The Hindu Business Line : Beyond institutional marriages — Real issues in infrastructure financing

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Beyond institutional marriages — Real issues in infrastructure financing

Padmalatha Suresh

There is no denying that infrastructure development is the need of the country today. Any move that ensures enhancement in the quality and timing of infrastructure financing would, therefore, be welcome. If it is just any other financing, the State Bank of India seems the best suited to carry on the sacred tradition. But infrastructure financing requires specialised skills and financial instruments. Is the SBI equipped for the foray?

IT IS the turn of another `I' to be in the eye of the storm. The IDFC (Infrastructure Development Finance Corporation) recently made news that had nothing to do with its core functional objective — infrastructure financing. The Government's decision to make the IDFC an arm of the monolith, the State Bank of India was the bone of contention.

The issue catapulted to high-visibility status due to the mass resignation of the IDFC top brass. The revolt sent the IDFC-SBI marriage floundering even before it was solemnised, with the Government exploring various alternatives for an amicable solution.

Both detractors and supporters of the Government's move, however, would agree that infrastructure development is the crying need of the country today. Any move that ensures enhancement in the quality and timing of infrastructure financing would, therefore, be welcome.

What makes infrastructure financing so unique? If it is like any other financing that banks and financial institutions have been doing for a long time now, then the SBI seems the best suited to carry on the sacred tradition. But infrastructure financing requires specialised skills and financial instruments. Is SBI equipped for the foray?

The Centre's infrastructure development plan looks to increased dollops of private sector participation in big projects. The private sponsors would enter into concession agreements with the Government for fairly long periods, after which the infrastructure facility would be handed back to the Government or operated under another agreement. Such involvement of the private sector can happen only through the `project financing' route.

Hitherto, in India, the term `project finance' was generally applied to medium/long-term loans by financial institutions/banks to finance setting up of new (or for modernisation/expansion) projects (as contrasted with short-term credit for working capital extended by commercial banks).

Putting together definitions of international experts (Finnerty, 1996, p 2; Newit and Fabozzi, 2000, p 1; Kleimeier and Megginson, 2000), project financing involves

Creation of a legally independent project company,

financed with equity from one or more private sponsors, and

non-/limited recourse debt from one or more lenders

for the purpose of operating a single-purpose industrial asset

The project financing approach to funding infrastructure projects holds a host of advantages for private sponsors and lenders alike and is thus the preferred funding alternative in most infrastructure projects world over.

However the lender, especially if a commercial bank like the SBI, will have to contend with the following issues peculiar to infrastructure project financing:

Long-term funds commitment — Due to huge investments and returns spread over several years. Banks, which typically borrow short, could therefore face an asset liability mismatch;

High leverage of project companies (as contrasted with their corporate counterparts) could heighten the lender's credit risk;

Non-recourse/limited recourse debt — The lender looks primarily to the cash flows from the project's underlying assets and not to the sponsors for repayment of debt.

The inherent project risks (market, operational, political, financial) may therefore lead to increased credit risk. In conventional corporate financing, by contrast, the lender's lien extends to all unencumbered assets of the borrower;

Contractual agreements — The project structure is a complex web of contracts, long-term supply agreements, offtake deals, third party guarantees, etc. The contract risk is therefore intertwined with the governing legal system, and the counterparty risk;

Higher risks mean higher returns — The paradox of infrastructure financing. The lenders should have some expertise in the infrastructure sector being financed if they have to understand the risk management and dynamics of the project; and

Asset-based financial engineering and new financial instruments — Each project is very large, the project company a stand-alone entity with no history, the assets are specialized and risky. Hence every financing would require unique instruments and innovative deal crafting.

The IDFC, SBI and other financial institutions have funded a number of infrastructure projects so far. Yet the numbers do not say it all. For every successful project, quite a few languishing are even after substantial funding.

Take the case of the $100-million Delhi-Noida Bridge project — India's first major private-public partnership (PPP) initiative conceived to provide connectivity between New Delhi and Noida, a satellite township.

The BOOT (Build-Own-Operate-Transfer) project had a 30-year concession period granted by NOIDA to the project pompany, NTBCL. The major sponsor, IL&FS, raised the entire capital on a non-recourse basis. The World Bank was indirectly involved as a funding agency for IL&FS.

The project included several first-of-its-kind features, and all the risks seemed to have been identified and mitigated. NTBCL's IPO, the first by a greenfield infrastructure project and the first with a take-out financing arrangement, was oversubscribed. However, the project proved that it was not an exception to the risk peculiar to a `retail' toll-road project — traffic risk. Since starting operations in February 2001, the `flyway' has suffered from lower traffic volumes compared with the projections in the project feasibility report, prepared on the basis of detailed traffic studies carried out by leading international consultants.

The financial restructuring of the company was recently approved by the lenders through the corporate debt restructuring mechanism formulated by the Reserve Bank of India to facilitate rehabilitation of viable projects. SBI holds a major share in the bank loan consortium with a loan tenor of 14 years.

It is, therefore, not enough if the government decides to create infrastructure to the tune of Rs 60,000 crore in the next few years through private-public partnerships, or tries to merge financing institutions to achieve this end. First, there should be public acceptance of infrastructure as a profit-making venture and clarity of service contracts.

Communication with, and education of, the target community on the monetary constraints in providing infrastructure upgradation is another priority. Last but not the least, there should be an institutionalised regulatory and legal framework untouched by political expediencies, embodying predictability, speed and recourse, to entice both private sector sponsors and lenders into infrastructure development and financing.

On their part, lenders should be willing to fund risky projects through creative, risk mitigating deals. Marriage or no marriage, institutional involvement in innovative infrastructure financing requires a shot in the arm.

(The author is a visiting faculty in Finance area — Banking and Infrastructure Financing — at IIMs. The views are personal. She can be contacted at padmalathasuresh@yahoo.com)

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