5th PEVCAI ANNUAL CONVENTION Reproduction and redistribution prohibited without permission www.deloitte.com/in
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Contents
ASSOCHAM Foreword........3 Trillion Dollar Opportunity A Perspective ................................................................................................................... 4 Availability of finances ............................................................................................................................................ 8 Private sector investment ....................................................................................................................................... 9 Financing Trillion Dollar Investment Availability Aspect ........................................................................................... 10 Debt Financing ..................................................................................................................................................... 11 Commercial Banks ............................................................................................................................................... 11 Infrastructure Non-Banking Finance Companies (NBFCs) .................................................................................. 12 Insurance Companies .......................................................................................................................................... 12 Overseas Market: External Commercial Borrowing ............................................................................................. 13 Measures to enhance fund availability ................................................................................................................. 14 Bond market ......................................................................................................................................................... 14 Banking reforms ................................................................................................................................................... 15 Insurance reforms ................................................................................................................................................ 16 Recommendations for ECBs ................................................................................................................................ 18 Financing Trillion Dollar Investment Private Sector Investment .............................................................................. 19 Assessment of FY2013 Infrastructure Investment ............................................................................................... 20 What ails the infrastructure sector ....................................................................................................................... 20 Policy response to infrastructure issues .............................................................................................................. 21 Modifying the policy/regulatory framework ........................................................................................................... 22 Facilitating project clearances .............................................................................................................................. 25 New investment cycle on anvil ............................................................................................................................. 29 Equity Financing A Perspective ............................................................................................................................... 30 Global Infrastructure Investors market ................................................................................................................. 31 Infrastructure private equity in India ..................................................................................................................... 33 Going forward scenario ........................................................................................................................................ 35 Way Forward ............................................................................................................................................................ 37
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ASSOCHAM Foreword India needs private equity more than ever to push forward the Infrastructure agenda. But to be most effective, the right partnerships are critical to seize market opportunities, open up new markets, and to share Market knowledge. India could become the second largest economy in the world by 2050. The key growth drivers are investments in infrastructure, domestic consumption, and a hub for global outsourcing. This is further supported by growth oriented policies by the government. The favourable environment has led to the growth of the private equity market. On the other hand, entrepreneurship has long been considered crucial for the economic development. An important element of entrepreneurship is the willingness and ability to mobilize private capital from both domestic and foreign sources thereby creating of new business that proposer and create jobs. Private equity can not only help companies grow and raise productivity but at the same time, it can also be a powerful driver of change by raising standards, fostering growth and promoting new opportunities for business. Private equity represents a modest share of the USD 1 trillion to be spent on infrastructure in 2012-17, about half of which would come from private sector funds, compared with a target of one-third in the previous five years. This paper prepared by Deloitte and PEVCAI Teams, gives an overview of the Twelfth Plan financing scenario and highlights the role of the Private Sector (and in turn of Private Equity as an asset class) in driving the private investment into the infrastructure sector and further fuelling the growth of the Indian economy. I convey the Teams and the 5th PEVCAI Annual Convention my good wishes.
D. S. Rawat Secretary General ASSOCHAM.
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Deloitte Foreword Achieving a sustained growth trajectory averaging at 9 percent entails robust physical infrastructure i.e. electricity, roads, ports, irrigation, water supply and sanitation and creation of such infrastructure required mobilization of funds for financing such projects. Notably, funding of domestic Infrastructure is in a period of flux. On both sides of the equation supply and demand there are positive and negative influences resulting from the economic slowdown as well as credit scarcity. While demand remains strong from the users of finance, suppliers have traditionally gravitated towards quality projects with little to differentiate. In this context, ability to meet infrastructure investment target of USD 1 trillion (INR 65,000 billion) as envisaged in the Twelfth Plan has two aspects to it. Firstly, availability of funds from sources from various sources including budgetary support, internal generation and borrowings. Secondly, ability of private sector to execute infrastructure projects and take up new investments under public-private partnership model Availability of finances for such huge investment would largely depend on the Government's ability to successfully increase reliance on the bond market as an alternative source of financing to bank loans and their ability to implement fiscal consolidation as a means of freeing up bank lending and reducing upward pressure on interest rates. Emphasis on private sector participation and policy / regulatory measures to attract private capital cannot be undermined given the huge pressure on capital rationing and funding requirements. In order to incentivise the large scale use of private sector participation in infrastructure, it would be useful to link the Government funding to the effort of developing proj ects as PPP. Further, there are credible reasons to believe that the Indian private equity market would make important contribution in this endeavor. Our GDP continues on its upward trajectory, bringing continual increases in new investment opportunities in the infrastructure which would be required to maintain the growth momentum. Plenty of opportunities and long term potential in the infrastructure would keep attracting private equity to invest in it. We trust the report provides an ample background for helping identify practical solutions to address concerns holding back investments in the infrastructure sector. Kalpana Jain Senior Director Deloitte Touche Tohmatsu India Private Limited
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Trillion Dollar Opportunity A Perspective The rapid growth of the Indian economy in recent years has placed increasing stress on physical infrastructure i.e. electricity, railways, roads, ports, irrigation, water supply and sanitation, all of which already suffer from deficit in terms of capacities as well as efficiencies. The pattern of inclusive growth averaging at 9 percent per year as conceived under the Twelfth Five Year Plan (2012-17) can be achieved only if this infrastructure deficit is overcome and adequate investment takes place to support higher growth and an improved quality of life for both urban and rural communities. Based on projections provided in the Mid-Term Appraisal of the Twelfth Plan, in order to attain a 9 percent real Gross Domestic Product (GDP) growth rate, infrastructure investment should be on average almost 10 percent of GDP during the Twelfth Plan. This translates into INR 41 lakh crore at 2006-07 prices (real terms), as estimated by the Planning Commission of India. At an annual inflation rate of 5%, this translates into an equivalent to INR 65 lakh crore in current prices.
Projected Investment in Infrastructure during the Twelfth Five Year Plan Year FY13 FY14 FY15 FY16 FY17 Total Twelfth Plan GDP at FY07 Prices (INR Billion) 68,825 75,019 81,771 89,131 97,152 411,900 Infrastructure Investment as % of GDP 9.00% 9.50% 9.90% 10.30% 10.70% 9.95% Infrastructure Investment (INR Billion in current prices) 8,885 10,734 12,803 15,245 18,125 65,794
Source: Mid-Term Appraisal Twelfth Five Year Plan, Planning Commission Note: WPI inflation used to convert to current prices; FY12 inflation based on Prime Minister Economic Advisory Council (PMEAC) projection
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The sectoral allocation of infrastructure investment as a proportion of GDP stands highest at 2.9 percent for energy sector (comprising electricity, renewable energy and oil & gas) followed by transport (railways, MRTS, ports, airports, roads & bridges and storage) at 2.8 percent.
Sector-wise Investment Pattern: Eleventh and Twelfth Plan (INR Billion at current prices)
Eleventh Plan (2007-12) Twelfth Plan (2012-17) Private Sector Participation Ratio Sectors INR Billion As % GDP INR Billion As % GDP Eleventh Plan Twelfth Plan A. Energy (1 to 3) 8,802 2.6% 23,242 2.9% 56% 61% 1.Electricity 7,285 2.2% 17,724 2.2% 43% 48% 2.Renewable Energy 892 0.3% 3,760 0.5% 88% 88% 3.Oil & Gas Pipelines 625 0.2% 1,757 0.2% 37% 48% B. Transport & Storage (4 to 9) 7,948 2.4% 22,446 2.8% 40% 56% 4.Raiways 2,012 0.6% 6,128 0.8% 5% 19% 5. MRTS 417 0.1% 1,466 0.2% 13% 42% 6.Ports 445 0.1% 2,335 0.3% 82% 87% 7.Airports 363 0.1% 1,035 0.1% 64% 80% 8.Roads & Bridges 4,531 1.3% 10,793 1.3% 20% 33% 9.Storage 179 0.1% 689 0.1% 55% 72% 10. Telecommunication 3,850 1.1% 11,140 1.4% 78% 92% 11. Irrigation 2,435 0.7% 5,953 0.8% 0% 0% 12. Water Supply & Sanitation 1,208 0.4% 3,013 0.4% 0% 3% 12. Grand Total (1 to 12) 24,243 7.2% 65,795 8.2% 37% 48%
Source: Planning Commission.
