The current state of transport infrastructure is curtailing economic growth in India, but the government is leaving no stone unturned in addressing the deficit, writes Siddharth Poddar.
Addressing the shortfall in infrastructure funding in India is a critical task for the government, particularly in the transport sector. Infrastructure bottlenecks are having an adverse effect on GDP growth and putting pressure on businesses operating in the country. For instance, Krishna Bhupal, director of GVK Power & Infrastructure, one of India’s largest players in the airport, transportation and energy space explains that while it takes just 15 hours on average to travel 1,000 miles in the US, the same in India can take anywhere between 40 and 50 hours. “This leads to large inventory holding by businesses and large working capital requirements,” he says.
One of the key reasons for the infrastructure gap is the shortfall in financing. During the government’s 11th five-year plan (2007-2012), the government sought to spend US$500bn on infrastructure. Ultimately, a total of US$430bn was spent, about 35% of which came from the private sector. While this sum was the largest spent across any five-year plan, there was still a significant shortfall of US$70bn.
Sushi Shyamal, Mumbai-based partner for infrastructure, industrial and consumer at Ernst & Young, says that until now, infrastructure demand has only partially been met. “The story in India is ‘demand creates infrastructure’, whereas it should be the other way around where infrastructure creates demand,” he says.
In the current five-year plan (2012-2017), the government has an infrastructure spending target of about US$1tn, of which the private sector is expected to contribute as much as 50%. This target will be difficult to meet because of the regulatory uncertainty over land acquisition, environmental clearance, pricing of services, bidding processes, return expectations, slow decision-making and the availability of long-term capital.
The Indian government is actively trying to address its infrastructure financing shortfall and has announced a range of initiatives that aim to enhance transport connectivity in the country. Thus far, India has seen rapid road development under the National Highway Development Programme (NHDP) and port capacity has been enhanced to more than 1 billion tonnes per annum.
Vikram Pant, a senior managing director with IDFC Project Equity, a subsidiary of infrastructure-focused financial institution IDFC, says the government has increasingly introduced policy measures aimed at increasing investment flow to the infrastructure sector.
“Key measures introduced over the past decade include higher budgetary allocations, changes to foreign direct investment rules, introduction of public private partnerships (PPPs), easing of external commercial borrowing norms, introducing model concession agreements, providing financial assistance and viability gap funding for private investors, setting up financial institutions and facilitating investment avenues like infrastructure debt funds for long-term capital, providing tax exemptions, and introducing various investor-friendly measures to promote the renewable energy sector,” says Pant.
According to Ashish Jain, Mumbai-based associate director, Standard Chartered Principal Finance, “there have been fits and starts, and sometimes backward steps over the years”, but he adds that recent measures undertaken by the government “seem to indicate that there is a concerted move to resolve outstanding issues in infrastructure development”.
One of the most important steps has been the establishment of the Cabinet Committee on Infrastructure, which will provide faster, single-window clearance for big-ticket projects where investment is larger than Re10bn (US$184mn). Another positive step in the transport sector is the increase in road projects awarded by the National Highways Authority of India (NHAI). Additionally, the expected implementation of a lower interest rate cycle over the next few months could also lead to new investments by increasing project level returns.
However, Bhupal at GVK believes that while the government is taking the right steps, it needs to be more consistent in its policies. “The policy towards infrastructure development should not alter on account of political change. In addition, ground level issues like various clearances – environmental clearance, land clearances and the like should not take inordinate time,” he says. He suggests that project sponsors (usually the government) should only call for bidding after obtaining key land and environmental clearances for projects. Moreover, the government should pre-audit concessions before the actual bidding takes place. In his opinion, both of these measures will expedite project execution.
Shaurya Doval, managing director of Zeus Caps, an India-based principal finance firm, says that in the latest five-year plan, the government has looked to increase private funding for transportation. As part of this initiative, it has launched the NHDP. This ambitious initiative includes improved connectivity between Delhi, Mumbai, Chennai and Kolkata in the first phase; north-south and east-west corridors in phase two; four-laning of more than 12,000km of roads in phase three; two-laning of 20,000km of roads in phase four; six-laning of 6,500km in phase five; and the development of 1,000km of expressway and other highway projects in phases six and seven, for a total investment of approximately Re2.2tn (US$40.3bn).
Doval adds the government is also upgrading infrastructure and connectivity in the country’s 12 major ports by initiating the National Maritime Development Programme (NMDP). Large parts of the NHDP and NMDP will be executed through PPPs.
The extent of private involvement has varied across different parts of the transport sector.
