Private Capital For Infrastructure Sector
The government has already taken a slew of pro-active measures to hasten the pace of infrastructure development and attract private capital in the sector
Rahul Mody, Managing Director – Infrastructure, Ambit Corporate Finance
The International Monetary Fund has pegged the Indian GDP growth rate at 7.6 per cent for the next five years until 2021. A strong and politically stable government, tight fiscal discipline observed by the government and RBI and benign inflation aided by low commodity prices, have proved to be a shot in the arm for investor confidence towards India. At a time of weak global growth and strained investor sentiment, India stands apart as an emerging economy that shows promise of growth.
To sustain high growth and support business activity, it would be imperative for India to develop a robust infrastructure. For example, in a country where national highways account for only 2 per cent of the total road network but carry 40 per cent of the total traffic, there is a dire need to undertake capacity expansion at the earliest. Recognising this challenge, the Indian government has provided for a planned outlay of $15 billion in the 2016 Budget for the Indian road sector alone. Similarly, significant investments are required in other infrastructure sectors, such as railways, ports, power, energy, etc.
Private Capital Needed: It is widely accepted that the level of investment required in the Indian infrastructure sector cannot come from the government alone. In the 12th Five Year Plan, the government had initially set an ambitious target to achieve $1 trillion of total infrastructure spending in the designated five year period. However, this target was subsequently revised to $500 billion and even then, 40 per cent of the total investments were expected to come from the private sector. This has led to the emergence of the public-private partnership (PPP) model over the past 15 years.
Addressing Challenges: In the past, the Indian infrastructure sector and certain PPP projects have grappled with structural, operational and financial challenges, in the absence of independent regulators in some of the infrastructure sectors. Protracted dispute resolution and rigidity in contract negotiation are key structural challenges that undermined investor confidence. Infrastructure development had also faced significant headwinds from chronic delays in the land acquisition process and clearances that materially affected the projects adversely. Similarly, absence of long-term financing instruments and limited funding capacity with commercial banks also have a bearing on the funding available for infrastructure projects, thereby impacting the risk-return profile.
A number of these challenges have been, or are being addressed by the government. The Kelkar Committee that was constituted to recommend action points for reinvigorating the PPP programme has also provided encouraging suggestions. It has, and should, lead to an increase in private sector investments. However, given the relatively limited capital available with the private sector in India and the leverage position of some of the participants, the importance of attracting foreign capital to support India’s infrastructure needs cannot be emphasised enough.
Attracting Foreign Capital: The infrastructure sector has emerged as a separate asset class in global asset management over the past decade. This is to cater to long dated liabilities arising from increasing ageing population and longevity in the OECD world. There is significant liquidity available for investments in this asset class. However, with the infrastructure asset supply becoming scarce in the Western markets, there is a significant opportunity to attract meaningful investments in Indian infrastructure. These infrastructure investors mainly comprise sovereign wealth funds, global pension funds, insurance companies, endowment funds, etc. Such investors are interested in investing in long term infrastructure assets that generate stable returns. As per our estimates, India could attract $50 billion over the next five years from such investors for the Indian infrastructure. Initially, these investors are likely to focus on operational assets. Hence, a number of transactions have happened or are in the process, in which these investors are acquiring predominantly operational assets or portfolios from Indian corporates.
In this context, existing assets that are operational, have stable cash flows and are owned by government agencies, can be monetised by way of a transfer of operational and management rights to private players in the form of a concession. Investment in long term contracts for these assets would be in line with the focus of leading sovereign wealth funds and global pension funds and could provide meaningful capital base to the government for financing greenfield projects. The government appears to be already evaluating this option by way of Toll-Operate-Transfer construction in the road sector.
Another major aspect that needs immediate attention is the lack of appropriate hedging products. In India, hedging instruments are relatively expensive (typically, 6-8 per cent p.a.) and are not long dated enough. Considering the long tenor of infrastructure assets, foreign exchange currency risk is a key concern area for the investors. Development of a wider portfolio of hedging products with longer a tenor would address investor concerns significantly.
The government has also proposed setting-up the National Investment and Infrastructure Fund (NIIF) with an initial corpus of Rs 200 billion, wherein a 49 per cent stake would be contributed by the government. The NIIF is envisioned to address the long-term investment needs of the infrastructure sector. Ideally, the NIIF should be flexible enough to have sector specific pools of capital as the economic drivers and investors’ understanding for each infrastructure sector would be different. For example, sectors like roads, power transmission and renewables, have more established framework (with foreign investors having already invested) compared to sectors such as smart cities, industrial corridors etc. Further, the initial focus of the NIIF should be on actionable investments – potentially acquiring operational projects, which will release funds for the developers to fund new infrastructure. Once foreign investors are comfortable with initial investments, funds can be tapped under the NIIF for greenfield projects.
The government has already taken a slew of pro-active measures to hasten the pace of infrastructure development and attract private capital in the sector. However, the Indian economy still has a lot of ground to cover in order to support the target growth levels and it would be critical to tap into long-term low cost pool of global capital on a sustainable basis to meet its infrastructure sector’s investment requirements.
Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.