During the past year, the government has taken various measures to resolve the manifold issues plaguing the infrastructure sector and revive investor confidence in the space. The high level of toxic loans, the majority of which are in the telecom, power and construction sectors, continue to be a cause of concern for the banking system. With steps taken in this direction, coupled with the development of alternative financing instruments, infrastructure financing is expected to get a leg-up in the short to medium term…
What has been the progress with regard to the infrastructure financing sector in the past 12-15 months?
The infrastructure sector, a key driver for economic development, has been at centre stage of various government policy initiatives. However, as the sector faced various challenges, the planned investment in the sector during the Twelfth Plan was revised downward to Rs 38 trillion by the NITI Aayog (from the initial estimates Rs 56 trillion). Private sector investments have also not picked up as envisaged, and the government has accounted for most of the investments (~68 per cent of the total investments).
No new thermal capacity addition has been planned/funded in the past three-four years due to sectoral issues. Telecom has also been under stress owing to growing competition, increasing spectrum prices and plummeting tariffs. Investments in roads remained subdued till recently, but the sector saw a slew of positive developments including the award of 53 projects (~3,082 km) under the new hybrid annuity model (HAM) and 91 projects (~3,080 km) under the engineering, procurement and construction (EPC) model over the past 18 months. Similarly, renewable energy projects, riding on the government’s continued policy thrust, registered large capacity addition of around 5,526 MW in solar and about 5,414 MW in wind. Transmission capacity addition also aggregated ~26,300 ckt. km in 2016-17.
Indian banks have been a major source of funds for infrastructure projects with a credit of about Rs 9 trillion. However, banks have been grappling with growing non-performing assets (NPAs), of which the infrastructure sector accounts for a major share. Banks are generally wary of funding the power and telecom sectors due to mounting sector stress; however, they are amenable to funding select HAM, transmission and renewable energy projects.
In the private equity (PE) space, an aggregate of around $3.5 billion was raised in 2016-17, which was higher than the previous year. Facilitative measures for infrastructure investment trusts (InvITs) and masala bonds have provided a better platform for infrastructure players to access overseas investors. Even in local markets there has been a perceptible shift from the traditional bank market to other segments like mutual funds, insurance companies and other non-bank players.
Recently, the infrastructure PE fund for $1 billion launched by Infrastructure Leasing & Financial Services (IL&FS) has also been receiving a good response from South Korean and Japanese pension funds. And I believe that there will be more to follow.
While it is true that the banking sector is currently passing through a tough phase with a high level of stress in its infrastructure exposures, some banks have lately begun to show interest in good funding proposals in the infrastructure space, including in providing refinance facilities with respect to operational assets.
With the gradual easing of stress and an increase in their risk appetite, banks will once again emerge as a key funding source for the infrastructure sector in the near future.
Over the past 18 months, greenfield activity in the infrastructure sector has been primarily driven by the addition of renewable energy capacity (both solar and wind) and the construction of HAM road projects. Despite the growth in renewable capacities, lenders have been cautious in financing greenfield projects. A significant decline in solar and wind tariffs due to intense competitive bidding and the resultant impact on project economics and timelines has been the primary reason for this cautious approach. Dollar-denominated green bonds have also emerged as a viable cheaper alternative for large developers to finance renewable energy projects.
Demand for financing in the road sector has been from developers who are constructing projects won from the National Highways Authority of India (NHAI) under HAM and from PE/pension fund platforms which have been aggregating operational road assets.
The port sector has been impacted by the decline in coal imports for the power sector, environmental issues surrounding the export of iron ore, land acquisition and other operational challenges. There have only been a few projects that are currently being developed or expanded. Another important constituent is urban infrastructure such as water and waste projects. While there have been several policy initiatives in this regard, there have been no large projects awarded in the recent past to private players owing to a lack of government initiatives and varying regulations across concessions issued by various local bodies.
What have been the most impactful policy measures over the past year? How has investors’ stance changed towards the infrastructure sector?
Initiatives to revive the road sector included HAM and the proposal for NHAI to monetise publicly funded operational highways under the toll-operate-transfer (TOT) model.
In the thermal power space, the Ujwal Discom Assurance Yojana (UDAY) proved to be a game changer resulting in considerable improvement in the financial and operational health of discoms. The Scheme for Harnessing and Allocating Koyala Transparently (SHAKTI), the new coal linkage policy, is expected to resolve coal supply issues of over 50,000 MW of power projects and also reduce tariffs.
Ude Desh Ka Aam Naagrik (UDAN) (the Regional Connectivity Scheme) launched in the previous fiscal year aims to bring around 250 unserved/underserved airports across the country under the scheme by 2020. Two new greenfield airports, Goa and Navi Mumbai, are being developed under the public-private partnership model with large investments.