Assuming 50 percent of the investment will be met by budgetary resources, the balance INR 32.5 lakh crore needs to be met through debt and equity. Until recently infrastructure investment in India was financed almost entirely by the public sector from the Government budgetary allocations and internal resources of public sector infrastructure companies. However lately, the private sector has emerged as a significant player in bringing in investment to build and operate infrastructure assets from roads to ports and airports and to network industries such as telecom and power. Private investment constituted about one third of infrastructure investment in the Eleventh Plan and this is projected at 50 percent for the Twelfth Plan period. In these times of tight fiscal environment, private sector will need to play a greater
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role without which infrastructure development will not meet the growing demand and could fall far behind current requirements impacting targeted GDP growth. The public-private sector mix of investment varies across various infrastructure industries. For instance private sector is expected to contribute more than 80 percent of total investment in the renewable energy, telecom, ports and airports. These are the infrastructure industries where user charges can pay for the investment. In case of roads, more than two thirds of the road network is in rural or in the less developed and remote regions where low levels of development and industrial activity preclude high traffic volumes necessary for commercial viability of toll roads. Hence, the contribution of the private sector is only one third of total investment for this sector (INR 10,763 Billion) and the balance two third is to be made up by public sector contribution. The source of financing proposed infrastructure investment for Twelfth Plan is represented below. Financing matrix of Infrastructure: Twelfth Plan (2012-17)
Source: Planning Commission.
Technically, there are two dimensions to above financing matrix for the Twelfth Plan. Firstly, availability of funds form sources mentioned in the matrix including budgetary support, internal generation and borrowings. Secondly, ability of private sector to execute infrastructure projects and take up new investments under public-private partnership model.
Availability of finances Of the three sources of public sector contribution mentioned in previous section, budgetary support for infrastructure would depend on the fiscal space available to both Central and State Governments after meeting contractual obligations like interest payments, wages and salaries and pensions. Besides, Central Government has to contend with rising defence and security related expenditure which are driven by threat perceptions and geostrategic considerations, subsi dies and massive expansion of programmes aimed at social entitlements. Higher levels of internal generation of resources largely depend on the extent of freedom and autonomy enjoyed by public sector undertakings involved in rendering infrastructure services to run their undertakings on commercial considerations. Scope for borrowings would mainly depend on Governments success in containing its fiscal deficit which would prevent borrowings by the Government for financing revenue expenditure so that private sector investment is not crowded out. In terms of non-debt and debt sources, almost 50 percent contribution each from debt and non-debt sources would be required. However, availability of debt is placed at INR 13,337 billion as against a requirement of INR 32,363 billion leaving a funding gap of INR 19,025 billion to be addressed.
Debt source availability versus requirement (INR Billion) Twelfth Plan (2012-17) Debt requirement Public Sector Borrowing 10,693 Private Sector Borrowing 21,670 Total Debt Requirement 32,363
Given the above gap in debt funding, the ability to meet infrastructure investment target of USD 1 trillion (INR 65,000 billion) will critically depend on two factors. First, the Government's ability to successfully increase reliance on the bond market as an alternative source of financing to bank loans and, second, their ability to implement fiscal consolidation as a means of freeing up bank lending and reducing upward pressure on interest rates.
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Further, India will need to borrow increasingly in the domestic market if it is to meet this target, since it has limited fiscal space and faces ceilings in terms of instruments such as external commercial borrowings. It faces a widening current account deficit - the latest figure reaching 4.9 percent of GDP (October- December 2013) - that constrains its scope to expand domestic investment and its balance of payments position. So far, banks have been the main providers of infrastructure financing. While this is not an optimal arrangement, given the long-term financing required for infrastructure investment, banks have been successful in financing greenfield projects. However, they now face a number of barriers to expand lending to infrastructure, including concentration risk such as exposure limits to groups (infrastructure companies) and sectors (e.g. power, roads) as well as to prevent build-up of asset liability mismatches in the system. Private sector investment As established, nearly 50 percent of the Twelfth Plan target is expected to be contributed by the private sector via public-private partnership (PPP) route. PPP has emerged as the new success route in Indias attempts to build world-class infrastructure. As planned infrastructure projects throw up funding and technological challenges, Governments are increasingly turning to the private sector with PPP route emerging as the most favoured mechanism for cooperation. It is not surprising then that the PPP concept has expanded across key infrastructure segments ranging from roads and communications to power and airports. PPP in fact, could be the key to policymakers attempts to create the requisite infrastructure for enabling double-digit GDP growth and enhancing peoples welfare. Out of 50 percent to total infrastructure investments in India during the Twelfth Plan, it will be no surprise if a large chunk of these investments are directed through the PPP route. However, achieving private sector investment target in the infrastructure sector during the Plan period is challenging mainly due to delays in clearances and liquidity crunch faced by the players. Besides, financial institutions are not willing to fund infrastructure projects. This results in developers facing liquidity challenges. Therefore, instead of taking up new projects, developers are now focusing on completing existing ones and addressing internal cash flow issues. The paper details the aspects of availability of finances for the gigantic trillion dollar investment projections and issues saddling the private sector investments in subsequent sections.
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Financing Trillion Dollar Investment Availability Aspect While infrastructure investment targets are ambitious, Indias domestic savings rate is very high and is projected to grow. Much of the infrastructure investment need can be financed domestically. Still, such high rates of infrastructure investment constitute over one-third of Indias financial savings and would entail as much as 21 percent of the incremental financial savings being directed to infrastructure.
