Infrastructure debt funds and public infrastructure projects in India

Abstract

Infrastructure plays a critical role in any economy both directly, by being a major source of employment and economic activity, and indirectly, by facilitating flow of goods and services, improving productivity and raising standard of living. Indian policymakers have realized over the last two decades that shortage of infrastructure in the form of highways, power generation and distribution, ports, airports, etc. has strained the economy as it vies for economic growth. One effect readily seen due to lack of infrastructure is periodic bouts of high inflation as the economy tends to overheat easily. The government has launched ambitious programmes in the road, power and ports sectors and has in recent years encouraged PPP models to reduce its financial burden and to encourage projects based on financial viability. Infrastructure (Infra) is a large and lumpy investment with characteristics of high capex, huge risk during development and long gestation periods. Hence it requires long-term finance at reasonable cost. However financial intermediation is not perfect in India and there is a dearth of long-term capital instruments, constraining corporates in their capital raising plans. Developers normally achieve financial closure by raising capital from commercial banks and look to refinance their loans at lower rates once a project is completed. Only reputed developers manage to refinance their loans in the capital markets since infra bonds normally manage to get ratings of BBB- and below, which is not acceptable to most bond investors in India. Commercial banks have short and medium term liabilities and hence face asset liability mismatch problems. Insurance and pension funds due to their long-term liabilities are ideally suited to invest in infrastructure. However they are constrained due to multiple reasons like 1) Minimum ratings of AA+ and above mandated by IRDA and PRFDA to invest in corporate bonds, 2) Credit rating models which do not account for the unique characteristics of infra projects and rarely assign them ratings above BBB-, 3) Underdeveloped bond markets lacking techniques like securitization and instruments like interest derivatives, thus not meeting requirements of developers and not allowing effective credit risk transfer by investors. It is important to understand that an infra project has a public goods characteristic to it. It is not meant to just generate profits for its developers but also provide a positive externality to the masses and society. Hence there is a need to focus on both economic viability and financial viability of the project, something which is lacking right now, as seen for instance by the constant increases in toll rates on highways which affect the poor most. Moreover social and environmental impacts are important to minimize negative impact on the displaced people, avoid political and legal issues, and ensure long-term sustainability. The Infrastructure Debt Fund proposed by the Planning Commission in 2010 and structured by the Parekh Committee assumes that the problem facing infra development in India is one of scarcity of capital, but IIFCL’s experience has shown that the problem is lack of creditworthy projects. There is ample idle cash lying around and not enough good projects to invest in. Hence the premise on which the IDF has been created seems incorrect. Moreover, none of the domestic investor organizations which were supposed to contribute to the fund are interested in doing so, either due to conflict of interest or because it does not make business sense. The fund is also seeking multiple changes in regulations from several regulatory bodies which seem unlikely to happen anytime soon. Instead of setting up Infrastructure Debt Funds, the government should attack the core problems that are hobbling infrastructure lending which are those of 1) strict regulations constraining IFs and PFs, 2) low creditworthiness of infra bonds, and 3) shallow bond markets. We have recommended that an 1) Economic Appraisal Unit be setup at the centre which will evaluate projects for their economic viability and thus better satisfy the goal of infra development, 2)Strengthening of IIFCL’s take-out financing role and also encouraging the credit enhancement business which IIFCL has recently explored, 3) Working with credit rating agencies to develop appropriate risk evaluation models for infra bonds, 4) Implementing Patil Committee recommendations to deepen bond markets, 5) Relaxing regulations surrounding investment decisions by IFs and PFs and allowing their managers more scope for commercial judgment.