Over the next decade, an estimated $1.5 trillion needs to be invested in enhancing the country’s infrastructure. However, in the past few years, there has been a declining trend in bank credit towards this sector. This is not only attributed to increasing liabilities in banks’ balance sheets but also an unwillingness of lenders to invest in projects with long-gestation periods. Thus, there is a need to attract capital from long-term investors, such as insurance funds, pension funds and provident funds.
Size of insurance and pension business
At present, in India, provident funds, managed by the Central Board of Trustees (CBoT), and private trusts have business worth Rs 21 trillion. Pension funds manage business of only around Rs 2 trillion, indicating that they are yet to pick up. The insurance industry has assets under management to the tune of around Rs 35 trillion.
The Insurance Regulatory and Development Authority (IRDA) mandates that insurance firms need to have a minimum investment of 15 per cent in the infrastructure and housing finance sectors. Currently, the insurance industry’s exposure to the sector stands at 16.3 per cent of the entire portfolio, which is only marginally higher than the mandate. However, there is no such mandate at present for pension and provident funds.
Of late, insurance companies have shown interest and participated in various infrastructure-related instruments such as Ujwal Discom Assurance Yojana (UDAY) bonds, bank infrastructure bonds, infrastructure investment trusts (InvITs), etc. A total of Rs 2.2 trillion worth of UDAY bonds have been issued which have been subscribed to by insurance companies as well as other financial institutions. Meanwhile, insurance companies have also participated in the few bank infrastructure bond issues that have taken place.
Further, annuity-backed bonds worth
Rs 100 billion have been issued in the market. Though the issuance is not very large, there is a reasonable appetite for such bonds as insurance companies are always inclined towards long-term investments.
In the past four-five months, two InvITs were listed on the stock exchanges. However, their tepid performance on the bourses, evident from the fact that they are currently listed at a discount, has not rendered the instrument attractive for insurance companies and pension funds. Finally, insurance companies have the least exposure to toll-based debt, which is currently to the tune of Rs 50 billion. The execution risk, in terms of uncertainty in toll traffic, involved in a toll-based project has kept insurance firms at bay.
Issues and challenges
Insurance companies are quite conservative in their approach as the IRDA mandates that more than 75 per cent of their funds be invested in AAA-rated assets and 5 per cent in less than A-rated securities. This is primarily due to the lack of capital in such companies to absorb losses. The fiduciary role played by insurance and pension players constrains their risk-taking appetite.
Most insurance companies and pension funds have historically been refinancing experts for the majority of their portfolio rather than being direct project investors, a factor responsible for the negligible level of non-performing assets of these firms. In order to avoid construction and execution risks, they participate only in operational assets with visible cash flows. Further, their limited underwriting and monitoring capabilities pose a major challenge for this investor class to take exposure in long-gestation infrastructure projects.
Another issue plaguing the infrastructure sector is the lack of bidding discipline, which continues to fret insurance and pension funds. Therefore, appropriate bidding by infrastructure players and proper monitoring of bidding conditions by an independent regulator would bring much comfort to insurance firms.
The debt-heavy financing structure of most infrastructure projects has made them a less attractive option for insurance companies. This is because of the lower sponsor shareholding in these projects, which increases a project’s volatility. Further, insurance companies seek credit enhancement for such risky projects, which is not yet forthcoming. Therefore, promoters with more skin in the game would reinstil confidence among investors.
The way forward
Assets under management of insurance and pension funds have increased at a compound annual growth rate of 18 per cent in the past five years. With the financialisation of savings and remarkable growth in the insurance and pension fund industry, there lies immense opportunity for this investor class to park funds in the infrastructure sector. Akin to insurance companies, pension funds should also be mandated to invest a minimum level in the sector.
The availability of capital is not an issue but the attractiveness of the infrastructure sector needs to be enhanced. Specialised institutions such as the National Investment and Infrastructure Fund will play a crucial role in channelising long-term capital into the sector. Further, projects bolstered by partial credit enhancements by banks will eventually find takers as well.
Based on a presentation by Sudhakar Shanbhag, Chief Investment Officer, Kotak Mahindra Life Insurance Company, at a recent India Infrastructure conference