Resetting the cycle

To see the digital version of this report, please click here.

To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com.

State Bank of India, along with investment banking arm SBI Capital Markets, has been the world’s biggest arranger of project-finance loans each year since 2008. Volumes, however, are falling and others are catching up.

Project financings in rupees totalled US$42.2bn-equivalent in 2011, US$19.8bn in 2012 and US$15bn so far in 2013, according to Thomson Reuters data.

Shrinking loan volumes pose a conundrum for India as it attempts to channel an ambitious US$1trn into infrastructure in the five years from April 2012. Macroeconomic challenges, flight of foreign capital, and a slumping rupee are clogging the investment cycle further. India desperately needs to get its infrastructure plans back on track.

According to Reserve Bank of India Deputy Kovernor KC Chakrabarty, only 10,690km of the 50,621km of planned road projects were awarded in the last five years, and only four of 16 planned ultra-mega power projects planned. Of the 251 oil blocks allotted, 110 had reported discoveries, but only six were actually operational, Chakrabarty said at the Annual Infrastructure Finance Conclave that SBI Capital Markets hosted in Agra last month.

Non-performing and restructured assets in the infrastructure sector have grown rapidly to Rs1.37trn (17.43% of total advances to the infrastructure sector) at the end of March 2013 from Rs 121.90bn (4.66%) at the end of March 2009, according to Chakrabarty.

“India needs to double its infrastructure spending to around 10% of its GDP to achieve over 9% GDP growth, which further requires new funding sources,” said a foreign investor, who recently cut his exposure to the country.

“A few years ago, corruption was used to do business, now business is corruption. The moral fabric is totally broken in the country and, no wonder, India surfaces in the 132nd position among 185 economies in the ease of doing business globally.”

Foreign investors may have less patience, but they are not alone in facing challenges. Reliance Industries, the Tata Group, GMR and GVK have all faced delays to major projects, some choosing to walk away from their concessions altogether.

Bankers, however, are quick to point out that they remain able and willing to finance the right projects. Indeed, GMR and GVK each cancelled road concessions long after securing funding for the projects.

“To say that the infrastructure sector has lost the confidence of investors and lenders is not entirely correct. Yes, we are still struggling with huge shortages of infrastructure everywhere and there is a lot of catching up to do, but it is also a fact that macro issues can be solved easily and political will both at the centre and state level is capable of taking Indian infrastructure development to the next level,” said Rajat Misra, senior vice-president in the infrastructure group at SBI Capital Markets.

Funding options

Indian banks are still lending, albeit selectively. However, India will need a wider range of funding sources to meet its infrastructure targets without overburdening the already-stretched banking sector.

Focusing on getting additional more long-term foreign direct investment will help. “With government departments working against each other, this is not possible. A business needs to be communicated on what it needs to do to obtain clearances and, once it has taken those actions, clearances must be given promptly,” said another Singapore-based investor.

Bank lending to infrastructure sector currently stand at US$120bn, or around 35% of total such loans to the industrial sector. So, not only do long-term fixed-rate products like senior bonds need to be introduced immediately, but there is also a need to develop interbank interest rate swap market for hedging interest-rate risks, bankers have said.

“External commercial borrowings alone will not be the solution for raising offshore dollars needed to fund the FX portions of infrastructure financings. Higher involvement of export credit agencies, more credit enhancement structures, project bonds, deepening of the local bond markets, a proper infrastructure debt fund market and presence of local big investors, such as the Employee Provident Fund, are needed to get the investment cycle going for the infrastructure sector,” the investor said.

ECA-backed lending in the Indian project finance market increased to US$13bn in 2011 from US$201m in 2010. In 2012, this dropped to US$2bn, but export credit agencies have already been involved in funding of a total of US$5.7bn year to date, according to Thomson Reuters data.

A two-step structure is being developed wherein an ECA will lend to a local bank and then the local bank will on-lend to the project developer.

This structure will overcome ECA’s reluctance to take project risk related to lesser-known developers as it gets transferred to the Indian lender. At the same time, the Indian lender benefits as it gets long-term liquidity at a cheaper price, which can be passed on to the developer.

“It’s a win-win situation and should be explored as an alternate source of funding. Of course, this source is not unlimited, but, for projects involving long-term funding, this is an important alternative,” said Misra of SBI Caps.