Savings and Infrastructure Investment Needs Percent of GDP FY10 FY13 FY14 FY15 FY16 FY17 Infrastructure Investment 8.0 9.0 10.0 9.9 10.3 10.7 Gross Domestic Savings 33.7 37.8 40.6 42.9 45.5 48.2 Out of which financial savings 22.0 24.8 27.2 29.1 31.1 33.4 Incremental Infrastructure Investment 0.3 0.6 0.5 0.4 0.4 0.4 Incremental Financial Savings 2.8 4.1 2.4 1.9 2.6 2.3 Infrastructure Investment as % of Financial Savings 34% 36% 35% 34% 33% 32% Percentage share of incremental infrastructure in incremental financial savings 21% 21% 20% 17%
Source: Mid-Term Appraisal Twelfth Five Year Plan, Reports submitted by Sub-Groups on Household Savings, Private Sector Corporate Savings and Public Sector Savings for 9% p.a. real growth and 5% p.a. inflation scenario
Yet, it is not just the adequacy of domestic financial savings that matters. These savings have to be intermediated into infrastructure to achieve these targets. During the first three years of Eleventh Plan, the infrastructure funding requirement has broadly been met through the channels mentioned above in the proportion described below:
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Sources of funds during first three years of Eleventh Pan
Source: Infrastructure.gov.in
It is evident that budgetary support constituted ~45 percent of the total infrastructure spending followed by debt from Commercial banks, Non Banking Financial Companies (NBFCs), Insurance Companies and the external sources constituting ~41 percent of the funding while the balance 14 percent was through Equity and Foreign Direct Investment (FDI). Debt Financing Until the mid-2000s, there was no major demand from the financial system to fund infrastructure investment due to fairly low quantum (around 3-5% of GDP). This was financed largely by budgetary allocations and internal resources of public sector enterprises engaged in infrastructure. In the Eleventh Plan, however, infrastructure spending picked up substantially with an important role played by the private sector and greater recourse to the financial system. Most of the debt financing came from banks, NBFCs, and external commercial borrowing (ECB), followed by insurance companies. Commercial Banks The financial system was able to respond to the rapidly rising demand for credit by infrastructure companies largely because banks stepped up lending by unwinding their excess investments in the Government securities maintained as Statutory Liquidity Ratio. Until the end of the Eleventh Plan, it is estimated that banks were able to provide about half the debt finance needs of infrastructure investment. However, this rapid growth in bank credit to infrastructure has resulted in a greater concentration of risks in banks, asset liability mismatch and reaching exposure ceiling limits of the sector. Banks have prudential exposure caps for infrastructure sector lending as a whole, as well as for individual sub-sectors. According to the information available, most of the banks have almost reached the prudential caps for power sector and other sectors like roads may not be far behind. 45% 14% 6% 4% 10% 21% Budgetary support Equity/FDI ECBs Insurance NBFCs Commercial Banks
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Going forward, credit growth will be determined mainly by retained earnings and increase in banks capital. However, as most of the infrastructure lending is by public sector banks (PSBs), raising capital can only take place if equity capital base is enhanced by the Government diluting it s shareholding or infusing capital into the PSBs. In the projections described below, infrastructure credit growth is assumed to be determined only by retained earnings. Assuming that retained earnings grow at 20 percent per annum for PSBs, and at 25 percent per annum for private banks, and infrastructure credit is estimated to rise to 15 percent of total credit, then the net incremental bank credit to infrastructure over the Twelfth Plan is estimated at INR 7.4 lakh crore.
Infrastructure Non-Banking Finance Companies (NBFCs) NBFCs also increased their lending sharply as the credit demand for power and roads expanded. The major Infrastructure Finance Companies (IFCs) which could be considered for estimating infrastructure finance are Power Finance Corporation (PFC), Rural Electrification Corporation Limited (REC), IDFC Limited, India Infrastructure Finance Company Limited (IIFCL), L&T Infrastructure Finance Company Limited and IFCI Ltd. Going forward, high historical growth rates observed in the past may not be feasible since NBFCs would need to take up further capital raising exercise to be able to lend significant amounts. Hence, for the purpose of estimation the growth rate for FY11-17 is assumed at ~20 percent per annum which is at the same levels as commercial banks. Insurance Companies Life insurance companies are required to invest up to 15 percent of their Life Fund in infrastructure and housing. Although the Asset Under Management of life insurers in the Life Fund increased at a compound annual growth rate (CAGR) of 16.31 percent p.a., the share of infrastructure investments during the same period increased only marginally at a CAGR of ~1.25 percent p.a. Insurance penetration is estimated to continue to rise, with the insurance premium growing from the current approximate 4 percent of GDP to 6.4 percent of GDP by the end of the Twelfth Plan. Investment in infrastructure by the insurance sector is projected based on the past few years average investment by insurance companies (about 63 percent of premium income) after deducting commissions and expenses, and the infrastructure investment as a share of the total insurance investment flows (of 6.2 percent). Although there is much greater scope for channelizing insurance funds for infrastructure (which needs long-term funding) there are various regulatory constraints in the sector precluding this.
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Overseas Market: External Commercial Borrowing Infrastructure companies have tapped external credit market, however the share of infrastructure investments in overall ECB borrowings has gradually come down. The estimates of the external borrowings during Twelfth Plan are based on the past five year averages (FY07-11) of the actual external borrowings.
Total Debt availability projections Commercial Banks- Projections (INR billion) FY12 FY13 FY14 FY15 FY16 FY17 Total Gross Bank Credit Outstanding 58,874 70,567 84,581 101,378 121,511 145,642 Yearly availability of funds 988 1,192 1,436 1,731 2,086 7,435
ECB- Projections (INR billion) Total Borrowing 549
Total Debt Funding Available (INR billion) 13,337 Source: Planning Commission
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Measures to enhance fund availability As observed, there is expected to be a shortfall in the available resources vis-a-vis requirement under different growth scenarios. Total funding gap is estimated at INR 19,025 billion. Certain focus areas could be: Broad areas of reforms to enhance fund availability Supplementing/widening the channels of infrastructure funding
Regulatory reforms for Insurance companies and Pension Funds so that more savings through these important channels gets mobilized into infrastructure. Reforms which ensure higher ECB and other forms of foreign capital inflows. Development of financial products and markets
Increase depth and width of the financial market. Reforms in the area of development of newer financial products for infrastructure financing such that a wider variety of investor is attracted. Creation of a growth enabling eco-system
Regulatory changes addressing replacement of committed but unutilized debt capital extended by the commercial banks with other forms of financing. Development of a frame work that reduces the market risk in infrastructure financing and asset liability mismatch of banks. Give commercial banks more flexibility to churn their portfolio of Infrastructure assets at shorter tenors by way of increasing asset classes. Revitalising the market for takeout financing, refinancing and securitisation.
Having the focus areas mentioned above as guiding principles, the following section describes some regulatory, policy and financial stimuli required in the immediate to the medium term. Bond market In many countries across the world, long-term bonds form a major share of infrastructure finance. However, the Indian corporate bond market is less than 5 percent of GDP. International bonds can provide access to term financing (can be up to 30 year plus tenor) to an extent not available in the bank market. However, Indian companies (even with high ratings) have been unable to tap the international bond markets for funding their long term investments in the infrastructure sector. Some measures that need to be undertaken for the deepening the corporate bond markets in India may
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include: (a) Financial: Implement uniform stamp duty across States; (b) Regulatory: (i) Allow banks and domestic financial institutions to provide credit enhancement for the infrastructure bonds; (ii) Develop regulatory framework for multi-asset collateralised debt obligations (CDOs) and (c) Creating robust market infrastructure: (i) Establish an integrated trading and settlement system (like Negotiated Dealing System (NDS) order matching system for G-Secs) and (ii) Move from a Delivery Versus Payment (DVP) I to DVP III system for corporate bonds. One of the reasons for lack of investor appetite for long term infrastructure bonds is withholding tax. While a reduction in withholding taxes payable for overseas borrowing by infrastructure funds has already been announced, the same withholding tax cap needs to be in place for infrastructure investments (with tenor exceeding 7 years) made either through IFCs or directly in the infrastructure companies. Also, Municipal bond market (Munis) in India has remained underdeveloped and relatively untapped. There have been exceptions in the past, for example, municipal bonds were issued by Municipal Corporation of Ahmedabad (INR 1 Billion in 1998). It is estimated that there is a potential of USD 270 billion being generated through Munis provided the Municipal Bond Market is tapped properly. This would, however, also require critical pre-conditions like transparency of corporate governance within Municipal Corporations, levy and collection of appropriate user charges, innovative project structuring, supporting tax regime, better framework for security creation and enforcement is equally or more critical. This together with the PPP model could drive urban infrastructure and spur a new growth area. Like PPP was well appreciated and important development of the Eleventh Plan, Munis and urban infrastructure growth could be the most important theme of the Twelfth Plan.
Infrastructure Debt Fund and long-term resources: Government may facilitate Infrastructure Debt Funds (IDF) through Mutual Fund route and NBFC route, and allow IIFCL to provide refinancing and takeout finance to IFCs.
