INFRASTRUCTURE FINANCING: TAPPING INTO A DIVERSIFIED

FUNDING POOL

Sreegul.S, II MIB, PG Department of International Business,

Sree Narayana Guru College, KG Chavadi, Coimbatore 641 105
Email.: rechusree@gmail.com Mobile No.: + 91 94971 35612

Dr.M.Saravanan, Assistant Professor, PG Department of International Business

Sree Narayana Guru College, KG Chavadi, Coimbatore 641 105
Email.: shravan.murugan@gmail.com Mobile No.: + 91 99434 37749

As a key asset infrastructure is one of the most important driving force of an economy and has a
direct impact on the overall growth and development story of the country. Infrastructure assets
support a wide range of systems in both public and private sectors without which the industrial
society of today simply wont function or be as efficient. Generally developed world tends to
have better infrastructure than emerging economies but having said that the overall spending on
infrastructure in GDP terms by developed economies have been declining recently whereas the
emerging world has increased its overall spending on infrastructure. In a fast growing economy
you would expect the demand for infrastructure assets to increase immensely year-on-year and
the opposite is true for a slow growth economic environment.

So the state of a countrys economy certainly plays an important role in infrastructural needs of
that nation. Infrastructure assets should always be forwarding looking because the rapid growth
in population and economy especially in emerging countries will put strain on the existing
infrastructure creating bottlenecks relatively quickly but at the same time parts of the countries
experiencing lower or minimal growth may create a situation of overcapacity. Conceiving a
smart and forward looking infrastructure asset and supporting it with the right capital is always
critical. In the past federal, state, local tax bases other funding sources has been used to pay for
vital infrastructure projects across the world. We have seen the business model for developing
and funding infrastructure assets evolve in the last decade where a number of high profile

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infrastructure assets were built and paid for through Public Private Partnership or Initiative (PPP
or PPI).

Although a number of high profile PPP projects have failed this model of developing and
financing infrastructure projects is still considered one of the best way to pay for it. While
emerging economies have the need to keep building vital infrastructure to support their growth
and improve the living standards of its citizens, the developed nations especially the US are
sitting on an aging infrastructure that needs to be updated. All this requires capital and with the
ongoing financial CRISIS it is getting harder to source funding for infrastructure assets as banks
are still struggling to fix their balance sheet. Also the asset-liability (ALM) mismatch is one of
the major defects in the traditional business model followed by banks today which makes it
tougher for them to commit more resources towards financing infrastructure projects.

Most infrastructure projects require long term capital commitments ranging from 7 to 20 or more
whereas banks own source of capital ( i.e. deposits) tend to be of much shorter tenure ranging
between 1 to 5 years or less. There are also regulatory issues including of the overall exposure to
the sector and the credit risk rating of the asset which limits the ability of traditional banks to
commit capital. Alternate source of capital providers including of hedge funds dedicated to
investing in infrastructure sector as an asset class tend to prefer investing in liquid assets and in
most cases their exposure to the sector is limited to owning stocks or debts of listed utilities, toll
road operators, constructions companies, ports operators among others.

There is a strong need to diversify the source of capital base by making infrastructure an
appealing asset class to a wide range of investors especially when governments including of
developed as well the developing world are targeting infrastructure spending. Recently the
ministry of finance of India announced an initiative called Infrastructure debt fund as to way to
attract capital into the sector. This is a step in the right direction but having said that the proposal
doesnt address the core issue facing prospective investors when looking at infrastructure
financing opportunities. The government of India is targeting an investment of over US$ 1
trillion (around 10% of GDP) on infrastructure in its 12th five year growth plan for the country
and the expectation is that the private sectors share will be 50%. It is no doubt a highly
ambitious plan and through Infrastructure debt fund the governments objective is to facilitate the
flow of capital from public and private sectors as well as foreign investors into infrastructure
projects in India.

