Global markets can close India's infrastructure gap

IFR 2107 31 October to 6 November 2015
6 min read
Asia
Jonathan Rogers

INDIA’S INFRASTRUCTURE MARKETS is an inescapable story given the country’s pressing need for the basic building blocks that developed countries take for granted. But it is one that has long proved challenging for the sponsors and the banks that have funded the country’s major projects, principally in the traditional power sector.

Here it has been a story of excessive ambition on the part of sponsors, expressed most clearly in a legacy of excessive leverage via the mezzanine funding that has frequently been used to grab a slice of the action. It’s difficult to cough up internal rates of return of up to 19% for mezzanine lenders when cost overruns, unreliable off-takers and an ever-changing regulatory backdrop hover over you. That is how it has been in the Indian power sector.

India’s often cosy relationships between big equity investors and the banking system have resulted in an overhang of non-performing assets at the banks that have still yet to be cleaned up. No country is more sorely in need of a “bad bank” to clean up banks’ balance sheets so that they can get back to the urgent business of lending again to the infrastructure sector.

Given that more than 70% of India’s outstanding infrastructure debt sits on the balance sheets of the country’s state-owned banks, it would be tempting for the government to simply keep on injecting capital in the hope that this will be allocated to more infrastructure projects.

But the recent establishment of a seven-point plan to address pressing issues in the banking system – including dealing with bad debt and corporate governance – indicates a willingness to adopt best practice that’s quite encouraging.

India’s often cosy relationships between big equity investors and banks have resulted in an overhang of non-performing assets

THE CAPITAL MARKETS may be understandably wary of the non-performing asset issue, but it seems it will be up to international investors to inject much-needed funds into India’s banking system.

According to ICRA, Indian banks will require an injection of Additional Tier 1 capital to the tune of around US$6.2bn between now and March next year. Almost five times that amount will be required over the next three years to meet Basel III funding requirements.

Against that backdrop, I’m not sure the global markets will embrace loss-absorbing paper from India at anything other than a relatively hefty yield premium, particularly given that the country’s notably capricious financial authorities haven’t had their mettle tested via a systemic banking crisis.

If any offshore investors are going to get written down to zero in the event of the authorities declaring a bank non-viable, India, with its mountain of bad loans and a perennially vulnerable freely floating currency, looks the most likely place for it to happen.

Hence, if my judgement is correct, pricing that huge pile of Basel III-compliant supply will involve execution at levels way back from the implied yield curves of India’s major banks. Let’s wait and see.

But to return to Indian infrastructure, I am somewhat intrigued by an ongoing consent solicitation exercise for renewable energy company Greenko. This involves offering holders of the company’s US$550m 8% notes due 2019 20bp compensation for agreeing to waiver change of control clauses on the paper.

The company, which focuses on renewable energy in India, is selling its Greenko Mauritius subsidiary – which issued the bonds – to a subsidiary of Singapore sovereign wealth fund GIC. Rather than buying back the bonds at 101, as stipulated by the COC clause, the company and its advisers Deutsche Bank and JP Morgan are hoping that investors will be tempted by the US$2 they are being offered for every US$1,000 of paper held.

I’D BE INCLINED to get my two dollars simply because the paper was last quoted at 105 bid, but that doesn’t tell the whole story. There’s always a risk of cash leakage from the opcos to the new holdco, or of investors finding themselves subordinated in the event of a further change of ownership.

It will be an interesting one to watch, but I imagine the comfort provided by the presence of GIC will prevail and there will be a take-up north of 75% to the consent solicitation.

Beyond the nitty gritty of the tender exercise, it also demonstrates that Indian infrastructure is firmly entrenched in the minds of the international private and institutional equity community. The likes of GIC and the IFC want a slice of the Indian infrastructure story and are willing to book lower IRRs than other institutional buyers because of their access to ultra-cheap funding.

India-based DCM bankers I spoke to recently believe a wave of consolidation is afoot in the Indian power sector, such that the highly leveraged sponsors are going to get taken out by big private equity and sovereign wealth fund players. If that means the numerous stalled projects littering India’s infrastructure landscape can now make it across the line then it is no bad thing.

Indeed it might be time to start scooping up Indian infrastructure bonds in secondary. That must have been the thinking behind the run-up of more than 15 points in the price of Greenko’s bonds over the past four months.

Jonathan Rogers