The Hindu Business Line : Funding crisis in infrastructure

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Funding crisis in infrastructure

While the current liquidity issue would make it difficult for small- and mid-sized players to zero in on funding avenues, lenders themselves could apply severe caution in project appraisals.

— K. Murali Kumar

Bigger projects…recent bids for road projects have an average estimated cost of Rs 800 crore.

Vidya Bala

The last few months have seen renewed request for creating diverse avenues to fund the infrastructure sector in the country. Recent reports have it that the Government is looking at a Rs 50,000 crore-fund dedicated to lending for the infrastructure sector.

The call for funding the sector has gained fresh momentum, especially after China’s plan to boost its infrastructure spending as part of a stimulus package to revive the slowing economy.

In a recent statement emphasising the need to invest in infrastructure as a counter-cyclical role in the present situation, the Prime Minister, Dr Manmohan Singh, has also promised to review infrastructure development projects to expedite their implementation and ensure that there is no constraint of funds.

What has led to this increasingly conscious effort to provide funding to the sector? The obvious answer would seem to be the liquidity crunch. As is the case with other sectors, the shortage and high cost of funds have left many an infrastructure player high and dry — unable to bid for or achieve financial closures of projects and fund working capital requirements.

However, unlike most other sectors, the cost and availability of funding has far-reaching implications for infrastructure projects for the following reasons:

One, delays in financial closures could result in lower internal rate of return (IRR) for projects, dragging payback periods and even make such assignments unviable.

Two, significant change in the cost of borrowing can reduce the return on equity on such projects.

And, three, availability of funds is a cost of concern now, than ever before for the simple reason that the size of projects from hereon is likely to be of a scale much larger than those implemented so far.

Players would not only have to scout for debt sources but also look for sources to fund their equity contribution, given the massive size of the projects.

We discuss these implications in detail and how the sector is more prone to be impacted by the present financing scenario.

Financial closure

The current liquidity crunch combined with an economic slowdown has resulted in lenders taking a cautious stance especially for funding infrastructure and realty projects. This has led to delays in financial closures.

According to recent data released by the National Highway Builders Federation, projects worth over Rs 10,000 crore were struggling to achieve financial closure even as interest rates moved to 14-16 per cent from 9-11 per cent earlier.

Why is financial closure so crucial for infrastructure projects? Financial closure is that primary stage of a project lifecycle where all principal stakeholders (government, private developer and lenders) arrive at a consensus as to the terms and conditions governing the project’s financing. Successful closure is, therefore, an indication of the project being bankable, thus kick-starting implementation.

While the current liquidity issue would make it difficult for small- and mid-sized players to zero-in on funding avenues, lenders themselves could apply severe caution in project appraisals. For instance, they could well be concerned about the adequate coverage for debt servicing in the event of lower revenue flows from tolls or volumes or tariff for projects in roads, airport or rail. This concern could be truer in the current scenario of slowdown.

The repercussion of a delay in financial closure is a huge jump in the initial estimate of overall project cost, thus jeopardising the returns expected.

A tight funding scenario has in fact led to lower participation in the recent spate of highway projects, which received bids from fewer developers as IRRs no longer appear attractive for private participation. Of the 27 highway stretches which have received initial bids, 16 of them had less than five bidders and two projects found no takers.

Larger scale of projects

The funding crunch also poses a bigger threat for the ambitious $500 billion investment proposed by the Government in various infrastructure projects (such as road, power and airports) over the next four years (Eleventh Plan).

Apart from the massive investment planned, the average size of projects is also set to increase, posing greater challenges on the need to raise adequate debt and equity. The recent bids for road projects have an average road length of over 100 km and average estimated cost of close to Rs 800 crore, providing an indication of the larger scale of projects to be handled in future.

Gearing to meet crisis

How are the developer community and the Government trying to overcome the funding crisis? The former has been handling the larger size of projects and higher quantum of equity contribution by bidding through consortiums/joint ventures.

A list of bids for road projects where project evaluation is complete suggests that barring a few, most projects have been bid by consortiums or partnerships.

From the Government’s side, the response has been in the form of easing of norms for classification as ‘standard assets’, easing of external commercial borrowing norms and appeal to World Bank and other multi-lateral funding agencies for higher lending.

While this may offer a partial relief, infrastructure dedicated funds together with Government participation may be a better long-term solution for viable projects. While investment sentiments remain low, Government backing/participation could well lift sentiments. Further, tapping the retail investor savings, through assured return bonds, may find tremendous appetite in the current risk-averse scenario.

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