New Financial Instruments: Create a single regulatory window for clearing innovative debt products typically in the mezzanine space. For instance, products such as Rupee denominated convertible bonds or Optional Convertible Debentures (OCD) can help develop the corporate debt market . Banking reforms As on date, sectoral lending limits have been reached, increasing the systemic risks to the banking system. There is an urgent need to develop take out financing schemes to ameliorate stress. Some of the suggestions to adopt this are as under:
Allow commercial banks to reduce burden of Infrastructure debt financing: Like infrastructure NBFCs, banks to be allowed to raise infrastructure bonds which qualify for exemption of Income tax under Section 80CCF with an exemption limit to INR 100,000. Refinancing Scheme with matching tenor needs to be devised. Current IIFCL scheme has only 10 year
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tenor and other restrictions making it unattractive for banks.
Provide banks more flexibility to churn their infrastructure loan portfolio: Since the sectoral cap for lending to infrastructure has been reached, this prevents the banks from granting fresh sanctions. To this extent, large lenders such as SBI need to start quoting two way quotes and create market in the infrastructure receivables space. Regulatory framework for multi-asset CDOs allowing securitization to happen needs to be implemented. While there were early adopters like ICICI Bank and Citibank, almost all transactions in the market are privately placed. Lack of appropriate legislation/legal clarity and unclear accounting treatment exacerbate the situation.
Need for banks to raise more capital: In order to be able to fund a growing economy, public sector banks need to raise further capital, especially if infrastructure lending by banks is to be kept intact for the Twelfth Plan. According to an independent study carried out by IDFC in February 2011, diluting Government stakes in all major PSBs to 51 percent by raising capital in 2013 could yield INR 1.45 lakh crore more funds to lend to infrastructure from commercial banks. For example, the dilution of the Government stakes to 51 percent in two major NBFCs viz. REC and PFC, 67 percent and 73.72 percent held by the Government (Quarter Ending June 2011), works out to about INR 7,994 crore at current prices which may result in additional increase in lending assets of IFCs by ~ INR 53,300 crore.
Possible capital raising by PFC and REC: Government Holding as on 30th June 2011 Market Cap As on 30th June 2011 (INR Crore) Equity dilution (%) Potential Capital Raised (INR Crore) PFC 73.72% 18,300 22.72% 4,158 REC 66.80% 24,286 15.80% 3,837 Total 7,995 Source: IDFC Insurance reforms Since infrastructure financing is long term in nature, the depository profile of insurance companies is more in tune with the funding requirement of the sector. Banks, as discussed, face asset liability mismatch issues because their depository base is short term against long term nature of infrastructure loans assets. Similarly, pension funds are key investors in long term infrastructure bonds. In India both had jointly contributed around 5 per cent to the total investment in infrastructure in the Eleventh Plan. Insurance/Pension funds have the ability to invest for longer terms, these institutions are restricted by their respective regulatory bodies (IRDA and PFRDA) which limit their exposure to the infrastructure sector even when they have sufficient funds available to invest.
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Some suggestions to increase investments in infrastructure from these insurance companies are described below: The IRDA (Investment) Regulations 2000, as amended from time to time, stipulate that not less than 75 percent of debt instruments excluding Government and Other approved Securities shall have a rating of AAA or equivalent rating for long term instruments and not less than P1+ or equivalent for short term instruments. This limit may be changed to not less than 50 percent in AAA rated and AA+ rated debt instruments may be incorporated, which would increase of better availability of insurance funds for debt instruments. The tenor of investments in infrastructure related facilities may be revised to not less than 5 years from the present not less than 10 years to enable insurance companies to invest in brown field infrastructure companies/projects and also to enable the life insurance companies to fund the take-out finance arrangements. Insurance company investments into the special purpose vehicles (SPVs) of infrastructure projects, debentures of private limited companies and non-dividend track record companies in infrastructure need to be included with in the ambit of approved investments thereby providing flexibility of funding options for infrastructure projects. For higher investment by the life insurance companies in infrastructure projects, the exposure can be considered for revision to 20 per cent of the total project cost from current level of 15% of project equi ty as being done by IIFCL.
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Recommendations for ECBs Recently, take-out financing arrangement has been permitted through ECB, under the approval route, for refinancing of Rupee loans availed from domestic banks by eligible borrowers in the port, airport, roads including bridges and power sectors for development of new projects. However there is a need to simplify the process for take-out financing/refinancing Rupee loans through ECBs for infrastructure companies. Current timelines to engage foreign lenders for takeout are limited making it difficult for foreign lenders to come to an agreement at the initial stage itself and assume the execution risk at the time of take out. This condition of entering into tri-partite agreement may be dispensed away with and an amount for such take-out financing through ECB automatic route could be declared on an annual basis. There is a need to relax the all-in-price ceiling for ECBs (i.e. 500 basis points over the 6 month Libor) for infrastructure projects with average maturity exceeding 7 years. The interest rate ceilings set by RBI on ECBs put constraints in availing foreign currency loans for domestic infrastructure projects. Relaxation of the ECB ceiling of USD 500 million per annum per company for automatic route will help make ECB stable source of financing and ensure increased ECB funding. This may be increased to USD 1 billion for Infrastructure financing. International Investments: To facilitate flow of funds from the international market with flexible but prudent regulatory framework, following measures could be considered: Bringing IFCs in the infrastructure sector under the automatic route in line with other corporate. Exempting withholding tax on interest and other payments to ECBs by infrastructure sect or, including IFCs. Allowing, within a certain limit, Indian corporates in the infrastructure sector, including IFCs to issue Rupee denominated bonds in the international market.
To conclude, concrete policy and regulatory measures need to be undertaken. Some of the most important include measures taken to increase the breadth and the depth of the corporate bond markets in India, higher involvement of insurance and pension fund companies in infrastructure funding, and providing an environment that is attractive to foreign investors.
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Financing Trillion Dollar Investment Private Sector Investment The Twelfth Plan has identified the crucial challenge of immediate reversal of growth deceleration with revival of investment sentiments. The plan has emphasised for an action plan to address implementation constraints in infrastructure which are holding up large projects. Share of Private Sector Investment Sector Share in USD 1 trillion infrastructure in investment in Twelfth Plan Share of private investment Electricity 27% 48% Roads and bridges 17% 34% Telecom 17% 92% Railways 9% 20% Irrigation 9% 0% Renewable energy 6% 88% Water supply and sanitation 5% 2% Ports including Inland Water Ways 4% 87% Oil and Gas pipelines 3% 48% Metro Rail Transport 2% 42% Airports 2% 80% Storage 1% 72% Source: Planning Commission 2012. The share of private investment in the total investment in infrastructure rose from 22 percent in the Tenth Plan (2002-2007) to 38 percent in the Eleventh Plan. The Eleventh Plan succeeded in raising investment in infrastructure from 6.2 percent of GDP in FY08 to about 7 percent in FY12. The Twelfth Plan aimed to raise it further to 9 percent by FY17. There is special emphasis on electricity generation with 27 percent of the planned investment expected to be directed towards this sector. The Eleventh Plan added 55 Giga Watts (GW) of generation capacity which, though short of the target, was more than twice the capacity added in the Tenth Plan. The Twelfth Plan aims to add another 88 GW. There is an additional investment of USD 57 billion for renewable energy (additional 30 GW of renewable energy) of which private sector is expected to contribute as much as 88 percent. Compared to the last plan period there is doubling of investment share targeted at the port sector (including inland waterway)
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with further increase in private participation. The scale of private investment would require a significant reinforcement of an enabling policy and regulatory environment. Even though the planned investment in infrastructure is on track but going by the last plan performance on targeted investment, the pre-requisite is to provide a conducive business environment which protects domestic and foreign investor interest. The Eleventh Plan achieved 93 percent of targeted investment because of performance of only few sectors like electricity, telecom and oil and gas pipelines. But critical segments of infrastructure, i.e. roads, railways and ports, have under - achieved their target mainly because of the lack of private investment. Assessment of FY2013 Infrastructure Investment Total investment across all infrastructure sectors in 2012-13 was INR 534,645 crore, the least since 2010- 11, mainly due to less than satisfactory performance in electricity, roads and bridges. This raises concerns over the Governments ambitious target to attract investment of INR 65 lakh crore (at current prices) into the infrastructure sector during the Twelfth Five-Year Plan. In 2012-13 GDP grew at a decadal low of 5 percent, impacting infrastructure spending and 2013-14 is not expected to be any better as overall economic sentiment is poor. Prime Minister Dr. Manmohan Singh had earlier stated he expected economic growth in 2013-14 at 5 percent, similar to that in 2012-13.
