The Hindu Business Line : How to bridge funding gap for infrastructure?

According to the Eleventh Plan Approach, the country needs Rs 14.5 lakh-crore of infrastructure investment. Financing infrastructure in the short term is a challenge, and will remain so in the long term unless financial, regulatory and legal reforms are simultaneously implemented.

The infrastructure deficit today is critical. Studies show that this inadequacy has set India's GDP back by at least two percentage points. The inclusive growth aimed at by the Budget and the Eleventh Plan would remain elusive as long as reliable power, water or transportation network is not provided. A recent study attributes inflationary tendencies in the economy to poor infrastructure — up to 40 per cent of farm produce rots in fields or en route to customers due to inadequate transport network, leading to increased prices for staples.

International experience suggests that India has been doing many things right — Firm political will, a relatively stable and growing economy, a developing capital market, and schemes to foster Public-Private Partnerships (PPPs) in infrastructure. However, policies by themselves do not ensure sound implementation.

Investment

The Eleventh Plan Approach provides some concrete numbers to work with. India requires infrastructure investment of Rs 14.5 lakh-crore (about $320 billion) over the Plan period. It is obvious that most of this investment will have to happen through PPPs and the project-financing route. A back-of-the-envelope calculation shows that the proposed investment would require Rs 10.15 lakh-crore of debt, assuming an average debt-to-value ratio of 70 per cent, quite common in project financing structures.

Assuming the debt requirement will arise evenly over five years, roughly Rs 2.03 lakh-crore per year will be required for infrastructure financing. Bank credit is currently growing at about Rs 3 lakh-crore per year, and if projects were to be funded by banks alone, this would imply channelling 50-60 per cent of bank credit into infrastructure.

Such huge funds outlay appears infeasible, given that banks have other commitments by way of reserve requirements and directed lending, and lack sufficient long-term liabilities to support infrastructure loans.

Bridging shortfall

Shortfall in bank credit can be supplemented by agencies such a IIFCL, which will be pumping in debt funds of about $3 billion (around Rs 13,500 crore) in tranches over the next three years, or an annual debt availability of Rs 4,500 crore per year.

Assuming banks lend 10 per cent of their credit portfolio for infrastructure, the debt availability would amount to Rs 35,000 crore per year. Compare this with the debt requirement topping Rs 2 lakh - crore per year. How do we bridge the financing gap?

Though India has been seriously considering long-term bond markets as a viable alternative, and the Patil Committee's report is more than a year old, little tangible result has emerged. A study by the Bank for International Settlements (BIS) reveals that at end 2004, India's corporate bond market constituted only 3 per cent of GDP, though the stock market capitalisation was at 57 per cent. In contrast, the size of China's corporate bond market was over 10 per cent of its GDP, and that of Japanese, Korean and Malaysian markets well over 40 per cent.

Equity-debt mismatch

Interestingly, the larger the size of the corporate bond market, the larger the bank credit market. The statistics lead to two conclusions — one, India's equity market is more vibrant compared with its debt market, and, two, India needs to deepen its bond market without further delay to expand the size of its bank credit market. The latest Economic Survey specifically recommends bringing the debt market on a par with the equity market.

Similarly, the idea of tapping long-term resources from institutional investors such as insurance and pension funds has been doing the rounds for long, but with no perceptible results.

Alternatives

Other alternatives being considered could at best be sources to bridge the financing gap till long-term funds are accessed — using foreign exchange reserves (which option is being hated and loved at the same time), viability gap funding, or short-term revolving funds established for this purpose.

Foreign investors and private equity have been increasingly entering the country. For instance, the likes of Cayman Islands-based Trikona capital entered India with investment plans of over $10 billion over the next several years, but have found the procedures stifling. However, excitement and forecasts apart, sustainability and volatility of these inflows need to be considered. These facts imply that financing infrastructure in the short term is a challenge, and will remain so in the long term too unless policy is well implemented.

Private involvement

Private sector involvement in infrastructure presupposes efficient risk allocation and risk-reward trade-offs. It also presumes structuring project financing deals to ensure sufficient incentives for capital (equity and debt) providers to invest in these projects.

Therefore, simultaneous and speedy progress on multiple fronts is necessary:

Project financing is structured on contracts. A 2007 World Bank study reveals that enforcing contracts in India consumes an average of 1,420 days, costs up to 36 per cent of debt value, and involves 56 procedures. China, in contrast, can enforce contracts in 292 days at 27 per cent of the debt value with 31 procedures. Sadly, the number of enforcement procedures in India is comparable to relatively underdeveloped African countries. Speedy reforms in contract enforcement procedures, specially designed for infrastructure lenders, would make financing more attractive.

Infrastructure projects can be risky. In the case of financial distress, both equity investors and lenders would require the support of efficient bankruptcy laws. In India, bankruptcy procedures prolong for 10 years, costing 9 per cent of the assets, with measly recovery rates of 13 per cent. In contrast, bankruptcies in China take about two years to resolve, cost 22 per cent of assets, with recovery rates of 32 per cent.

Sadly again, the handling of bankruptcies in India is one of the worst (133) among 175 countries surveyed. More unfortunately, India's `ranking' has dropped in 2006. A bankruptcy code delivering efficient ex-post outcomes, specially designed for large projects, is urgently needed if financing is to be made attractive

Global statistics show that bank lending is the most preferred source of credit for large projects. Increasing popularity of infrastructure investments has led to a new-found interest in securitisation of pools of project finance assets. If banks in India have to evince interest in funding infrastructure, credit risk transfer mechanisms should be in place at the earliest. The absence of tangible developments in credit derivatives or Collateralised Debt Obligations (CDOs) is bound to weaken banks' risk taking ability.

For debt markets to function efficiently, credit rating mechanisms should be expanded If it was Sardar Sarovar yesterday, it is Nandigram and Singur today. Environmental regulations on paper are of no use. Strict implementation of norms will reinforce the faith of the common man in the need for infrastructure, and make lenders comfortable with the credit risk. Unless financial, regulatory and legal reforms happen simultaneously and at a scorching pace, infrastructure-driven economic growth would remain a target — discussed, debated, and hard to achieve.

(The author is a finance consultant and visiting professor at IIMs. Feedback may be sent to padmalathasuresh@yahoo.com)

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