By G Padmanabhan
As I look back at my stint at the Reserve Bank of India, I recall with a smile the period I spent in the Foreign Exchange Department (FED) and Internal Debt Management Department (IDMD). While in FED, we worried no end about “messing” markets whenever the rupee turned volatile; in IDMD the worry related to a “missing” market. I am referring to the NDF (non-deliverable forward) market and the Corporate Bond market respectively. While the RBI has moved a long way forward in ameliorating the challenges posed by the NDF market, the Corporate Bonds market continues to be a conundrum given its role in infra financing.
Since the mid-1990s, efforts have been made by the government towards infrastructure development. If we borrow “Cooperation has failed …but it must succeed” (Dantwala Committee) for the infrastructure sector, the apposite restatement would be, infrastructure development in India has succeeded in some segments, but overall continues to disappoint most stakeholders.
The 1990s saw liberalisation reforms in key infrastructure sectors such as electricity, telecom, and roads; specifically to invite private sector participation. From pure government initiated models, PPP (public-private partnership) was brought in, and India achieved significantly. For instance, if we compare since independence, road length has increased from 4 lakh km to 59 lakh km, installed power capacity has increased from 1,000 megawatt to 370-plus gigawatt, number of electrified villages has gone up from 3,000 to over 6 lakh, port capacity has gone up 27 million tonnes to 1,400 million tonnes and we have 137 airports. The telecom sector has had a complete makeover. Notable progress has been achieved but we have miles to go.
Despite many sector-specific financing institutions like PFC, REC, HUDCO and IRFC, infrastructure financing continues to be a big challenge. India Infrastructure Finance Company Ltd (IIFCL) was established in 2006 as a specialist infrastructure financing institution and caters to long-term financing needs of the sector. We had a few like ICICI, IDBI, when our infrastructure dreams were still budding, but we permitted all of them, the last one being IDFC, to convert into universal banks.
Initially, banks led the way in financing infrastructure development despite their asset-liability mismatch issues. But a combination of inadequate long-term finance, lack of appropriate skillsets required for project preparation and appraisal and a string of external issues relating to timely implementation and poor entrepreneurial skills led to a huge burden on banks’ balance sheets. It is estimated that about 18% of infra loans in banks books have turned NPAs.
Recent issues have added to an already complex environment. No country in the world has built infrastructure entirely through private sector efforts. Government involvement either by way of direct financing or credit enhancement or guarantee support has played a very important part.
In this context, the National Monetisation Pipeline (NMP) assumes significance. The government is looking to realise Rs 6 lakh crore from existing brownfield infrastructure projects through multiple methods, including leasing concessions, InVits (Infrastructure Investment Trust) and PPP. This is designed to attract funds for the ambitious National Infrastructure Pipeline investment of Rs 111 lakh crore over a five-year period. But in a country like India, with limited fiscal spending headroom, this alone may not suffice. Private investment and foreign capital will have to augment government efforts. This means private investments have to be facilitated in a big way into infra projects.
Long gestation infrastructure projects are generally characterised by multiple risks, including policy, pricing, payments and regulatory risks. Risks particularly aggravate during the construction phase of the project. Largely for this reason, foreign investors have generally invested in brownfield, already operational, revenue visible, projects. A basic premise of effective implementation of projects is the identification and allocation of these risks to the appropriate stakeholders who are best able to manage and mitigate them. Successfully addressing these issues is why the private provision in telecom and airports has worked, while power languishes.
There was a visible spurt of private investments, particularly in the road sector from 2008 to 2016, with the sector leading the way for PPPs. The then new-found process induced a positive outlook amongst all stakeholders. However, in their attempt to “quickly” reap the fruits, the cardinal principles of PPP for adequate project preparation, balanced risk allocation-based contracts, and the right approach of ‘partnership’ were compromised. These led developers, with limited finances and risk-taking capabilities, to bear the onus of getting land acquisitions and all clearances, an area where the government has a better hand. It laid the seeds for delays and cost-overrun in projects.
The BOT (build, operate, transfer) model was also prone to aggressive bidding by over-leveraged developers. Real issues in projects quickly flowed to the lenders. Despite being the largest financial stakeholders in project, the absence of lenders in the Concession Agreements, inadequate dispute resolution system, rigid contracts etc, forced them to bear the brunt of such systemic inadequacies as they failed to recover their monies.
It is important to understand two basic concepts relating to return on investment, which is the key metric for attracting private investment. One is market-related rate of return on investment, and the other is economic rate of return. The bulk of infra financing will only happen when implementation and regulatory policy distinguishes in addressing the two concepts as otherwise, it would end up being far too expensive.
Covid has further changed the private sector behaviour. Private investors are largely unwilling to use their balance sheets for long-term project commitment and would rather prefer EPC-type contracts. This does not augur well for funds requirements for infrastructure, given the Covid-induced additional burden on the finances of the government. Also, foreign investment flows are increasingly looking for ESG (environmental, social, and governance)-compliance for investing in the sector. India is still some way from having an ESG rule book. This means except for the government, banks and select NBFC-IFCs, there are no takers for the implementation and construction risks of infra projects.
The way forward is a new financial architecture, wherein, banks fund infrastructure projects in line with their liability profile, ie, 5 to 7-year terms up to the completion of the construction phase of the project. Further, given their risk appetite, appraisal and risk mitigation capacities, banks are best suited to fund greenfield assets till completion. Post achievement of Commercial Operation Date, liabilities of such infrastructure projects can be offloaded to the bond market and/or other banks and financial institutions with a long term lending profile.