The government figures suggest that there is a funding gap of over US$ 135 billion and this is
based on the assumptions that there will be as much as 50% budgetary support for the planned
investment in its recently announced 12th five year plan and the policy & regulatory reforms will
mobilize over US $174 billion. Looking at the state of infrastructure in India and the balance
sheet strength of the local banks it is safe to say that in reality the funding gap may be much
higher than governments expectation. In the developed world, UK chancellor has earmarked
over GBP 30 billion in infrastructure spending in his speech delivered to the British parliament in
November of 2011. The UK treasury is hoping that two-thirds of its earmarked for infrastructure
investments will come from the National Association of Pension Funds and the Pension
Protection Fund. It is also seeking investments in infrastructure from insurance companies and
from China.
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 The United States will need to spend over $2.2 trillion on updating and developing infrastructure
assets across the country over a period of five years to meet the current needs and around $1.1
trillion of the overall spending would be new. This is according to the American Society of Civil
Engineers (ASCE), and while private sector is expected to make its contribution most of the
heavy spending will have to come from the government as evident from the previous spending
on infrastructure in the US. The Congressional Budget Office figures suggests that the federal
government, state and local governments spent over US$ 312 billion in 2004 on just water and
transport infrastructure in the United states with very little contribution from the private sector.

The current state of the global economy makes it extremely difficult for infrastructure projects to
get funded. In markets like China banks are over exposed to the sector by lending to local
government financial vehicles (LGFV) and most local governments are sitting on bad projects
that arent making money and have also created overcapacity. There is also a lack of an efficient
and developed secondary market for infrastructure loans in emerging market economies
especially in countries like India, making it difficult for both public and private sector banks to
refinance their loan books and in most cases the banks are as the end users of credit by holding
the asset on their balance sheet until maturity therefore becoming super exposed to the sector and
minimizing their ability to grant more loans. Also Indian banks have recently been running a
daily deficit of over INR 1trillion per day for the past few months causing a systemic liquidity
deficit in the banking system further limiting their ability to commit more capital to the sector.

Considering the above, Infrastructure debt fund (IDF) initiative of the ministry of finance of
India does sound like an idea whose time has time come as it proposes to offer banks a platform
to help refinance their existing loan book and by means of credit enhancement also be able to tap
into low cost long term funding sources including of Insurance and pension funds. Having said
that Indian banks will be competing for capital with their peers and there are no guarantees that
foreign pension and insurance funds will pick Indian infrastructure assets over others. Money has
no nationality and most investors will need to understand the structure better before committing
capital. According to the public information released by the ministry of finance of India, the
proposed IDFs will either be formatted as a mutual fund or a non bank financial company under
modus operandi set out by the regulatory agencies including of SEBI and RBI.

Although the case for IDFs has merit going forward the structure will have to evolve
incorporating the realities of the market. Besides IDFs other plausible long term, simpler and
sustainable solution will be for banks to set up their own independent infrastructure investment
companies or in a consortium with credit guarantee agencies, construction & development
companies, Institutional investors, regional development banks, multilateral agencies, utilities
among others. As the promoter of the Infra Investment Company (IIC) banks will inject their
existing infrastructure assets and loan books along with the cash flows (from the projects) into
the balance sheet of the company and other founding partners will provide seed capital (in cash
equity) of around 10% to 15% of the assets held by the company in order to secure a strong
rating and valuation. The Infra Investment Company (IIC) will have fixed and guaranteed
revenue stream coming from existing infrastructure assets it owns and it will be relatively easier
for such a company to secure a credit loss insurance cover on its pool of revenues further
protecting its cash flow.

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CONCLUSION

To access a diversified pool of investor base the IIC could do dual listing in local and foreign
markets, issue bonds in local as well as foreign currency supported by its balance sheet and the
strength of its credit rating. It can also act as a platform to deliver infrastructure related credit and
assets to end users including of pension and insurance funds. Also through the IIC institutional
investors such as pension and insurance funds could commit new capital into the sector removing
the need for them to hire a fund or portfolio manager to manage their investment in the
infrastructure sector across various asset class. Infrastructure assets are a vital support pillar of
any economy and though some investors may consider the sector boring, good Infrastructure
investments does create a positive cycle of growth, providing essential networks and services,
stimulating economic growth and improving the standard of living for current and future
generations.

Also the investment in the sector tends to be less volatile than any other publicly traded
securities. Although the Infra structure Investment Company may not address all the existing
issues in the sector but by adopting a flexible strategy the IIC should be able to tap into a wide
range of funding pool including of retail equity investors, institutional investors, sector focused
investors among others. It provides an opportunity to Investors who in principle do like
infrastructure but are reluctant to buy into it because of the lack of liquidity that comes with it.