Infrastructure investment shortfalls (INR Billion) Sector 2011-12 (A) 2012-13 (P) 2012-13 (E) Shortfall Electricity 1,904 2,134 1,768 17% Non-conventional power sector 281 282 257 9% Roads & Bridges 1,301 1,401 1,077 23% Urban Infrastructure (Water Supply & Sanitation) 257 340 312 8% Ports 168 183 125 32% Total 3,913 4,343 3,540 18% Source: Planning Commission. We have analysed below the factors leading to poor private sector appetite for investment in sectors like power, roads, and ports followed by measures which have been initiated by the Government to revive the infrastructure investments in these sectors. What ails the infrastructure sector The infrastructure sector has been lagging for the last few years. This has led to slowdown in economic growth and infrastructure investments. While there are multiple issues that have plagued the sector, t hese problems are interconnected with one issue leading to another. In other words, there has been a domino effect which has led to the present state of affairs. Main issues are: Policy paralysis: The troubles for the sector started with the policy paralysis that led to delays in
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statutory approvals and related clearances like land acquisition, environmental and forest. Project viability takes a hit: With projects getting delayed due to lack of clearances (leading to cost and time overruns), viability of projects was adversely impacted. This led to deterioration in the financial strengths of infrastructure companies. Demand slowdown: Apart from supply side issues mentioned above, slowdown in the economy led to demand side issues with lower than anticipated traffic growth and low demand for power over past few quarters. The slowdown also impacted Government spending, further hurting infrastructure companies. Other issues: In addition to the above, there were other factors that impacted infrastructure projects. For example, power projects had faced paucity of domestic coal as domestic coal production hit speed bumps. To exacerbate the situation, imported coal prices increased (change in reference rate for Indonesian coal) throwing viability of many power projects haywire. Road projects saw aggressive bidding with developers promising to pay hefty premiums to win projects. However, many of these projects later failed to achieve financial closure due to lenders shying away from funding these unviable projects. Issues with dispute resolution framework: All these issues led to developers either walking away from projects (termination of road projects citing delay in clearances) or knocking the Government doors for relief (for tariff revision for power projects or premium restructuring for road projects). However, this resulted in protracted arbitration which exposed the absence of adequate dispute resolution framework to deal with complex issues facing the sector. All these issues have resulted in a situation where new projects were not being initiated, under construction projects started witnessing slow execution and operational projects started becoming distressed. Consequently, infrastructure players bore the brunt with falling profits/ballooning losses resulting in a situation of financial distress. Due to this deterioration in financial matrices, infrastructure companies have shifted their focus to survival from growth. Fresh capital expenditure (capex) plans are being deferred time and again, impacting every player in the infrastructure value chain. Policy response to infrastructure issues The Government seems to be adopting a three-pronged approach to solve the sector ills. First, the Government is considering modifying regulatory framework. It is also framing dispute resolution mechanisms to deal with the dynamic nature of infrastructure projects. Second, as far as existing projects are concerned, it is trying to get projects moving by speeding up clearances and removing execution bottlenecks. Lastly, the Government is looking at reinvigorating the capex cycle by awarding new projects. We analyse these measures in detail below for each of the sectors i.e. roads/highways, power and ports.
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Modifying the policy/regulatory framework Roads/Highways Sector As mentioned, the major issues that have impacted road development in India in the last 2-3 years are the aggressive bidding for projects by developers and the delay in receiving environment/forest clearances and land acquisition.
Premium restructuring: Many road projects awarded over FY12 had attracted aggressive bids from developers, who had promised to pay substantial premium to National Highway Authority of India (NHAI) for winning these projects. With the economy slowing down and project timelines getting stretched due to delays in clearances, many projects failed to achieve financial closure. Recently, the Cabinet Committee on Economic Affairs (CCEA) has approved premium restructuring for all projects awarded on premium basis. Projects will be evaluated on a case-by-case basis to ascertain their eligibility for premium restructuring. An expert panel under Mr. R Rangarajan (Economic Advisor to the Prime Minister) with representatives from Finance and Surface Transport Ministries, will be set up to finalise guidelines for the same. This move is positive for the roads industry since it will resolve the impasse in which road projects have been stuck for the past two years.
Amendments in the prequalification criteria: Over the last few years, some road projects have seen a large number of players getting prequalified to bid for projects. Certain projects have seen close to 100 players being prequalified. As a result of the large number of players getting prequalified, many projects have seen aggressive bidding while many of these projects have later been unable to achieve financial closure. As a response, the following changes have been suggested in the prequalification criteria for road projects: making technical/financial criteria more stringent, focus on financial closure as bid qualification, barring players with non-performing assets (NPA) etc.
Amendments in the Model Concession Agreement (MCA): With the changing economic scenario, Government felt the need to amend current MCA which provides regulatory framework for the roads sector. Following changes have been suggested in the MCA: (a) Fulfilment of authoritys Condition Precedents (CP) before appointed date; (b) Status of CPs during bidding process provision of likely timeframe required for fulfilment of CPs and penalty for non-fulfilment; (c) Increasing the penalty for delay in land acquisition - The rate of penalty is to be enhanced to INR 100 (from INR 50) per 1,000 sq. mt. for each day of delay; (d) Presence of State Support Agreement (SSA) - NHAI will ensure execution of the SSA before the bidding process; (e) Compensation for delay in toll hike notification. (Source: Edelweiss Research, Feedback Report) In the Union Budget FY14, it was announced that a regulatory authority for the roads/hi ghway sector would be set up. This independent body would primarily look at the current challenges being faced by the sector such as financial stress, construction risk and contract management issues. There have been other key policy initiatives that have been taken in the recent past for the development
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of the sector: Companies enjoy 100 percent tax exemption in road projects for five years and 30 percent relief for the next five years. Companies are also granted a capital of up to 40 percent of the total project cost to enhance viability. Infrastructure finance companies such as India Infrastructure Finance Company Limited (IIFCL), National Highway Authority of India (NHAI), Housing and Urban Development Corporation (HUDCO), Power Finance Corporation (PFC) etc. have been allowed to issue tax free bonds to a total of USD 9.2 billion in FY14. Interest payments on borrowings for infrastructure are now subject to a lower withholding tax of 5 per cent vis--vis 20 per cent earlier.
Power Sector One of the biggest issues being faced by power developers is the inadequate domestic coal supply and volatility in the cost of imported coal. The uncertainty on the fuel cost front has thrown developers calculations haywire since many PPAs do not have adequate provision of fuel cost pass through. This has put the profitability of many existing power plants at risk while also significantly raising concerns about under development power projects. In addition, this has had a negative impact on new capex plans in the power sector with the viability of power projects coming under a serious cloud. Compensatory tariff: As far as existing power projects facing losses are concerned, the Government is in the process of giving compensatory tariff e.g. Tata Powers Mundra and Adani Powers Mundra and Tiroda plants. Additionally, the Government is working to step up domestic coal production by fast tracking clearances.