Airports developed under PPPs today handle about 60% of the country’s air traffic, mainly through Mumbai, Delhi, Hyderabad, Bangalore and Cochin.
In the road sector, private sector participation has been substantial and through various arrangements such as build, operate and transfer (BOT) and operate, maintain and transfer (OMT) models. Standard Chartered, for example, is an investor in IL&FS Transportation Networks, one of India’s largest listed road BOT companies.
The implementation of the new increased tariff order by the Airports Economic Regulatory Authority (AERA) for Delhi International Airport has helped returns and encouraged further private sector investment, says Jain.
Pant says during the 11th five-year plan, around 4,200km of NHAI road projects were commissioned either by the private sector or through PPPs. And according to the World Bank, between 1990 and 2011, India awarded a total of 600 projects on a PPP basis, entailing total investment of US$270bn. Through the NHDP, India has the world’s largest PPP programme for road development.
In contrast, private sector investment in Indian ports has been experiencing a “distinct slowdown”, according to Andrew Yee, global head of infrastructure, principal finance at Standard Chartered. Yee says a number of projects targeting private sector investment have come unstuck, including Jawaharlal Nehru Port Trust’s fourth container terminal, Ennore’s container terminal and the Chennai mega container terminal project.
“Clarity on some of the outstanding issues such as the draft Port Regulatory Authority Bill, rational revenue shares and improvement in the economic and trade scenario would help to positively change sentiment,” says Jain.
The most significant source of capital for the infrastructure sector in India is the national banking system and this is likely to continue. Pant says: “The limited sources of long-term debt financing, contrasted against the healthy balance sheets of Indian public and private sector banks, has resulted in Indian banks being the largest group of lenders to Indian infrastructure projects.” As of April 2012, loans by Indian banks to infrastructure projects stood at Re6.2tn (US$113.7bn), up 18% from the previous year.
But the worry is that the long-term needs and long gestation periods of the infrastructure sector often result in asset-liability mismatch for banks. Moreover, banks are cutting their exposure limits for the sector as a whole or for large private groups active in it. This could potentially impact the availability of adequate bank funding for infrastructure, unless the Indian government eases the relevant exposure limits.
According to Shyamal of Ernst & Young, various non-banking financial companies are taking long-tenor exposures on infrastructure projects as well, but banks continue to be the lead members in any consortium for specific projects. According to Yee, the importance of bank credit is also evident from the fact that infrastructure loans as a share of total credit increased from less than 2% in financial year 1996 to 14% in 2012. Moreover, during the first three years of the 11th five-year plan, the banking sector accounted for the largest source of funds for the infrastructure sector, barring central government funds.
Life insurance companies and pension funds have access to long-term funds and are a natural source of capital for infrastructure assets. In India, says Pant, the insurance and pension sectors have in excess of Re30tn (US$550.4bn) in investible funds. However, legacy investment guidelines and mandates have prevented these entities from investing meaningful sums in the infrastructure sector, he notes. He adds that the government is talking of financial sector reforms which may result in these funds being invested in the development of infrastructure assets.
India also needs investor-friendly policies. In the highways sector, the government plans to relax the lock-in period for initial bidders of projects. This will allow the original concessionaries to exit the projects once the construction is completed, Shyamal says, meaning that financial investors can enter the project when the initial development risk is taken care of.
The relaxation of shareholding lock-in requirements is a key step that should help in the optimum utilisation of various forms of capital available for the sector. Pant explains that it is important to create an environment where promoters can exit assets once they are commissioned and the operations have stabilised, as this allows promoters to churn their limited capital and gives long-term investors with a strong focus on yield exposure to the Indian infrastructure sector.
According to Shyamal, the government needs to develop the infrastructure bond market, which can be subscribed to by domestic and foreign pension funds and insurance companies. The government has set up dedicated institutions such as the India Infrastructure Finance Company (IIFCL) to advance long-term, relatively cheaper funding to the infrastructure sector. It has also permitted issuance of securities such as tax-free bonds by infrastructure-focused companies and has allowed infrastructure debt funds to make long-term capital available.
The IIFCL, for instance, has been permitted to issue tax-free bonds worth Re100bn (US$1.8bn), initially from institutional investors and then from retail investors. Moreover, India is sitting on foreign reserves of about US$300bn, which could also be used to fund a portion of its transport infrastructure requirements.
With India’s infrastructure outlay expected to be US$1tn over the next five years, it is imperative for the government to draw as much capital from all possible sources, domestic as well as foreign.