Infrastructure Financing: A Continuing Conundrum

Despite several initiatives taken by various stakeholders, the challenges related to infrastructure financing projects continue to prevail. Lack of intent is not the reason for the situation; it’s the mere complexity attached to funding such long-term infrastructure projects.

Infra projects are characterised by:

• High Execution Risks
• Long Tenure Concessions (Often up to 15-25 years)
• Regulated Operations
• Dependence on a Single Asset
• Concentrated Cash Flows
• Vulnerability To Changes in Public Policy.

The absence of proper structuring to mitigate these risks resulted in significantly high NPA ratios, especially in some legacy sectors such as thermal power and toll road projects. Both these segments are highly exposed to execution as well as revenue risks. The burgeoning NPA levels resulted in a complex vicious cycle of making the lenders averse to taking exposure to infrastructure financing projects while making credit flow both restricted and expensive, thus hitting the viability of such projects.

Inordinate Delays, Inaccurate Forecasting, and The NPA Challenge

The issues related to execution have been one of the biggest challenges for the sector, resulting in significant delays and cost overruns. Timely acquisition of right of way (RoW), getting requisite approvals/clearances, occasional unavailability of raw materials, inadequate manpower and frequent change in scope are some of the key reasons which result in inordinate delays in project execution.

As per the latest data from the  Ministry Of Statistics And Programme Implementation (MoSPI), as many as 470 central sector projects have witnessed a combined  cost overrun of  Rs. 4.37 trillion (~20% of original cost) and  560  projects have an average time overrun of 46.94 months.

The delays coupled with an inaccurate estimation of revenues has resulted in high deviations in the actual cash flows vis-à-vis the initial projections. This has, thus, impeded the debt servicing capability of these projects. Overall, exposure to the infrastructure sector is around 25% of the total outstanding debt; however, in terms of NPAs, the contribution is as high as ~42% (of total NPAs). This is a reflection of the high instances of losses for the lenders in this sector.

National Infrastructure Pipeline: The Next Big Thing?

In light of the huge funding requirements of the National Infrastructure Pipeline (NIP), the importance of the availability of adequate financing avenues for infrastructure becomes even more critical now to reduce the dependence on sovereign resources.

The Central Government has set an ambitious infrastructure investment target of over ₹ 111 lakh crore during FY 2020-25 under the NIP. The planned NIP translates into an average annual investment of ₹ 18.5 lakh crore, which is a significant increase from the pace of the average annual infrastructure investment of ₹10 lakh crore in the past.

However, avenues for funding remain limited – while the corporate bond market has grown considerably over the years, the depth still remains low with limited investors and issuances dominated by financial institutions and public-sector entities.

In addition to improved access to funding lines being required for the desired development of the Infrastructure sector in the country, it is also critical to enhance the availability of bank guarantees (BGs) as these are required throughout the project life cycle, right from the bidding phase till completion, even the defects liability period.

In these times, availing BGs has become a big hurdle, given that many public sector banks (PSBs) are grappling with highly stressed assets from the construction sector. Banks are also demanding higher-margin money and collateral requirements, in line with the increased risk perception associated with non-fund based (NFB) limits. For many companies that have grown at a fast pace over the last three-four years, arranging higher collateral is becoming a tough condition to fulfil.

Experience with past initiatives 

There have been several initiatives in the past, such as the formation of DFIs, introduction of a partial credit enhancement scheme, floating of various IDFs, efforts to deepen the bond market, etc. However, the impact on credit flow to the sector hasn’t been in line with the expectations.

Counter-intuitively, these schemes also tried to cater largely to the better projects available in the market, where the credit availability anyways isn’t that bad. One cannot really blame lenders or investors for adopting a ‘flight to safety’ approach here, as they always have the option to deploy funds in better perceived (rated) assets/industries.

Empirically, almost 75% of the infrastructure assets currently have a credit rating of BBB (lowest investment grade rating) or lower. The ratings, which are assigned based on the “probability of default” (PD) approach, consider a ‘single day, single rupee’ delay to any lender as a default. Hence, they are totally independent of the prospects of subsequent recovery of lenders’ dues.

Thus, for infrastructure entities, obtaining high credit ratings becomes a challenge on account of high exposure to execution risks, operational and maintenance risks, concentration on single asset cash flows, unpredictable ramp-up periods, risks pertaining to counterparties, uncertainty related to any new competition on account of long concession periods, and regulatory risks. The high-risk perception has kept some of the prominent investors like pension & insurance funds at bay, which have long term funds matching the long tenure requirement of the infrastructure sector.

Way Forward for Infrastructure Financing

Not all is bad with infrastructure projects. In fact, they offer many unique features like:

• Nearly monopolistic market position
• Steady demand growth
• Stable pricing formats
• Low incremental CapEx risk
• Low technological obsolescence risk

Further, PPP projects get additional security in the form of availability of termination payments, contractual protection through some form of a non-compete clause, sovereign counterparty, etc. Well-designed structures can allow investors to benefit from these fundamental strengths while mitigating the associated risks by using features such as ring-fencing of cash flows and a well-defined payments waterfall mechanism.

It may not be a revelation to most of us that investment in the right infrastructure development is one of the most critical requirements of the country at the moment. Firstly, we remain highly deficient in this aspect, and also investment in infrastructure results in the highest multiplier effect in terms of overall economic development. Thus, it’s high time that we focus our energies on leveraging the positive features of the sector while drawing learnings from past failures and not looking at all projects with the same lens.

Many projects which had defaulted in the past due to some short-term blips or inappropriate loan structuring, have actually been able to achieve the divine rating of ‘AAA’ on the back of their fundamental strength coupled with immaculate structuring, and attracted interest from marquee investors, for both debt & equity. In a nutshell, if the underwriting is done accurately with the help of data science and several analytical tools available, followed by continuous monitoring of the credit then the instances of default can drastically come down thus bolstering the confidence of lenders, and consequently improving the overall funding access for the sector.