Standard bidding documents: On the issue of future power plants, the Government has revised the bidding framework by coming up with a new Standard Bidding Document (SBD) for the power sector. It has recently cleared the proposal of tweaking the SBD for Case-II thermal power plants and that for Case- I plants is expected shortly. The new SBD for Case-II projects addresses the risk associated with fuel price volatility and fuel availability as fuel cost has been made a pass through. At the same time, clarity has been brought in the termination and other generic provisions in the contract. Bidding is to be based on single parameter capacity charges as compared to a levellised (including capacity plus variable charges) tariff earlier, bringing in more objectivity in the bidding framework. The capacity charge would be linked to depreciation and loan repayment as well as to the inflation index. This decision is expected to speed up the process of awarding the proposed Ultra Mega Power Projects (UMPPs) at Bedabahal, Odisha and Cheyyur, Tamil Nadu. It is expected to kick-start investment of ~INR 400 billion in the power sector.
Financial restructuring of State Distribution Companies: While the Electricity Act 2003 envisaged
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separation of interlinked activities of SEBs and making them individually self -sustaining entities, the situation, especially of distribution entities, has not improved meaningfully over the years. State Governments, entirely responsible for the distribution sector, have failed to keep pace and the situation has gone from bad to worse. Realising the importance of the distribution sector in the power value chain, the Government in September 2012 decided to intervene by rolling out a scheme to restructure State discoms keeping in mind Shunglu Committees recommendations. The scheme entails measures to be taken by State Discoms and State Governments for achieving financial turnaround by restructuring the debt with support via a transitional finance mechanism by the Government. Key feature of the scheme is converting 50 percent of outstanding short-term liabilities into bonds to be taken over by respective State Governments and the balance 50 percent to be rescheduled by lenders with adequate moratorium of at least three years backed by State Government guarantees.
Tariff hikes: Recent tariff hikes and offer of State Government support would revive confidence of developers. Some states have been granted steep tariff hikes in recent years in order to reduce the widening gap between their average cost of supply (ACS) and average revenue required (ARR) on power supply. Discoms have also been asked to strictly follow planned reduction in aggregate technical and commercial (AT&C) losses in the system. While AT&C losses have improved marginally, much more needs to be done to lower them further. (Source: Edelweiss Research, Feedback Report) To promote investment and for the development of power sector, the Government announced various measures in the Union Budget for FY14, key ones of which are: Government to reintroduce generation based incentives for wind power projects to boost capacity addition in the sector for which USD 147.3 million is to be allocated to the Ministry of New and Renewable Energy. To reduce dependency on imported coal, a Public Private Partnership policy framework is to be devised with Coal India Limited to increase coal production. Low-interestbearing funds to be provided from National Clean Energy Fund (NCEF) to Indian Renewable Energy Development Agency Ltd (IREDA) for on-lending to viable renewable energy projects. The total plan outlay for the power sector for FY14 is estimated at USD 1. 6 billion, a significant 27 percent higher than the revised estimate of USD 1.5 billion for FY13. During FY13, Government liberalized FDI policy for power exchanges by allowing FDI investment up to 49 percent.
Port Sector Regulatory framework for major ports has been amended to anchor developer interest. Existing norms for port tariffs are governed by a complex formula based on return on capital and implemented by the Government-appointed, but largely autonomous, Tariff Authority for Major Ports
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(TAMP). These rules were widely seen as restrictive, hampering growth and therefore putting off investors. Global port operators with substantial investments in India such as PSA International, APM Terminals and DP World have repeatedly expressed their grievances at what they see as a crippling tariff structure. Port tariff reforms are under way in India and guidelines for determining tariffs are expected to lean increasingly towards market-based mechanisms. The Ministry of Shipping has already announced that projects approved under the PPP mode from April 2014 will not be bound by previous regulations. The Twelfth Plan envisages INR 1.07 crores of new investment for the development of non-major ports out of which INR 1.05 crores is expected to come through the PPP route. Facilitating project clearances Measures discussed above largely relate to regulatory/policy and are more relevant f or future projects. In addition, to ensure that existing infrastructure projects that have been stalled get requisite clearances fast, the Government has established with an institutional mechanism in the Cabinet Secretariat called the Project Monitoring Group (PMG) which will be headed by an Additional Secretary. This cell will work to revive ~330 stalled infrastructure projects which have a total investment size of ~ INR 16,000 billion. The working group would evolve a protocol for resolving problem areas, while the sub-groups will try to settle specific issues. Various ministries (like roads, railways, environment and forest, coal, shipping, telecom, commerce, mines, civil aviation etc.) have been asked to assign a nodal officer of the rank of Joint Secretary or above to co-ordinate with the cell. The sub-groups on coal and environment are slated to meet every week - given the plethora of affected projects. PMG has been vested with powers to deal with different ministries and departments at central, state and local body levels to get the projects fast- tracked. The cell will coordinate with the Cabinet Committee on Investment (CCI) to ensure speedy clearance for projects. (Source: Edelweiss Research, Feedback Report) The success of these initiatives could be a make or break for the infrastructure sector.
Roads/Highways Sector The PMG has secured environment clearance for eleven infrastructure projects worth ~INR 150 billion. The details for roads projects are as below: Projects that have received environmental clearances Project Segment Location Cost (INR billion) Cuttack Angul road project Road Odisha 11.2 BSCPL Aurung Tollway Road Chhattisgarh 12.3 Source: Government documents, News articles, Edelweiss Report Apart from the projects listed above, the Cabinet Committee of Infrastructure (CCI)/Project Monitoring Group (PMG) has also discussed clearances for other projects on a case-by-case basis. The projects discussed and the actions taken are summarised below:
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Other projects looked at by CCI/PMG: Project Cost (INR Billion) Issue Decision taken Sasan project (Reliance power) 200 Stage II clearance for Chhatrashal block The developer needs to submit compliance of stage I conditions to Ministry of Environment and Forest (MOEF); thereafter stage II clearance will be granted L&T Hyderabad Metro Rail 164 Permission for quarrying The company is in the process of obtaining clearances; matter to be taken up with the state government. Nigrie project (Jaiprakash Power Ventures) 100 Diversion of forest land for railway siding Company is yet to identify land for compensatory afforestation and further approvals would be granted only after the developer does so. GMR Kishangarh Ahmedabad expressway 77 Premium restructuring Premium restructuring to be considered. JAS Infrastructure and Power 74 MOEF clearance Geological report for the captive coal block is yet to be prepared. Thereafter, mining plan will be approved and developer can approach MOEF for clearance Athena Chhattisgarh Power 62 Fuel supply Fuel Supply Agreement (FSA) to be signed Tori-I power plant (Essar Power) 97 MOEF clearance Proposal pending with Jharkhand state government; to be send to MOEF for forest clearance IOCL project- New marketing terminal at Eastern sector refinery, Paradeep 2 Approval of DPR for railway siding Required approval given Delhi Airport Aerocity Security clearance Security clearance given Jindal India Thermal Power, Angul, Odisha Fuel supply Linkage recommended to ministry of coal for Phase II of the project Source: Government documents, News articles, Edelweiss Report
Power Sector The CCI has cleared 18 power projects with a generation capacity of 15.6 GW and involving an investment of INR 838 billion (banks have lent INR 133 billion to these projects already). The CCI has asked Coal India to sign fuel supply agreements (FSAs) for all these projects. Power projects for which FSAs have been approved Project Generation capacity (MW) Investment (INR Billion) Maruti Clean Coal and Power Limited 300 15 TRN Energy 600 28 Korba West Power 600 29 DB Power 1,200 58 Jhabua Power 600 30
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Tirodha Phase I, Maharashtra, Adani Power 800 40 GMR Kamalanga Energy 1,050 60 Lanco Babandh Power 660 35 Talwandi Power 2,000 100 Haldia Energy 600 34 Prayagraj power 1,980 95 Mejia TPP (Unit-VIII) DBC power project 500 25 Raghunathpur TPP DBC Power Project 600 30 DB Power Ltd. II 600 32 RKM Powergen 1,440 90 Corporate Power 540 47 Lanco Amarkantak 1,320 77 Abhijeet MADC Nagpur Energy 246 14 Total 15,636 838 Source: Government documents, News articles, Edelweiss Report
Apart from these projects, as per a CCI directive, Coal India has offered supplies to 8,240 MW power projects that do not feature in the list of entities with which Coal India had to sign FSAs as per the presidential directive, but are commissioned and need immediate coal linkage to start power generation. The total investments in these projects were ~INR 437 billion. Additional power projects which will get fuel supplies Project Developer Generation Capacity (MW) Lalitpur Power Project, Uttar Pradesh Bajaj Hindustan 1,980 Kawai Project, Rajasthan Adani Power 1,320 Chhattisgarh Project GMR 1,370 Singrauli Project, Madhya Pradesh Essar Power 1,200 Malibrahmani Project, Angul, Odisha Monnet Power 1,050 Tirodha Phase II, Maharashtra Adani Power 1,320 Source: Government documents, News articles, Edelweiss Report Following CCI intervention, a couple of power projects have seen progress. NTPCs North Karanpura project has taken off after the CCI resolved the dispute with Coal India over the site of coal reserves and restored the coal linkage. Following this, NTPC has already applied for the renewal of the time-barred environmental clearance. Similarly, Lancos Babandh project has obtained the first-stage environment clearance from the Centre. It is expected to secure the second stage approval (forest clearance) soon.
