Budget paves way for funding

For a sector that corners close to half of the government's planned gross budgetary support, infrastructure still remains a funds-strapped sector. The customary 15-25 per cent higher allocation awarded in the Budget has not done much to support the increasing private sector participation in this space.

This drives home the gravity of the issue: GMR infrastructure levied the country's first Airport Development Fees for the Delhi airport in February 2009 as it did not have sufficient funds to go ahead with the expansion. Fees for an airport that was not yet ready!

The 2011-12 Budget proposals for infrastructure, therefore, open up new avenues to address the mounting long-term funding crisis in the sector. With private participation in sectors such as power, highways and airports gaining significance, companies would have to fund projects they bag. To understand as to how the Budget proposals can aid long-term funding, we look at the enormity of the task of funding the infrastructure sector and the current funding channels for the private sector.

Challenges aplenty

Of the Rs 20.5 lakh crore of revised infrastructure spending estimates for the Eleventh Five-Year Plan, 36 per cent is projected to be private investment, up from 24 per cent in the Tenth Plan. Private spending, which has already reached majority proportion in airports, ports and power may only go up. Companies such as Tata Power, Mundra Port & SEZ and GVK Power & Infrastructure are cases of private sector spearheading key projects.

In absolute terms, private spending in the current plan is a sum of Rs 7.4 lakh crore ? over three-times that of the Tenth Plan.

To understand the enormity of this, let us look at the options available to private players: assuming the typical 70:30 ratio (debt: equity) for funding infrastructure projects ? Rs 2.2 lakh crore would be required as equity and the remaining Rs 5.2 lakh crore through leverage.

With a year to go for the closure of Eleventh Plan, around 34 per cent of the above equity requirement has entered in the last four years (till December 2010) as FDI in three major infrastructure sectors ? construction, power and telecom. FDI inflows have however deteriorated this year. FDI in construction in FY-11 (till December) for instance, is 70 per cent lower than the sum received in FY-10. With increasing time overruns faced in these sectors, there appears to be little incentive for FDI money to flow in at this point in time.

Local institutional equity participation, internal accruals and promoter contribution form rest of the equity. Companies also do apply for viability gap funding grant, but only if it can be proved that the project is unviable.

Finding debt

If the above task is not imposing enough, corporates confront the bigger task of tying up debt funds, to financially close the project before commencing work. Borrowings from banks and financial institutions and external commercial borrowings make up the major sources of debt funding for corporates. Banks for instance, had an exposure of Rs 4.9 lakh crore as of December 2010 to the infrastructure sector. Does this meet almost the entire Rs 5.2 crore debt requirement of the private sector in the Eleventh Plan?

Not really. For one, a good proportion of this sum is lent as working capital. Short of such rotating credit, banks typically have a liability profile of three to five years, whereas infrastructure loans would need to be extended for 8-15 years. Hence, banks are constrained by an asset liability mismatch, if they pump up lending to the sector.

External commercial borrowings too, remain restricted to an elite few in the sector. For one, the country's credit rating, as well as project rating, goes a long way in determining the cost of funding.

A Lanco Power's long term rating of BBB- or Adani Power's LBBB rating simply means they may have access to funds but at high costs. Taking on the burden of hedging may not be easy to handle for companies.

Other sources such as domestic mutual funds, insurance and pension money seldom find their way into infrastructure, given their internal mandates. NBFCs, although offering more hope, account for mere 9 per cent of the total financial assets of all funding institutions put together and do not play a large role, except in the case of the power sector. That not all the above channels have systematically funded the sector was evident when the Finance Ministry in 2010 stated that there was a deficit of Rs 1,84,500 crore in the total debt requirement of public and private sectors for financing infrastructure in the current plan.

Enter? FIIs

Given the above background, the Budget's proposal of a five-fold increase in FII limit for corporate bonds for infrastructure, allowing FII stake in unlisted infrastructure SPVs and dedicated debt funds, can do some good to the sector.

For one, it can over time, increase the width and depth of the markets for infrastructure funding. This is a prerequisite for more players with deep pockets to enter.

Two, while it is argued that FIIs may not be willing to lock themselves in for five years, international experience suggests that FIIs have favoured utilities or developers with steady cash flows.

An IRB Infrastructure Developers with a portfolio of roads or an NTPC with steady cash streams are unlikely to be shunned by FIIs.

However, there is little data available to know how far existing FII limits in infrastructure corporate bonds have been tapped.

Three, the Budget proposes to sweeten the offer from notified infrastructure debt funds by allowing such funds to withhold only 5 per cent as taxes on interest payments instead of 20 per cent at present.

Even interest on foreign currency loans to Indian corporates are currently taxed at 20 per cent.

The lower withholding tax coupled with the high interest rate arbitrage between India and the developed markets may serve as sufficient sweeteners for FIIs to seriously consider this avenue.

These steps may not offer any overnight solutions and are unlikely to help achieve the 10 per cent infrastructure spending on GDP in the 12th Plan.

However, they do open up fresh avenues for long-term financing of infrastructure, which are deficient today.

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