Cameron: We have more optimism at this time than a year or so ago

Infrastructure investment has been of paramount importance in India since the last decade as the country seeks to address the massive infrastructure deficits it faces across all key sectors. In the past, public budgetary allocations and internal resources of government-controlled infrastructure companies have been major sources of financing for the country’s infrastructure projects.

Recently, though, the private sector has emerged as a significant player in deploying funding as well as owning and operating infrastructure assets across key sectors from roads and communications to power and airports.

The country set an infrastructure investment target of US$1 trillion for its 12th five-year plan (2012-2016), and nearly 50% of that is expected to come from the private sector via the public-private partnership (PPP) scheme. In comparison, only about a third of the infrastructure investment in the 11th five-year plan was contributed by the private sector.

The infrastructure requirements across all sectors suggest there are abundant opportunities for domestic and foreign private sector players as the government alone cannot fund all these projects.

However, despite the apparent opportunities, infrastructure investment in the country has been sluggish in the last couple of years, largely on account of delays and policy bottlenecks faced by projects initiated earlier, resulting in a backlog of uncompleted projects.

“Over the last couple of years, we have seen a reduction in investments due to the combination of external and internal factors,” says James Cameron, managing director of HSBC Project Finance. “There has been a reduction in the rate of procurement. There have been challenges faced by domestic infrastructure players within India, and also the challenges in terms of attractiveness of valuation of the projects, compared to the risks involved in them.”

Returning confidence

However, confidence is slowly returning amid hopes that the new government with its decisive mandate can tackle some of the key bottlenecks both in project procurement and financing. The new government, under the leadership of Prime Minister Narendra Modi, whose Bharatiya Janata Party won a landslide victory in the May elections, has promised to bring about policy changes and structural reforms to push forward a long-term infrastructure investment cycle and clear the country’s infrastructure backlog.

Following a slowdown in projects in the last couple of years, there is widespread expectation among market participants of a positive medium-term outlook for the sector.

“Today, there are a few significant fundamentals that make the market interesting for the broad range of players in India’s infra space again,” notes Cameron. “While there remains a significant amount of challenges, it is fair to say we and most other participants have more optimism at this time than a year or so ago.”

Notwithstanding the current optimism, the key to sustaining private sector interest in India’s infrastructure lies in the policy clarity and the confidence that changes will remain in place.

“The central theme on infrastructure spending would be whether there would be policy clarity and policy certainty for private sector investors to step in,” notes Abhishek Dangra, director at Standard & Poor’s. “While some of the channels that the government has opened would help funds to come in more smoothly and at a faster rate, the private sector would need policy clarity on such matters as land acquisitions and environmental clearances, which in the past have delayed and increased the cost of quite a few of the projects. Additionally, talks between the private sector and the government on increasing tariffs because of time and cost overruns have not been very smooth. The main starting point for investors will be if the policies are clear, and if there is appropriate mechanism for resolving disputes when they arise.”

Past roadblocks

In the past, the power and transport sectors had enjoyed much interest from the private sector. Recently, however, investors have shied away from the power sector due to the scarcity of coal and cases of some assets being stranded. Coal-fired generation accounts for around 60% of the capacity in India and the lack of coal has been a key challenge for power companies. Some power projects are either not operational despite being ready, or are running below capacities because of fuel shortage. In its first budget, the government has promised to ensure availability of fuel for all projects commissioned before March 2015.

“The government has been clear in its intentions that they are not going to push for too much capacity on the greenfield side of the power sector at this stage, but will wait to correct the bottlenecks around fuel linkages, land acquisition process and environmental approval of projects,” says Khawar Iqbal, director of project and export finance for India at HSBC. “We are speaking with developers of conventional power plant projects, which had been suffering due to the lack of coal; now they are seeing an improved situation. It is still early days, so we need to see how it pans out, but the government’s focus seems to be in de-bottlenecking the sector.”

Road infrastructure too was attracting hyper-active bidding from the private sector in the past few years, leading to a rather high valuation of these projects. However, land acquisition and environmental clearance issues have been major constraints. It is estimated that nearly a quarter of the projects were delayed due to land acquisition issues. In the transport sector, close to 90% of the projects that have been stalled are related to roads and railways.