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Port Sector In the Union Budget FY14, it was announced that two new major ports will be established at Sagar, West Bengal and in Andhra Pradesh to add 100 million tonnes of capacity and a new outer harbour will be developed in the VOC port of Thoothukkudi, Tamil Nadu through PPP at an estimat ed cost of INR 7,500 crores. The PMG has secured environment clearance for couple of ports as below: Projects that have received environmental clearances Project Segment Location Cost (INR billion) Development of Haldia dock-II (North) Port West Bengal 8.2 Development of Haldia dock-II (South) Port West Bengal 8.9 Source: Government documents, News articles, Edelweiss Report
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New investment cycle on anvil Apart from taking steps to amend the regulatory framework and speed up clearances, the Government is also trying to bring projects to the bidding table. It hopes to award these projects and thereby give a fresh lease of life to the moribund capex cycle in the country. Some of the projects on which the Government is focusing are listed below: Road projects like the Eastern Peripheral Expressway, Delhi-Meerut Expressway, Mumbai-Vadodara Expressway. Power projects like the UMPPs at Cheyyur and Bedabahal and power transmission projects. Port project in Durgarajapatnam, Andhra Pradesh. Railway projects like the Mumbai elevated rail corridor, locomotive projects, Dedicated Freight Corridor project. Airport projects like the Navi Mumbai Airport, O&M contracts on PPP basis. (Source: Edelweiss Research, Feedback Report) The Governments focus on reviving project award is a step in the right direction. Many of the projects targeted are large ticket projects and may need a lot of Government intervention with regards to getting clearances/land acquisition in place or for setting up of regulatory framework (like in case of expressways) before the bidding starts. To this extent, we believe it may be a while before project award actually happens. Still, the Governments effort to bring these projects to the bidding table is a definite positive. In a bid to ramp up investor sentiment, in June 2013, the Government of India set an investment target of INR 1.15 lakh crore in PPP projects across infrastructure sectors in rail, port and power in the next six months. The proposals include Mumbai elevated rail corri dor (INR 30,000 crore), two international airports in Bhubneshwar and Imphal (INR 20,000 crore) and power and Transmission projects (INR 40,000 crore). A steering group is being formed to monitor the award and implementation of projects on priority basis. Besides airports and Mumbai's elevated rail corridor projects, the group will also monitor two Locomotive projects (INR 5,000 crore), accelerating E-DFC (Eastern-Dedicated Freight Corridor) (INR 10,000 crore) and port projects (INR 10,000 crore)
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Equity Financing A Perspective As India opened up infrastructure for private sector participation in it s Eleventh Plan, a large pool of Indian infrastructure companies participated. The increasing investment from private players, attracted Private Equity funds to start up India infrastructure focussed funds to reap the benefit of the India growth story.
FDI in infrastructure over past few years (INR billion) Sector FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 Foreign Direct Investment 300 313 299 245 367 329 95 Source: Economic Survey However, as discussed earlier the issues around project implementation has subdued/eroded equity internal rate of return (IRR) for Private Equity. This has resulted in reduced investment activities in past few years. The equity investment, including FDI, during the first three years of the Elevent h Plan was approximately 14 percent of the total investments made towards Infrastructure whereas the overall debt contribution was 41 percent (implying a debt equity ratio of 2.93:1).
Equity (including FDI) availability estimates for Twelfth Plan (INR billion) Sector FY2013 FY2014 FY2015 FY2016 FY2017 Total Equity (Foreign Direct Investment /Equity) 616 736 880 1,054 1,265 4,554 Source: Planning Commission Equity funding will be a key constraint going forward, possibly even bigger than debt funding. A large part of equity investments rely on foreign investments with domestic investment institutions not too keen at primary level for taking equity in Infrastructure projects. Regulatory changes which will make projects commercially attractive are needed to draw adequate equity capital to infrastructure sectors. The private equity market in India has to be analysed in juxtaposition with the global infrastructure investor market as it is largely driven by the global market trends.
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Global Infrastructure Investors market A recent survey by Deloitte LLP, UK of infrastructure investors across continents reveals that the infrastructure asset class has successfully weathered the economic storm, with many investors citing that their investments have been resilient during the financial crisis. Approximately 70 percent of investors stated that their investments are currently achieving or exceeding target internal rates of return (IRR) . Following their experience of the downturn, investors are bullish about the sectors prospects, with the majority stating a clear focus on investment in core infrastructure assets located in the safe haven geography of Western Europe. A number of overarching market characteristics and trends across the infrastructure investors landscape emerged from this survey as defining the sector today: Funds are performing well against IRR targets. This bodes well for the sector and indicates that confidence has returned to the infrastructure market following the financial crisis. Increasing focus on asset management to deliver returns. Increased focus on asset management, and in particular, pro-actively managing leverage. Encouragingly, a majority are expecting their investee companies to increase capex investment over the next few years, as this is often viewed as an easier strategy to drive IRR performance than Merger and Acquisition (M&A) activity.
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Lack of supply. Market is characterised by "deal-hungry" infrastructure investors who have significant capital at their disposal but who are continually hitting a "road block" in terms of finding the right asset to invest in. This lack of supply of assets is driven by the fact that many of the large disposal programmes announced by major European Utilities and Governments have not commenced, as they focus on more immediate priorities.
Regulatory risk remains the key concern. High on the topical agenda, regulation is seen by the investors as the key risk, both from an investment and asset management perspective. What was once seen as a key attraction for investing in infrastructure assets is increasingly being treated with trepidation.
Focus on 'tried and tested'. - the majority of investors have maintained their focus on core infrastructure assets which demonstrate essential characteristics, such as high barriers to entry and monopolistic features, often combined with the business being regulated and/or offering long-term contractual protection of revenues. In addition, although there is clear appetite to invest in jurisdictions outside of Europe (particularly due to the Eurozone crisis), in terms of actual deals completed, Western Europe continues to be the preferred jurisdiction for most investment managers. Globally, following their experience during the downturn, almost all of the investors interviewed stated that they have a resolute focus on investing in core infrastructure assets over the next two years, which continues the trend seen earlier. Regulated utility and transport assets continue to be highly attractive investments. At the same time there are clear concerns with regards to the regulatory environment, number of funds pointing to the impending tariff reductions. As with the findings in the survey, Western Europe continues to attract the strongest investment focus by the vast majority of investors. However, increasingly, there is more appetite to deploy capital outside of Europe, with the exception of India and China. Former darlings of the global economy, these jurisdictions appear to have become increasingly less attractive to investors as their high economic growth of recent years has slowed.
