Restarting the engine
Things are looking up for project lending after reforms have made it easier for banks to deal with failing projects and lend at longer tenors.
After a subdued couple of years, India’s domestic loan market is enjoying something of a revival. Dominated by project financing, the market has been a victim of policy paralysis ahead of this year’s elections, but green shoots have surfaced in key sectors such as ports, power and roads.
With the pro-reform Narendra Modi government in power, market participants are confident that stalled projects stuck will soon be restarted and financings will fall back in shape. Since June, when the new government was sworn in, several measures have been taken to address infrastructure financing challenges.
Projects worth Rs6.2trn (US$105bn) across industries were shelved in 2013 due to bureaucratic gridlock, according to CMIE, an economic think tank.
“Long-term financing for infrastructure has been a major constraint in encouraging larger private-sector participation in this sector. On the asset side, banks will be encouraged to extend long-term loans to the infrastructure sector with flexible structures to absorb potential adverse contingencies, sometimes known as the 5/25 structure,” said Indian Finance Minister Arun Jaitley in his maiden Union Budget speech in June.
“On the liability side, banks will be permitted to raise long-term funds for lending to the infrastructure sector with minimum regulatory pre-emption, such as CRR (cash reserve ratio), SLR (statutory liquidity ratio) and priority-sector lending”, the minister said, announcing that Indian banks will be able to issue long-term senior bonds onshore for the first time.
Indian rules require its lenders to keep 4% of their deposits with the central bank as CRR. Banks also invest 22% of their deposits in government bonds as per the SLR requirements.
India’s mostly state-owned lenders have shied away from issuing senior bonds in the local market simply because the Banking Regulation Act of 1949 does not explicitly allow them to do so. Nevertheless, lenders had continued to support the pick-up in infrastructure lending since 2002 to result in short-term deposits. Almost half of all bank-related funding in India matures in one year or less.
However, this asset/liability management (ALM) mismatch is set to correct as lenders have started issuing long-term senior bonds. Icra, the local associate of Moody’s, has estimated that Rs2.7trn to Rs3.5trn of onshore senior bonds can be issued to fund infrastructure. This issuance could increase between Rs24trn and Rs29trn during a six-year period from 2015 to 2020, it said.
Two other key measures will ensure that long-term financing does not remain a challenge.
Evoking foreign interest
In early September 2014, the Reserve Bank of India allowed all recognised non-resident lenders providing external commercial borrowings (ECB) to extend loans in Indian rupees on condition that such funding be fully hedged with banks in India.
Earlier, borrowers were eligible to raise ECB in rupees only from their foreign equity holders.
“This is a major move as it will not only give great access to foreign lenders in the rupee loan markets, but benefit borrowers with diversification of lenders and, hopefully, in future with cheaper funds,” said Rahul Bannerjee, managing director, capital markets, Standard Chartered Bank, India.
Indian banks are cannot lend below their respective base rates. As he minimum base rate is around 10%, it puts average PF lending in the 13%–15% range.
The central bank’s ECB rule change has given rise to a possibility of foreign banks lending below these local base rates. As the hedging costs remain high, this new route of lending is still expensive – but perhaps not for long. The cost of swapping US dollars to Indian rupee is around 8%, and analysts expect the hedging cost to go down in the coming months after cuts in the domestic interest rate.
Enhanced roles of foreign lenders in the infrastructure financing will also lift total loan market volumes and provide the much needed diversification push to a market now the domain of state-owned banks.
In 2013, total loan volumes stood at US$32.4bn-equivalent, while January–September 2014 volumes were at US$33.4bn, according to Thomson Reuters data.
New structure, better times
Another of RBI’s relaxed rules holds a lot of hope for onshore lenders. In July, the central bank allowed local lenders to extend long-term loans under the 5/25 structure. Typically, Indian projects have been funded with 12 to 15 years of financing even though assets have a life of 20 years or more. This is because lenders do not borrow long term, resulting in having to squeeze repayments to shorter periods.
Such a structuring, coupled with high interest rates, not only make project financing expensive, but highly susceptible to stress because any small delay in the project has a profound impact. This problem compounds as stressed loans, genuinely affected due to structuring issues, cannot be given extra time as any extension of a loan tenor is construed as a restructuring and results in higher provisioning.
“Hundreds of projects have been a victim of such incompetent structuring. But now with the 5/25 structure and various clarifications of the RBI on restructurings, most of these projects can be rescued,” said a loan banker with a local bank.
The 5/25 structure will allow lenders to provide officially an infra loan for up to 25 years with a built-in refinancing after year five. Bankers say loans based on 5/25 structure will have bullet payments, unlike existing full amortising structures.
“The 5/25 structure will be a game-changer for Indian project financing. It will free-up cash flows of the project, giving relief to borrowers, while lenders will also be happy to refinance loans without getting stressed about restructuring woes,” said Bannerjee of StanChart.
Bankers have already started working on the new 5/25 structure for loans involving long concession periods.
The 5/25 structuring is allowed only for loans sanctioned after July 15. Also, after year five, central bank rules require the refinancing to involve some new lenders.