The Reserve Bank of India (RBI) through its Scheme for Sustainable Structuring of Stressed Assets and amendments in earlier schemes like strategic debt restructuring aims to revive large stressed projects by allowing lenders to acquire equity stake in stressed projects and also facilitate change in management in deserving projects. Also, the Insolvency and Bankruptcy Code, 2016, has consolidated the multiple frameworks existing earlier into a comprehensive law. The government has also amended the Banking Regulation Act, allowing special powers to RBI to direct banks in terms of dealing with the resolution of stressed assets. These measures are going to be instrumental in the early resolution of stressed assets.
Other measures adopted by the government include the introduction of the goods and services tax which will stimulate the investment environment in general. InvITs have also opened up a new avenue to raise funds for completed infrastructure projects and unlock the invested capital.
In the past year, three areas that would account for the maximum impact in terms of policy changes and consequently will support a better outlook for the sector are:
- Focus on building more renewable energy infrastructure
- Development thrust on the housing sector, especially mass housing and
- Improvement in the operational and financial parameters of power distribution companies.
Since the current government came to power in May 2014, several landmark policy initiatives have been taken in the renewable energy segment. There have been several large debt deals, both in the form of dollar and masala green bonds. This heightened interest for quality institutional players in the renewable energy segment has sent a very positive signal to investors.
For the housing sector, a host of policy measures, including tax holidays and infrastructure status for affordable housing, the introduction of the Real Estate (Regulation and Development) Act, and the creation of smart cities has provided a positive outlook for investors.
In the power sector, the full impact of UDAY will be seen in the next year or so. At an aggregate level, the combined losses of state power utilities have come down significantly. With a focus on increased payment compliance and reduced debt burdens, the power sector will see greater investor acceptance for both greenfield and operational assets.
Overall, the infrastructure sector will see more investments in the coming years from international investors, both in equity as well as structured debt for various projects.
UDAY, launched by the central government in November 2015, is one of the most important policy initiatives in the past 18 months. While we are yet to see the impact of lower aggregate technical and commercial losses and tariff increases, significant savings in interest cost to discoms has resulted in faster payment of receivables to developers, a significant positive from an investor perspective. The removal of tax holidays and expiry of generation-based incentives for wind projects have been some of the key negatives.
Another key development over the past few months is NHAI’s initiative to monetise 75 operational highways under the TOT model. Global pension and sovereign wealth funds, PE equity investors and global toll road operators are expected to bid for these projects. In the absence of significant changes, the investor stance for infrastructure projects, other than in renewable and roads, remains muted.
What are the key challenges that remain unaddressed?
The infrastructure sector, in general, is marred by inherent delays and uncertainty in obtaining regulatory approvals, non-timely compliance of obligations by government agencies, flawed risk sharing, and weak regulatory and dispute resolution mechanism. For meeting the large funding requirements of the infrastructure sector, there is also a need to develop alternate financing institutions/avenues to reduce dependence on banks.
The thermal power sector is plagued by issues such as the lack of fresh power purchase agreements (PPAs), subdued power demand, lower plant load factors (PLFs), promoter’s inability to infuse equity/funds, substantial time and cost overruns, the absence of last-mile funding, and discoms’ proposal to cancel/renegotiate already signed PPAs on grounds of higher tariff, although the issue of coal supplies is expected to be resolved with the implementation of SHAKTI.
Some of the key challenges in renewable energy include not honouring a project’s “must-run” status, falling tariffs, proposal to renegotiate/cancel already signed PPAs, and delayed payments leading to a severe cash crunch position.
Some of the lingering issues in the road sector include delayed approvals and release of funds in case there is a change in project scope, delays in grant disbursement, first charge on last-mile funding, termination payment based on project cost as calculated by the authority, quoting lower operation and maintenance expenses with returns built into the bid project cost in the HAM model, and the provision of performance security in TOT model.
One of the key challenges in infrastructure financing is matching liabilities with the long-term funding requirements of projects. Unlike in the developed world, where infrastructure financing is largely done through institutional investors, in India, it is public sector banks that have supported a large portion of infrastructure funding. This has to change. More institutional investors like insurance companies, pension funds, etc., have to move in to fund long-gestation infrastructure projects.
A recent study done for the Asian Development Bank suggests that securitisation can go a long way in meeting some of these requirements. It is also best suited for infrastructure projects that have stable cash flows over the tenure of their project concessions. There is a need to look at various ways of structuring such as securitisation, including providing credit enhancement from banks or financial institutions, so that large institutional investors are attracted to these products.