Analysts are also calling for more projects to be financed in the capital markets to relieve more pressure on banks. Cumbersome regulations have so far been hampered efforts to introduce securitisation, but some market participants see an opportunity to spread risk through new products.

“The transport segment globally has seen bond issuances backed by future cash flows as security. These bonds are issued on the back of divergent sets of revenue streams from the underlying infrastructure assets. The starting point, of course, is that the project implementation phase is over and the asset is generating cash flows. These cash flows can be used either to retire existing debt or to undertake further developmental activity,” said Joshi of India Ratings.

Such financings can securitise toll-road receivables, concessionary receivables from the National Highway Authority of India, lease rentals from airport shops, port fees and other income streams.

Bond markets

Banks also need access to longer-term funding.

Bank lending to the infrastructure sector ballooned to Rs7.86trn in 2012–2013 from Rs72.43bn in 1999–2000, representing a compound annual growth rate of 43.4% versus overall credit growth of 20.4%.

Much of that lending, however, relies on short-term resources, leaving banks exposed to a potentially dangerous asset-liability mismatch.

The net short-term liabilities of government-owned banks represent 17.5% of their total assets, according to an India Ratings report in May, citing March 2012 data. That funding gap had widened from 4% of total assets in March 2002, leaving banks exposed to higher money-market rates at a time when then central bank has been squeezing liquidity to support the rupee. Bank liabilities due in one year or less now equal to 48% of total bank liabilities.

“There is nothing structurally wrong with the project financing frameworks in India per se, but certain steps need to be taken urgently across infrastructure sectors to make projects bankable once again.”

Indian banks are not explicitly allowed to issue senior bonds in the rupee market. Although lenders have circumvented this in issuing senior debt through their offshore branches, or won special exemptions, no bank has attempted to sell senior unsecured debt in the rupee market.

That effectively limits banks’ own appetite for longer-term assets, restricting the tenor of funding available to holders of long-term concessions.

Industry experts feel these local senior bonds should at least have tenors of 15 to 20 years and then only these will be able to fix the existing flawed financing structure [of long-term funding with short-term money] that, invariably, has led to restructurings during stressed conditions.

“Senior bonds can be useful to finance infrastructure projects,” said Atul Joshi, managing director and CEO of India Ratings and Research, the Indian affiliate of Fitch Ratings.

“Once infrastructure projects start getting financed through loans of longer tenors, their rating levels would improve given better ability to service the loans on operationalisation of the projects. In turn, the risk weights of the assets would reduce, resulting in better and efficient capital allocation by banks.”

Learning cycle

To improve that efficiency, however, India needs to find a way to recycle capital that is tied up in delayed projects, especially in the power sector.

“India is one of the largest PPP markets in the world and there is nothing structurally wrong with the project financing frameworks in India per se but certain steps need to be taken urgently across infrastructure sectors to make projects bankable once again,” said Sanjay Sethi, head of infrastructure advisory practice at Kotak Investment Banking.

Banking sector financing to infrastructure is concentrated in the power sector, where big projects are struggling to remain viable after a spike in the cost of imported fuel – notably Indonesian thermal coal. With no provision to pass on the increased costs to local offtakers, some power developers have opted to shelve plans rather than operate at a loss.

“A time-bound resolution of the domestic coal availability and pass-through of imported coal prices is needed, failing which we will be staring at large NPAs in the banking sector as well as significantly high demand-supply gap in the power sector,” said Sethi.

“It is not unheard of across the world for PPAs [power purchase agreements] and concession agreements to be reopened to reflect significant changes in market dynamics. We should do the same in India albeit with complete transparency involving public consultation and giving a one-time window to developers to restructure existing contracts together with some penalties so that the infrastructure projects remain viable especially in a capital constrained economy like India. We cannot afford to let these projects languish,” he added.

Toll-road developers are calling for changes to make the country’s national highway agency fully accountable for handing over 100% of land access within a set timeframe, after a series of projects were abandoned following delays in land acquisitions or securing environmental or other approvals. Industry experts also argue that transfer of road assets need to be made easier.

There is, however, some room for optimism. Prime Minister Manmohan Singh in August pledged to fast-track 36 stalled projects totalling Rs1.83trn to revive the economy.

“A few clauses need to be tweaked in the concession agreements and more power needs to be given to regulators to make them more independent. The good news is that the government has started taking steps in this direction,” said Misra of SBI Caps.