Market participants believe PPP investments in the road sector may take some time to return because in the last five years, large domestic players have been aggressively bidding in the sector, consequently pushing up valuations. And most financiers have already reached their limit on the segment. On the other hand, a quicker pickup is expected on the airport sector where many of the projects involve brownfield expansion.

FDI in India Railways

In a sign that the new regime will be able to implement its policy changes, the country’s parliament in August ratified the government’s landmark proposal to allow foreign direct investment in railway infrastructure.

Under the new policy, India will allow 100% foreign investment in India Railways’ construction projects through the special purpose vehicle route in such segments as high-speed railway system, suburban rail corridors and dedicated freight line projects implemented under the PPP scheme. Previously, no foreign direct investment was allowed in India’s railways system. Foreign investors, however, are still barred from railway operations and safety.

The new policy has opened up vast opportunities for foreign investment as India looks for funding sources to refurbish its 160-year-old railway system that has failed to modernize amid the paucity of funds. The network spends 94% of its revenues on operating costs, leaving next to nothing for investment.

“There is much opportunity for [private sector investors) in railways, but it does not yet have a proper PPP framework except for the Mass Rapid Transit (MRT) projects,” says HSBC’s Iqbal. “The government, however, is keen to push the PPP mode in railways and the cabinet’s approval to allow 100% FDI in railways should help push the progress for greater participation from the foreign private sector. However, it could take some time – maybe the next 12 months – before some action can be seen there.”

The plan was originally announced in the government’s first union budget, which also had a number of other infrastructure-friendly initiatives including increasing budgetary allocations for road and port connectivity as well as policy measures to facilitate PPPs and encourage private sector funding of these partnerships.

The budget identified a number of sectors where PPPs would be implemented. These include metro and light rail systems, airports, gas pipelines, and rural and urban infrastructure.

“Overall, there is quite a good improvement on the policy front,” says S.K Agarwal, senior vice-president at SBI Capital Markets. “Right now, the focus of the government will be in rectifying existing policy framework/procedural issues to ensure the completion of projects that delayed. The initiation of new projects will take place only after a while – maybe three to six months later at least –because project preparation and planning will take some time for new projects.”

Easing rules to boost projects

Another critical change announced by the new government is its decision to ease rules for long-term financing for infrastructure, which should provide a major boost to infrastructure funding and drive a new investment cycle.

The Reserve Bank of India now allows banks to raise long-term rupee bonds with tenors of more than seven years, which will be exempt from cash and statutory reserve requirements, provided the bond proceeds are used for long-term infrastructure projects and affordable housing.

Banks are also allowed to offer loans with a tenor of up to 25 years to the infrastructure sector, versus a tenor of just 10 years previously. These loans can be refinanced every five to seven years, without being classified as restructuring, which would otherwise require the banks to set aside higher general provisions.

“This is a major boost for projects,” says Agarwal. “This makes it easier for a take-out of loan by the bond market, following a completion of five/seven years of projects.”

In the budget, the government also proposed to provide liquidity both in terms of equity and last-mile project completion funding to projects that are at various stages of completion but have not been completed due to the lack of funds or because their lenders are not extending loans after the sponsors have gone to liquidity stress. In that case, the government has announced that they will put funding in place, where investors will be government entities as well as banks which will evaluate the projects and provide liquidity, both equity and debt, to see that these projects are completed and assets that are operative are created.

As PPP is seen as the preferred mode for India’s infrastructure projects in key sectors, the government has proposed to form an institution called “3P India”, which will look at streamlining the PPP procurement process. The body will have no regulatory purview but will examine and correct various issues and policy bottlenecks that have disrupted the growth of PPP in India.

“[A] bottleneck in PPP implementation is the capacity of the state and local governments and agencies responsible for procuring PPPs,” says Ray Tay, vice-president and senior analyst at Moody’s. “As such, the proposal to create 3P India, an institution that facilitates procurement, will enhance the effectiveness of PPP programmes. PPPs in India have a spotty track record, and although we believe this budget is a step in the right direction, successful implementation will take several years.”