital. Therefore they are adversely affected because of the tax treatment meted out to unlisted equity shares. Hence special consideration should be given to private players in the infrastructure sector to encourage investments.

7.            Foreign borrowings

With respect to foreign borrowings, several options are there like increasing the cap rate for longer tenure loans, relaxing refinancing criteria for existing ECBs/FCCBs; allow Indian banks for credit enhance ECBs (which is currently allowed only for foreign banks), etc.

8.            Utilising foreign exchange reserves

India’s foreign exchange reserves stand at USD 311.5 bn (Sep 2011) .

These reserves are primarily meant to provide a buffer against adverse external developments. But they do not add value to any real sector as they are invested in foreign currency assets such as government bonds. So, the returns on these reserves are quite small.

The Deepak Parekh committee on infra financing is also in favour of allocating a small fraction of total reserves for infra purpose. This method of funding is already being used in some Asian countries like Singapore. After accounting for liquidity purposes, external shocks, high rate of domestic monetary expansion & real risks of disruptive reversals of capital flows; some of funds can be used for infra.

9.            Future cash flows as tangible security

The loans given to infrastructure project consortiums by banks are not secured & fall under the unsecured loans asset class for banks. Currently RBI mandates that provisioning of such unsecured loans is kept at 15% (additional 10% for sub standard unsecured loans) . Therefore total amount of loans to infrastructure projects are constrained because of the sub standard unsecured nature of these loans.

The primary source of repayment of these loans is the future cash flows accrued from the project once they are completed and ready for public use. These cash flows can act as a security under certain conditions and debt covenants. For instance in case of road/highway development projects, RBI passed an order that a) annuities under build-operate-transfer (BOT) model and b) toll collection rights where there are provisions to compensate the project sponsor if a certain level of traffic is not achieved, be treated as tangible securities

This article has been authored by Ankur Bhardwaj from MDI Gurgaon

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