We need an environment where long-term financing happens with a set of banks taking up financing and passing it on to another set of banks over a period of time. It must be like a ‘relay race’ where the baton (financial assets) is passed on to the next runner (bank/financial institution), thereby enabling an effective sustainable solution for long term financing in the immediate short run. The Channel Tunnel financing is an example where one set of banks passed on the asset to another set of banks so the amortisation period of the project increases and enhances the project viability, helps reduce user charges and create a multiplier effect in the economy.
At present, in India, refinancing a project is treated akin to ‘restructuring’ which requires higher provisions by lenders. Refinancing of standard assets with no overdues should be encouraged, particularly from the regulatory perspective. Such refinancing may be considered by the RBI, without impacting the asset classification, in line with global best practices
A point to emphasise is that in our country, most of the infrastructure financing problems are linked to government moral hazard problems, eg, honouring operational contracts in a time-bound manner, allowing free market pricing of tolls and user charges, and clearance of land acquisition/licences. These cannot be resolved by the central bank or by a newly set up DFI (Development Finance Institution).
When startups can raise billions in the capital markets without any difficulty, why is infra financing proving to be a conundrum over decades? The answer is the time horizon and the associated risks. Stability of return on investments, stability of rules of the game over the period of investment, and, very importantly, contracts being honoured irrespective of change in bureaucracy or government, are all of critical importance. India is a country of contradictions where pricing rules get distorted, even thrown out, not by providers, not by distributors, not by users, but by politics (even judiciary!).
There is no single major institution in the country as of now prepared to assume implementation, construction risk. One suggestion could be the passing of a dedicated infrastructure law that facilitates a seamless working of the whole system. This will ensure the sanctity of contracts (for example stop repudiation of contracts entered into by the previous government) and address implementation and pricing issues too.
Corporate Debt Market
In parallel, we need to think of developing a corporate debt market. G Mahalingam, whole time member, SEBI, had flagged the following critical issues with reference to the development of the corporate debt market. First, the corporate debt market is a Rs 36-lakh crore market. This may look big. But this is just about 18% of India’s GDP. The US is more than 120%, Brazil 70% and Korea 50%. So, we still have miles to go.
Second, there is hardly a secondary market and much of the investment has to be “held to maturity”. Third, most of the primary issues are through private placements. So, the question arises whether price discovery is efficient. Fourth, institutions supervised by the insurance and pension fund regulators have long term funds, yet have been shy of permitting investment except in top-rated securities.
Recognising the most critical of the issues is the availability of liquidity; SEBI is learnt to have proposed a separate Repo Corporation for Corporate Bonds. This is a very welcome step since this proposed market making institution will help increase liquidity in secondary markets for corporate bonds, thereby facilitating increased primary issuance of lower credit rated bonds, which is the space most infrastructure Special Purpose Vehicles are located in.
Is asset monetisation a way to fund infrastructure? Take Railways for example. Its potential to monetise assets is enormous. Additionally, they can tweak their functioning by converting hundreds of railways stations into multi-utility centres. Similar models can be thought about for other areas as well. The InvITs initiative is a significant step. But asset monetisation has to be strategic to be effective.
Could asset monetisation be resorted to capitalise on the proposed DFI? One always needs to ask the question whether the inflows from monetisation are intended to be used for reducing the sovereign debt burden for adhering to FRBM (Fiscal Responsibility and Budget Management) commitments, or bring in new efficient, cost-effective, income-earning operating models.
A Lazy Suggestion
One lazy suggestion that comes up these days to address the funding problems for the government is to eye the RBI balance sheet. RBI reserves are not merely showpieces to behold, so one needs to be careful. Unless expenditures are directly in foreign currency, they can only be “circular” transactions with the RBI having to buy them back for stability in the forex markets. In other words, this can result in huge monetary expansion and consequent macroeconomic effects. Already a proof of concept of giving $5 billion to Indian Infrastructure Finance Corporation achieved little. The government flirted with the idea of overseas long-term borrowing, which appears to be on the backburner now.
Another methodology could be replicating the financing model for the bullet train project, which involves the use of large, low cost, foreign currency loans from overseas official institutions. As a rule, public transportation requires direct budgetary support so the role for private efficiency in owning and running these is limited. It is to be noted that InVits is picking up and the MF industry is also attracted to it. So is that the future or a separate product per se or going back to a modified version of Bad Bank to take up pending and over delayed projects and pushing these through a possible way forward?
While we await the structure of the proposed DFI, the mere establishment of a new DFI may not solve issues unless we solve the operational and functional issues that beleaguered the DFIs of the past. The National Bank for Financing Infrastructure and Development (NABFID) Act is unlikely to be a panacea to end the woes of the infrastructure sector. The sustainability of its financing structure hinges on the enormous concessions (in tax and hedging cost) planned to be given to it and that entails huge fiscal implications.
Infra financing has been a challenge for many years. Many recent efforts offer hope that we are finally going to find effective solutions. Where we need to improve is effective implementation. The government has to be an important player in any of the new initiatives. Government’s stretched financing is a concern but perhaps not if the borrowing is spent in creating capital assets.
(The author, an independent director on the Board of Axis Bank, is former Chairman, Bank of India and former Executive Director, Reserve Bank of India)