India’s complicated infrastructure story
The boom in the sector over the last decade led to mistakes of excess and reckless optimism that have come home to roost
It was in early 2004 that the State Bank of India posted me to the strategic business unit (SBU) for project finance. The mission was to set up a number of project appraisal teams which would help the bank capture the upcoming large financing opportunities in the infrastructure sector as also greenfield industrial projects. This was a time when the reforms unleashed from 1991 onwards, as also the investment direction shown by the Rakesh Mohan Committee, started to show up in the form of sustained high GDP (gross domestic product) growth rates averaging CAGR (compound annual growth rate) 8.5%. The media was full of catchy headlines about the India story, the India century, India versus China, India’s imminent entry into the ranks of the global A-listers, the future belonging to the Brics nations and so on.
The Planning Commission had begun to set out ambitious outlays for the infrastructure sector in the five-year plans (FYPs). These went up from $220 billion for the 10th FYP to $500 billion in the 11th FYP and $1 trillion in the 12th FYP with private sector contributing 20%, 30% and 50% of the resources under the public-private partnership (PPP) rubric, respectively. In the absence of large term-lending institutions as also the lack of an active corporate bond market for raising cheap long funds, banks had opportunities to provide large-ticket loans to corporates and their special purpose vehicles. Many of the promoters who entered the infra arena were first-timers with excellent execution capabilities but equally limited capital.
While most term funding in banks is done on a debt-to-equity ratio of 67:33, in the case of infrastructure projects, the norm was 70:30, in line with “international” practices. Subsequently, on many an occasion, this was tweaked to 80:20 based on, inter alia, perceived attractive project viability parameters—but more proximately, bargaining skills of the project promoters vis-a-vis banks. With an almost lemming-like instinct, many private equity investors, anticipating the upswing in economic fortunes, jumped on to the infra bandwagon by supplementing the margin requirements of promoters. Given the upbeat, increasingly competitive mood in the country and the entrepreneurs’ desire to grab all possible opportunities, the latter not only started to bid very aggressively but also began gold-plating the projects with exceptional increases in costs which were duly certified by big-name technical consultants to meet the lenders’ requirements. For example, in January 2004, when I joined the SBU, a kilometre of road construction costed approximately Rs4-5 crore but by late 2007, the justified costs had gone up to Rs23-29 crore per kilometre.
These were early years for banks in infra-financing. Term lenders like IDFC had highly knowledgeable officials (who in fact, gave me many a valuable lesson on the subject in my early months in the SBU) but had little appetite for the loans. Hence, banks rapidly grow their loan books, often hitting their sectoral and group exposure limits. New concepts were introduced by the banks, like cash sweep to reduce the long tenure of the loans and improve the asset liability management mismatch in case projects achieve better than estimated cash accruals; perpetual part debt in airport financing in recognition of its capital-intensive nature and need for regular replacement capital expenditure; take-out finance (which never took off—even in later years following a renewed effort by the India Infrastructure Finance Co. Ltd due to zero/undefined incentive structure for the risk holders). SBI signed a memorandum of understanding with the Life Insurance Corp. of India for take-out financing with much fanfare in 2005 but it died a premature death as the bank was unwilling to make an interest sacrifice (on the back of very low prevalent interest rates) in favour of LIC.
The meltdown in the financial world of the Western economies carried over to the real sector in developing economies, like India. The concomitant political imbroglio at the time also resulted in decision-making suffering with important time-critical issues being put on the back-burner. Government machinery got sucked into handling the fallout of large scams unearthed by the Comptroller and Auditor General in the telecom, thermal power (coal) and road sectors. The result was a plethora of incomplete projects where promoters did not have the wherewithal for last-mile execution. Interestingly, GAIL (India) Ltd and Coal India Ltd subsidiaries had provided many raw material supply contracts on “take or pay” basis, but their failure to provide the materials at predetermined rates to the extent required led to many power and some steel projects being stranded. The Vemagiri gas-based project in Andhra Pradesh was a classic example—a project was kept 95% complete for years on end to enable the lenders to classify it as a standard asset under a special Reserve Bank of India dispensation.
As they say, hindsight is always 20/20. The lenders funded projects based on the reasonable assurances of all stakeholders, including government agencies, of doing their part for the successful implementation of each project. Also, loan appraisals were based on what were considered to be realistic consultants’ assumptions, made against the backdrop of the encouraging growth trajectory.
The unravelling of the story caused by some of the factors mentioned above put paid to the promise resulting in huge stress on the portfolios of the banks. As a result, today the pendulum has swung to the other end with all lenders extremely shy of entering the segment again, and taking recourse to well-collateralized loans like home loans, property loans, etc., to register the anemic growth in their asset portfolios. So the infrastructure story today is one where the Union government is playing a pivotal role using its resources for execution of new and stalled projects with the help of engineering, procurement, construction contractors and, to a limited extent, relying on a hybrid version of the PPP model. Will history repeat itself? Only time will tell!
Ashwini Mehra is a former deputy managing director of the State Bank of India.
Comments are welcome at firstname.lastname@example.org