Financing Infrastructure -Exploring Alternatives Other Than Promoter Equity & Bank Loans

Posted in Finance Articles, Total Reads: 4867 , Published on November 08, 2012

Infrastructure sector is the backbone of an economy and the growth of all other sectors depends on this sector. For a developing country like India, it is essential to build better network of roads for the ease of transportation, to develop ports and airports for enhancing trade, to upgrade the existing railway network and to invest in power projects and telecom sector for supporting the growth of industrial and service sector.

The fast growth of Indian economy in recent years has placed huge stress on its physical infrastructure, which is suffering from substantial deficit. So, it is becoming increasingly important to focus upon infrastructure development as it will not only help in attracting best global investment in the country, but will also propel industrial, economic and social development. Inspite of this, the current expenditure on infrastructure is only 8% of the GDP (approx.) which is very less as compared to global standards

During the eleventh five year plan, the investment in infrastructure had been given key priority and it was estimated to be US$500 billion, out of which 36% was expected to come from private-public partnerships. According to planning commission, this figure is expected to double i.e. to US$1 trillion during the twelfth five year plan with half of that expected from private sector. But this seems to be quite an ambitious plan as India’s growth in various sectors relative to eleventh five year plan has been mixed. India is currently facing a deficit of US$150 billion to US$190 billion in financing core infrastructure sector and the rising of interest rates by RBI to curb inflation has further added to the woes of infrastructure sector by making the cost of construction costly thus, hampering the infrastructure development. So, the need of the hour is to look for various financing options for this sector.

Though India is a lucrative market for many investors, yet there are several risks that are impeding the investment in the Infrastructure sector. Infrastructure projects always have some risks but in developing countries, the risk is usually high because infrastructure projects are undertaken not by companies having strong balance sheets but by special purpose companies which take up individual projects on B.O.E.T. (build, operate, earn and transfer) basis. Several risks associated with projects which make the investments difficult in the sector are

- Due to long construction periods, infrastructure projects are susceptible to unforeseen developments which might lead to time and cost overruns.

-  The technical performance of the project during its operational phase can fall below the levels projected by investors for a num­ber of reasons.

- The project might face market risk as there might be a possibility that the market conditions assumed in determining the viability of the project may change.

- Also, the cost of infrastructure projects is highly dependable on interest costs and they require a long payback period, which makes them prone to risk of increasing interest rates.

- Some infrastructure projects, which are dependent on foreign financing and generate fixed income in domestic currency, have risk due to changes in foreign exchange rates.

- Infrastructure projects have to interface with var­ious regulatory authorities throughout the life of the project, making them especially vulnerable to regulatory action.

One of the most popular ways of financing is bank loans but these are not very efficient in our country due to asset liability mismatch in banks as the infrastructure projects require long term loans while the deposits within the bank are on the short term basis. So, we need to explore different financing alternatives in the infrastructure sector.

- External Financing- The key source of financing can be external financing, which is provided by multiple agencies and has various flavors. An example of external financing is international bond market, which has an advantage of having long maturity periods ranging from 10 to 30 years which matches with the tenure of infrastructure projects, thus, protecting them against interest rate fluctuations.

Another key source is funding from multilateral institutions such as World Bank and Asian Development Bank. Earlier, these institutions used to fund public projects but now their inclination has shifted to private or PPP (Private- Public Partnership) owned projects. These institutions also act as a catalyst in attracting private investments in the infrastructure projects due to their transparent project evaluation methods and ability to benchmark projects against international standards. The International Finance Corporation (IFC), the private sector arm of the World Bank Group, could also play an important role in financing private sector infrastructure.

- Developing strong BCD (Bond, Currency and Derivatives) Market- Developing the strong bond market by giving tax incentives on infrastructure bonds will help to channelize the household savings in infrastructure sector. Currently, tax free infrastructure bonds worth Rs. 3000 crores has been allowed by the government which is very less as compared to other developing countries. This limit can be revised in the twelfth five year plan. The chart given below shows that the bond market in India is still underdeveloped compared to other countries of the world.

Strong currency market can also help to attract and sustain inflows of foreign capital in the infrastructure sector and for this purpose availability of foreign exchange hedging instruments needs to be strengthened. Also, if credit derivatives are allowed, it will encourage FIIs to invest in infrastructure bonds due to presence of credit insurance against credit risk. The Reserve Bank of India (RBI) has already came out with a credit default swap (CDS) guidelines that would allow corporate entities including insurers, FIIs and mutual funds (MFs) to hedge risk against default in corporate bonds to which they subscribe.

-  Use of Innovative instruments to promote debt financing- To attract domestic financing to the infrastructure projects, some innovative instruments such as mezzanine debt can be used. Mezzanine debt refers to hybrid instruments that lie somewhere in between debt and equity. A variety of such instruments, including simple subordinated debt, convertible debt, debt with stock warrants, and debt with an additional interest payment above the coupon rate contin­gent upon financial performance, exists. These instruments help to improve the quality of debt and its marketability.

- Setting up of Specialized Financial Institutions- Setting up of Specialized Financial Institutions (SFIs) will help in identifying financeable infrastructure projects more effectively and proactively than multipur­pose financing institutions. Moreover, they might be able to help structure projects in a manner that makes them financeable, taking care to meet the complex risk mitigation requirements of different types of investors.

-  Take out Financing- Since the long term nature of financing required by infrastructure project creates a problem, Therefore, the financing arrangements in which infrastructure projects can be financed for short term and then refinanced later by long term debt might be needed. A SFI such as IDFC can help to guarantee such arrangement with pre-determined financing cost.

- Setting up of Infrastructure Debt Fund- Infrastructure projects have a long pay-back period and they require long-term financing in order to be sustainable and cost-effective. Banks alone have been unsuccessful to meet these requirements due to asset-liability mismatch. Also, long term sources of investments such as insurance and pension funds have not been able to provide financing to these projects due to their risk perceptions. So, set up of infrastructure Debt fund has been announced recently by Ministry of Finance. The Debt Fund would raise low-cost long-term resources for re-financing infrastructure projects that are past the construction stage and associated risks. Through a package of credit enhancement measures, these debt funds would be channelized to infrastructure projects that are backed by a ‘buy-out’ guarantee from the government.

The above suggested alternatives could help to cater to the need of financing in Infrastructure sector to a large extent. Also, the steps taken so far by the government have been encouraging but the government could still consider several policy reforms and interventions to stimulate capital flows into infrastructure. The necessary action should be taken to remove bottlenecks to flow from existing sources of capital and provide effective mechanism to provide an effective facilitation mechanism in order to maintain the growth momentum of the economy.

This article has been authored by Ambika Garg from DoMS IIT Roorkee.

If you are interested in writing articles for us, Submit Here

Share this Page on:
Facebook ShareTweetShare on Linkedin