Developers may support projects that have long-term economic value instead of propping up all projects to please banks
Srinivasan Nandakumar
The government?s ambitious $1 trillion target for infrastructure investment in the 12th Five-Year Plan has many interesting dimensions to it. While clearly the quantum of investment envisaged is huge, it would also appear essential given the country?s massive shortage of adequate and quality infrastructure?be it in transportation or energy or different components of urban infrastructure.
From an economic strategy perspective also, channelling investments into the sector holds immense potential to galvanise the present phase of sluggish growth. However, the push for investments into infrastructure projects comes at a time the sector itself is in the throes of acute stress.
Anecdotal evidence suggests that bank funding for new projects has practically dried up or, at the very least, considerably slowed down. There has been a virtual pendulum swing–from an environment of extreme eagerness to fund to a near-complete freeze.
Equity markets?both public and private?also seem to have lost interest in the sector. The current stress?resulting in some payment defaults and forced restructuring of loans?has been brought about not only by external factors (e.g., delays in land acquisition and environmental permits) but also by an inadequate appreciation of the risks inherent in funding infrastructure projects, coupled with sub-optimal financial structures (e.g., inadequate provision for contingencies, absence of or inadequate reserve accounts, etc.).
India Ratings continues to have a negative outlook for infrastructure projects as a whole in India. The agency expects a further intensification in many previously identified macroeconomic challenges, including equity capital constraints, high interest rates, slowing GDP growth and currency depreciation, and sector-specific stresses, including fuel (coal and natural gas) shortages, weak off-takers (power distribution utilities in many states), execution delays for power and prospects of slowing traffic growth for transportation.
Project sponsors? inclination to extend non-contractual support to projects funded on a non-recourse basis has somewhat cushioned the extent of stress. However, given their stretched balance sheets, sponsors will struggle to raise funds for a growing number of construction projects and support under-performing assets, largely because stock markets remain weak and volatile. This may force developers to selectively support projects that have long-term economic value in contrast to their earlier strategy of attempting to preserve vital bank relationships by propping up all projects. Such a scenario could trigger more project loan defaults or necessitate debt restructuring programmes.
Although interest rates appeared to have peaked earlier in the year, financing costs for individual projects have not fallen by as much as was widely expected by issuers, thus exacerbating strained cash flows.
So, is it all gloom and doom and is it the end of the Indian infrastructure story? Not quite. On the contrary, given the infrastructure deficit facing India, the long-term economic viability of several projects is strong. For the sector to capitalise on this strength and present itself as a sustainable and attractive proposition in the eyes of investors and lenders, two critical areas have to be addressed.
Firstly, the government must expeditiously act on the policy and regulatory fronts to remove bottlenecks in project execution and operation and ensure that committed investment is not jeopardised by uncertainty. Secondly, the different stakeholders must learn from their past mistakes and conceive financial structures that adequately address risk upfront.
Some recent measures taken by the government are noteworthy. The reform-linked restructuring package for power discoms and the attempts made to get Coal India to sign fuel supply agreements are major steps. However, the key will lie in the speed with which these announcements get translated into concrete action. Of course, some problems such as the weak financial health of the power utilities are structural in nature and do not lend themselves to quick, short-term solutions.
The guidelines for setting up infrastructure debt funds, as also the partial guarantee product introduced by India Infrastructure Finance Company Ltd, to credit enhance projects could fuel interest from bond market investors and provide an alternative financing avenue to the sector.
In order to create significant and sustained investor interest, it is vital that the government, in its pursuit of the PPP model, frame laws and regulations that aim to strike a balance between the sometimes inherently contradictory proposition that public infrastructure (with numerous stakeholders) represents delivery of an essential public good or service versus the private sector?s expectation of a reasonable rate of return.
Investors can live with risk but would shy away from uncertainty. Independent, empowered regulators functioning within the ambit of a transparent legal framework and a smooth contract enforcement regime will address this concern to a great extent.
Simultaneously, it would be necessary for project developers, financiers and advisers to pay close attention to adequate risk mitigation during the stages of bidding and achieving financial closure before beginning construction.
Investment in thorough due diligence?of the various factors that could affect the success of a project and their likely financial implication?is vital. Revenue forecasts must be based on conservative assumptions and should take into account a certain level of volatility occurring over a long period. Contingency provisions and reserve accounts must be sized to provide sufficient cushion against downside scenarios. Capital structure must not be heavily geared unless it is possible to stretch debt maturities really long; where debt is front-loaded, amortisation needs to be sculpted to reflect the cash flow profile of the project. Construction and debt draw down should not commence until all conditions precedent ? including land, permits and factors of production (example: fuel for a power project)? are firmly completed.
In short, it is vital that a comprehensive risk management framework precede the actual investment in infrastructure projects rather than adopt an attitude of: ?let?s make the investment and address risk as we go along?.
The author is senior director-global infrastructure & project finance group, India Ratings & Research