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From an investment perspective please indicate the level of focus Companies will have on the following markets over the next two years (5 being very high and 1 being very low)
Source: Deloitte Report 2013
Infrastructure private equity in India As mentioned, private equity firms have shied away from Indian roads, ports and power projects in the last few years as the credit profiles of many companies have deteriorated amid delays in project approvals or access to fuel for power plants. Moreover, the infrastructure sector has suffered due to inadequate political momentum and experienced investments almost completely dry up with ongoing regulatory uncertainty compounding this problem. Nevertheless, in the absence of mature bond market and bank reluctance to lending, more equity is needed to fund infrastructure development in India. Key challenges for private equity in infrastructure currently are as below. Policy/Regulatory issue. Regulatory uncertainties pertaining to these sectors e.g. changes in model concession agreement, pre-qualification criteria for bidding etc. in road sector, compensatory tariff/fuel pass through, restructuring of state utilities etc. in power sector and tariff reforms in port sector, have taken its toll by driving away the private equity investors. Concern about returns. A previous wave of private equity investment in Indian infrastructure was often in early stage projects, many of which were bogged down by delays, eroding prospects for returns. This is particularly true of investments made during the boom years of 2004 through 2007, which are now reaching maturity. Their performance is causing concern among Limited Partners (LPs). High leverage. Due to high gearing of most of the infrastructure companies, assets are under distress in view of repayment burdens which further worsens the project profitability. Expectations mismatch over asset valuations. Despite the trend towards more realistic valuations given that majority of infrastructure assets are in distress, developers/promoters tend to reference 0 1 2 3 4 5 Central/Eastern Europe India/China North America Western Europe 2007 2010 2013
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valuations to a good market situation. Macroeconomic environment. India's performance on macroeconomic factors including GDP growth, inflation and other economic factors were disappointing throughout 2013 resulting in increased concerns to the private investors. While the policy framework remains uncertain and continues to deter investment, Government reforms embarked on towards the end of 2013 is expected to dispel these concerns. Although these issues create certain cause for concern, we have reason to believe that the fundamentals of the Indian private equity market are sound. The Limited Partners (LPs) and General Partners (GPs) still believe in the long-term potential of private equity in India and in India's growth story. While the economy may have slowed down, GDP continues on its upward trajectory, bringing continual increases in new investment opportunities in the infrastructure which would be required to maintain the growth momentum.
Going forward scenario Going by recent trend, private equity investment in Indian infrastructure is poised to pick up following a lengthy dry patch as debt-stressed operators of toll roads and other projects come under pressure from banks to offload assets to strengthen balance sheets. Large private equity houses i.e. Kohlberg Kravis Roberts (KKR), the Blackstone Group and Macquarie Group are looking at buying completed projects, a relatively safe bet, tempted by valuation expectations that have reportedly fallen significantly over the past two years. The Central/State Governments have taken initiatives to clear up the regulatory as well as clearance hurdles stalling infrastructure investment. These measures are aimed at reviving the new investment cycle in the infrastructure by addressing investor concerns such as bid document changes, premium restructuring in the road sector, compensatory tariff, bidding criteria changes in power sector, etc. This is expected to result in multiple opportunities in these sectors for the equity investors as well as addressing some of their key concerns thereby attracting the new investment. Fund Raising. Fund raising continued to be challenging, with infrastructure private equity firms closing on USD 540 million of new commitments in Q2 2013. Though this is more than double the value of new commitments raised during the previous quarter (USD 251 million), at an absolute level this remained rather low, especially when compared with the monthly investment rate of USD 500 million to USD 600 million in the last few months. However, this is not expected to have a material impact on private equity investments in the near to mid-term, as a large part of investments in India is made by global funds from their global capital pools. CDC, the UKs development finance institution, has announced a major new investment into Indian infrastructure, bringing new capital to key sectors including roads, ports, social infrastructure and power. CDC has committed USD 200 million to the India Infrastructure Fund 2 (IIF2) run by IDFC Alternatives Limited. The commitment from CDC, which is its largest ever to an Indian investment fund, has helped IIF2 reach a first close of USD 644 million, with the IDFC team targeting a total fund size of USD 1 billion from a range of institutional investors. The fund will provide long-term, equity investment for both construction and operating infrastructure projects across the country. Everstones USD 250 million first close of Indospace Logistics Park Fund (managed by a joint venture between Everstone Capital and Realterm Global) to build industrial warehousing was the largest fund raised during Q2 2013. 75 percent of the eight new successful funds raised in Q2 2013 were raised by GPs with prior experience. Measures to enhance the equity availability. Additionally, certain measures on the policy/regulatory need to be implemented to enhance the availability of equity funds e.g. Increase the funding pool. Increased domestic funding for infrastructure needs to be facilitated by suitable policy amendments (with prudential limits) which would enable greater participation in private equity from domestic entities such as pension and provident funds, banks, insurance companies etc. Listing of funds. Security and Exchange Board of India (SEBI) to facilitate listing of infrastructure funds. Ability to list such funds would provide greater liquidity to the investors of such funds thereby making such
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vehicles more attractive to a larger set of investors. Tax treatment for unlisted equity. Tax treatment on unlisted equity shares especially for approved infrastructure sectors may be brought on par with listed shares. Most often each project is executed through a SPV, which would typically be an unlisted entity. This move can also bring down the effective cost for such projects. Recently, enactment of Finance Act 2013, Consolidated Foreign Direct Investment (FDI) Policy effective from April 2013, rationalization of investment routes and monitoring of foreign portfolio investments etc., would go a long way in facilitating flow of foreign funds in India.
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Way Forward The imperative of rapid scaling up of the infrastructure capacity in the Government and private sector (developers, contractors, consultants, financial intermediaries and investors) entails developing and implementing projects of the required scale and within the tight time frames envisaged. The recent initiatives on the part of the Government have begun to turnaround the story as far as the private participation is concerned through project execution and planning new investments. However, achieving private sector investment target in the infrastructure sector during the Plan period would largely depend on the Governments ability to address the regulatory uncertainty and clearance related issues going forward. This would reinstate confidence of the financial institutions in the infrastructure projects improving their liquidity challenges. Also, in order to incentivise the large scale use of private sector participation in infrastructure, it would be useful to link the Government funding to the effort of developing projects as PPP. It would be necessary to put in place a value for money framework acceptable to the Government and which would be used to systematically benchmark bids from the private sector for each project. Further, the ability to meet infrastructure investment target of USD 1 trillion (INR 65,000 billion) will critically depend on successful reliance on an alternative source of financing to bank loans (i.e. bond market) and implementation of fiscal consolidation as a means of freeing up bank lending and reducing upward pressure on interest rates. There are credible reasons to believe that the fundamentals of the Indian private equity market are sound. Our GDP continues on its upward trajectory, bringing continual increases in new investment opportunities in the infrastructure which would be required to maintain the growth momentum. Plenty of opportunities and long term potential in the infrastructure would keep attracting private equity to invest in it. Lastly, to implement an ambitious roadmap for the Twelfth Plan, improved standards of governance and concerted political will would be required to take these targets and goals from inspirational statements to actual development.
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Disclaimer This publication, prepared jointly by Deloitte Touche Tohmatsu India Private Limited (DTTIPL) and Private Equity and Venture Capital Association of India (PEVCAI) is based upon research and/or analysis of the secondary market data gathered from various public sources, which we believe can be relied upon for the purpose of this publication. By using reference to the various documents publicly available, neither DTTIPL nor PEVCAI has intended to infringe upon the existing intellectual property rights, if any, of the owners of such documents.
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