In the 12th Five-Year Plan, the Planning Commission of India has identified an infrastructure investment requirement of $1 trillion. The government of India alone cannot fund this requirement and it has to depend on the private sector either directly or through public-private partnership (PPP) initiatives to help finance nearly half of the investment needed. While government policies support the PPP model to meet the funding deficit, the bulk of private-sector funding for the PPP projects are through project financing by scheduled commercial banks, which on an average varies from 70-85% of their debt requirement.

In recent times, asset-liability management issues and liquidity constraints because of lending limits have had a negative impact on the liquidity of the project finance market. Medium-to-long term lending remains an unattractive proposition for many banks. Additionally, with the advent of Basel III global banking norms which include applying a high-risk weighting to long-term lending, however well structured, the situation is unlikely to improve.

Commercial bank financing supplemented with government support in the form of viability gap funding, soft loans, revenue shortfall loans and funding from multilateral financial institutions, export credit agencies and agencies and funds such as India Infrastructure Finance Co. Ltd and India Infrastructure Project Development Fund provide significant liquidity to the infrastructure financing market. However, these financing options have not been able to bridge the gap. Further, several PPP infrastructure projects have not been able to get off the ground and attain financial closure because they have not been deemed bankable.

Unlike in India, where there are several barriers to accessing the bond markets, long-term debt in developed markets is provided by bonds such as corporate bonds for infrastructure projects. Under these circumstances, we need to study the barriers to accessing the debt capital markets for project financing and provide solutions to overcome these bottlenecks.

Barriers to accessing the debt capital markets

The long-term infrastructure financing market needs natural long-term institutional investors such as pension funds and insurance companies, who seek diversified assets to match long-term liabilities. The scope of investments by such institutional investors is, however, limited by regulations.The significant challenge is in the credit rating requirement as the cash-rich pension funds and insurers can only invest in assets with a credit rating of AA or above (and A+ with special approval). Project financing involves greenfield projects and the significant level of construction and delivery risk restricts the ability to achieve a high credit rating (lowest investment grade or above). Also, since most of the infrastructure projects are implemented through special-purpose vehicles they are unable to get a credit rating of AA or higher at the pre-commissioning stage.

Thirdly, debt-market issuances by corporates are constrained by detailed primary issuance guidelines. Additionally, the corporate bond market is a largely private placement (93% of total issuance in 2011-12) driven market. Public issues are difficult, slow, expensive, risky and inflexible with the issue process taking several months compared to other markets where the process takes a few days (for example with shelf registration).

Way forward

A coordinated effort is required from the government, Reserve Bank of India, Securities and Exchange Board of India and Insurance Regulatory and Development Authority (IRDA) to create a vibrant bond market. Introducing a suitable mechanism for credit enhancement enables corporates with lower credit rating to access the bond market. Further, some structure for partial credit enhancement could be considered, for instance the Asian Development Bank’s (ADB) first of a kind $128 million facility developed with India Infrastructure Finance Co. Ltd (IIFCL) under which ADB and domestic finance companies will provide partial guarantee on rupee-denominated bond issued by Indian companies to finance infrastructure projects. This will boost the credit rating of a typical infrastructure project from BBB minus or A to AA.

Insurance companies have an estimated $300 billion of cash to put to work, while pension funds have an addition $30 billion. To gain access to these investments for infrastructure projects, there is a need to revisit the investment guidelines of institutional investors and restrictions must be relaxed.

There is also an urgent need for rationalization of stamp duty across states by introducing a standard national rate with a maximum cap. Further, the government could work at reducing or exempting stamp duty on debentures issued for infrastructure projects.

An effective and efficient bankruptcy regime is essential for development of robust debt market from the investor’s point of view. Reforming the laws, early resolution of debt recovery cases and streamlining insolvency procedures will go a long way in achieving investor confidence.

Finally, banks and financial institutions (42% of total issuances) followed by finance companies (26.4%) were the major issuers in 2011-12. To finance urban infrastructure requirements, municipal bonds issued by urban local bodies (ULBs) may be explored as an important source of financing. ULB issuances (around 25 since 1997) are, however, minuscule. The municipal bond market needs to be developed by providing a robust regulatory framework and possibly, tax-free status. The IRDA and the Pension Fund Regulatory and Development Authority’s investment guidelines in this regard should be reviewed.

Hemant Sahai is managing partner and Anjan Dasgupta is a partner at law firm HSA Advocates. The views are personal.

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