FINANCE

India needs $4.5 trillion for infrastructure development in the next 25 years, but who can fund?

India needs infrastructure to grow, but there’s hardly anyone to fund it. 

Over the years, banks — the largest financial intermediaries — have slowly begun to withdraw from the segment after poorly structured financing, corruption, regulatory loopholes and judicial interventions inflicted losses that have held them back for nearly five years. 

Alternative mode of finance — the bond market — is shallow and is yet to evolve, making it difficult for anyone with an idea to build a port or a power plant to find the financial resources. 

That has led to the contraction of investments’ contribution in the gross domestic product growth to 29.2%in the second quarter ended September 2018, from 38.69%in 2012-13, when the growth engine was kept humming with huge credit from the banking sector. 

The outstanding bank credit to the infrastructure sector which was at Rs 9.85 lakh crore in March 2016, after compounding an annual 39% for 15 years, fell to Rs 8.9 lakh crore in last fiscal as banks turned averse to infrastructure lending. 

“Form a CASA (current account savings account) perspective, if infrastructure becomes a large part of a bank’s exposure, there are chances of asset-liability mismatch,” says Ramraj Pai, president at Crisil, a unit of Standard & Poor’s. Asset-liability mismatch arises if banks take oneyear deposits to lend for five years. 

One of the reasons for banks’ infrastructure loans turning bad was that they mobilise one-year, or even shorter-term deposits for building power and road projects that took five years to build. This kind of funding became unviable for the projects and unjustifiable for banks. 

Who could fund India’s future? Insurers could be the answer. 

While funds that are lying with both banks and mutual funds — which form 48% of household savings with the financial services industry — are of short term in nature, it is the insurance companies which own funds for nearly two decades as individuals save for their retirement. 

“There is a definite win-win situation if investment becomes a bit more open,” said Vineet Arora, chief executive at Aegon Life. “There is a mandate of putting money into infrastructure. If we get freedom to choose and increase the limit into infrastructure…. It is good if we can get a paper of 20-30 years, whether it is infrastructure or government securities. It helps us design our asset liability and that is why you see insurance companies globally being big investors in infrastructure.” 

But that needs a sea change in the way the regulator looks at projects, especially the ones that take years to begin payments. 

INVESTMENT RULES 
Insurance companies, which are custodians of the nest egg of millions of middle class men, are guided by the rules laid down by the Insurance Regulatory & Development Authority of India (IRDAI) where prudence takes precedence over returns. 

The IRDAI stipulates that life insurers invest 50% in government bonds, 35% in other approved securities and 15% in infrastructure firms. It prohibits companies from investing in bonds rated below AA. 

That makes a substantial portion of the bonds outstanding in the market as no-go area for insurers. As far as top investment grade bonds are concerned, there are hardly any infrastructure companies. How does one solve the issue where one segment is crying for fund and the other that has it in plenty is unable to lend? 

The regulator needs to relook at its investment guidelines. 

“A combination of more sophisticated oversight to make sure that risks are not building up in the insurance sector, plus a greater degree of liberalisation has to happen because at the end of the day an insurance company is an asset manager,” says Jaideep Khanna, head of Barclays, Asia-Pacific. “As the insurance sector becomes more sophisticated, they should be offering different kinds of products and provide capital to fuel the growth of the country.” 

While there is a need for making long-term funds available for long gestation projects, there is inherent worries about these projects and the returns associated with them. 

“Many infrastructure loans that have turned sour have been covered by government guarantees,” said J Hari Narayan, the former chairman of IRDAI. “The government has not delivered on its guarantees. Banks can’t take on a government after it fails to honour the guarantee.” 

ALL INFRA BAD? 
Wild swings are part of the markets. Banks are no exceptions to exuberance and depression. The publicprivate partnership was peddled as the panacea for Indian infrastructure. 

That led to influence peddling to win contracts that paid for generations without much equity. This led to excessive leverage that, in many cases, resulted in a company having a debtto-equity ratio of 10 times or even more. Furthermore, a large scale siphoning off of funds too made many projects unviable. 

“We need to get the project appraisal done the right way,” RBI deputy governor NS Vishwanathan had told industry in 2016, when bad loans crisis had crippled banks. “Pricing of the loans should be commensurate with risk.” 

Apart from unviable projects, the poor funding structure added to the woes. 

A successful infra project could be like that of the Mumbai-Pune Expressway, that was conceived in the 90s and commissioned in 2002. Despite cost overruns, it was completed for Rs 1,630 crore. Sixteen years later, the project is being bid out at Rs 9,000 crore for another 15 years of toll collection. 

Roads and other infrastructure assets may not be viable at early stages, since they do not generate much cash to service debt, but in the long run most of them turn viable with financial engineering. 

Canary Wharf, the world’s biggest financial district in London that sank Paul Reichmann’s Olympia & York, is a testimony to how infrastructure projects even after going kaput can come back to life with increased economic activity. 

NEED TO CHANGE 
On paper, the regulator has mandated insurers to invest 15% in infrastructure. But the purpose is getting defeated in the absence of relaxation of rating requirements for investments. These firms invest in AAA-rated infrastructure bonds. Most of the target is met by lending to government-owned infra financing companies like REC, PFC and IRFC making a mockery of the intention. The definition was expanded in 2012 to include housing finance companies, one of the  .. safest segments for infrastructure exposure. 

“For private insurance companies, taking credit risk is hard,” said Prashant Tripathy, MD and CEO, Max Life. “If any project goes bust, the insurance company will go bust.” 

The average under-construction project is rated BBB, which insurers can’t buy into. Once a project is complete and starts generating cash, the rating automatically gets upgraded, but begins to yield less and leads to a missed opportunity to own a higher yielding paper. 

India needs $4.5 trillion to be spent on infrastructure developments over the next 25 years, estimates the latest Economic Survey. 

In fact, rating companies proposed a different rating scale for infrastructure firms based on likely recovery of dues over the life cycle of a project by factoring in the possibility of refinance or restructuring. This would be on the scale of EL 1 to EL 7. But IRDAI is yet to take a call. 

One way to begin could be with government beginning a ‘risk fund’ that could comfort the insurance regulator in relaxing the rules. 

“The government should create a huge risk fund, which can be offloaded to pension and insurance funds when the date of commissioning is decided,” says Narayan. “Insurance companies do not take the initial risk as they are not designed to take risks of that magnitude unless it is properly shielded.” 

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