Another key area where accelerated efforts are required is the rejuvenation of projects that are stalled or are under operational distress, either on account of high debt burden or lack of last-mile financing. A number of steps taken by the government and RBI have been in the right direction, and it is expected that there will be positive outcomes in the form of acquisition of stressed assets by long-term players in the next two years.
On the power sector front, there is a need to chalk out more long-term PPAs purchase agreements from state governments and distribution utilities, so as to lend a level of stability to the cash flows of power projects. This will automatically attract cheaper long-term financing to the sector, especially from overseas investors, in the form of mezzanine capital, bonds and external commercial borrowings.
There is an urgent need to find a resolution for the thermal power sector in India today. Declining solar and wind tariffs and a power surplus in a few states have directly impacted thermal power procurement across various states.
India has a large capacity of projects that have been recently commissioned, that have not contracted long-term offtake with discoms. With the short-term market being uneconomical, operational thermal projects without long-term PPAs have operated at low PLFs resulting in an inability to service debt. The implementation of regulations for coal price pass-through, coal procurement at competitive prices at regular intervals and the lack of clarity on domestic coal availability remain some of the key regulatory issues that need to be addressed.
Further, there is over 20,000 MW of gas power capacity which is currently not operational or operational at low PLFs, due to the non-availability of domestic gas and non-existence of peaking power tariffs to run on imported liquefied natural gas. This could also be a source of peaking power supply, and if these capacities are better utilised, this could help reduce the financial stress on some of these power plants.
What is the sector outlook for the next one to two years?
Clearly, India is riding on a wave of a conducive business environment coupled with an improved sovereign rating. Against the backdrop of various government initiatives designed to facilitate investment and stimulate the Indian growth story, the short-term outlook of India and the infrastructure sector in particular appears buoyant.
The short- to medium-term outlook is upbeat particularly for sectors such as roads, railways, urban infrastructure, renewables, ports and aviation, as substantial investments are planned in these sectors. However, the thermal power segment may experience subdued investment activity on account of large existing capacities grappling with stress or lying unproductive due to several factors. Though with a pick-up in demand, the segment is also expected to bounce back in the medium to long term.
Increased merger and acquisition (M&A) activity is expected particularly in the power and telecom sectors due to increased stress. Renewable sector projects may also change hands with the increased focus of international funds and investors culminating in greater M&A activity in this sector too.
Banks are expected to fund select projects in these sectors, exercising an overall cautious approach, given the current stress/NPA levels.
At a global level, economies are slowing. The effect of this will be a challenge for our economy as well. However, our high gross domestic product (GDP) growth plan and rising income levels will continue to drive economic prosperity for the country. With the expectation of a normal monsoon, softer interest rates and relatively benign inflation, the consumption growth story will continue into the next fiscal year.
In the past few years, the government has focused on measures to remove bottlenecks and facilitate a better environment for the infrastructure sector. The results of these measures will definitely be seen in the next one or two years. There is significant progress in the roll-out of new infrastructure projects in the country, a sizeable part of which will be supported by direct government funding and EPC contracts. At the same time, the private sector will also strengthen its presence with better risk management in the delivery of projects in the infrastructure sector. In order to enhance private participation, it is important to implement these projects in a timely manner and find innovative and optimal ways to manage the financing of these investments.
Investor interest in the road sector will continue to be driven by greenfield development of HAM projects by developers, the aggregation of operational road projects by PE-backed platforms, TOT roads bid by NHAI and InvITs launched by large road developers.
Renewable energy projects will continue to be the key driver of credit growth in the infrastructure sector in the next one-two years.
The much-needed new pipeline of projects and investor interest in bidding for these will be heavily dependent on the introduction of enabling regulations, the emergence of clarity on policy matters and the stability of a long-term infrastructure policy. The emergence of investable projects will also be key to the revival of the capital goods and other infrastructure-related ancillary sectors and for accelerating India’s overall GDP growth.
“Against the backdrop of various government initiatives designed to facilitate investment and stimulate the Indian growth story, the short-term outlook of India, and the infrastructure sector in particular, appears buoyant.”
Gopal Agarwal, Senior Vice-President, Project Advisory and Structured Finance, SBI Capital Markets Limited
“With the gradual easing of stress and an increase in their risk appetite, banks will once again emerge as a key funding source for the infrastructure sector in the near future.”
Ramesh Bawa, Managing Director and Chief Executive Officer, IL&FS Financial Services Limited
“Renewable energy projects will continue to be the key driver of credit growth in the infrastructure sector in the next one-two years.”
Bhavik Damodar, Partner, KPMG India