Battered infra dream awaits a new deal

“I had to use the company’s free cash reserves last year to pay workers. For us, this is like selling the family silver," the contractor, who requested anonymity, said. Meanwhile, the firm’s interest coverage ratio—a measure of its ability to repay lenders—has plummeted since 2019.

“I know state governments are starved of funds, but they must properly prioritise spending if resources are scarce," he said. “In Telangana, the government demolished its old Secretariat building last year and is spending over ₹1,200 crore to build a replacement. This is while contractors like us are not being paid. Our credit cycle has increased from three months earlier to up to five months now."

Given the quagmire that many private infrastructure firms find themselves stuck in, expectations of redemption via the upcoming Union Budget are quite high. The worries, and hopes, hinge primarily on financing—whether or not money will flow from the Centre to states and government agencies; to banks; and onward to under-construction projects and the bank accounts of private contractors.

“We shall definitely sustain the momentum of public spending in infrastructure," Union finance minister Nirmala Sitharaman had assured the industry back in December. “Because, that is the one way we ensure that the multipliers will work, and the economy’s revival will be sustainable." Whether those promises turn into reality will be keenly watched in the days ahead.

Slowing capex

The government, in fact, already has a massive five-year infrastructure spending scheme in place—the National Infrastructure Pipeline (NIP), which is supposed to run from 2020-25. The NIP proposes an allocation of ₹111 trillion across both physical and social infrastructure and the finance minister even launched the India Investment Grid website last year in order to give real-time progress reports to infra companies, investors and industry analysts.

Last October, Mint has reported how the NIP dashboard is riddled with inaccuracies and inflated project costs, all in order to just meet the ₹111 trillion target. Only one in five projects is even ready to be tendered out. Since then, the public funding crunch unleashed by covid-19 has only slowed down the NIP further.

About half of the funding for the NIP is meant to come from the central and state governments, and spending was projected to rise 10% every year. “Due to covid-related stress on government finances, many are now not in a position to spend on infrastructure," said Rajeshwar Burla, vice president of corporate ratings at credit ratings agency Icra and an infrastructure sector analyst. “Covid has slowed the NIP down by at least two years. So, you find construction contractors facing serious funding constraints. This is true particularly in Andhra Pradesh, Telangana and Madhya Pradesh. Maharashtra earlier made an announcement about curtailing the spending outlay on infrastructure to 67% of the budgeted amount."

This near collapse in public funding, especially at a time when India is striving to capture a slice of the global supply chain through its China+1 gambit, could have worrisome consequences. A brisk pace of growth in government capital spending directly contributes to a steady economy. The opposite has been happening in the first two quarters of this fiscal.

Despite the finance minister announcing a ₹25,000-crore stimulus in October, actual spending dropped by a further ₹1.6 trillion in the second quarter over a disastrous first quarter. Without the government building new highways, railway lines, power distribution and water supply networks, the private sector has little incentive to invest in boosting its capacity.

In a typical year, state governments spend twice as much as the Centre does on capex. For FY21, state governments had planned a combined capital expenditure of ₹6.46 trillion, according to the Reserve Bank of India’s report on state finances. States had aimed to reduce revenue expenses (such as salaries, pension, interest payments) and raise capital expenditure, mostly in social spending like education, water supply and sanitation, rural and urban development.

But months ago, the Reserve Bank of India (RBI) cautioned actual capex could collapse. And that expectation has played out. Average monthly tenders for infrastructure clocked ₹74,500 crore in FY19 and fell to ₹43,000 crore in FY20. FY21, so far, has registered about ₹60,300 crore a month, but the average isn’t rising fast enough to make a difference.

Bank credit dries up

Instead of turning open the public funding tap, the government could opt to take the build-operate-transfer path—meaning, its own finances may not be immediately required in order to prop up a project. Some other institution will then have to lend to get things off the ground, but banks seem to be in no mood.

“It’s fair to say that the banking system, in general, was deeply impacted by the previous cycle of infra building," Rajiv Anand, executive director (wholesale banking), Axis Bank, told Mint. “While it is important for us to create infrastructure, the first level of risk will have to be taken by the government. The banking system does not have the project finance appetite to take on large infra spending, which comes with execution and regulatory risks. So, the first flush of money needs to come from the government and as the project becomes bankable, these could be refinanced by the banking system."

Banks are going to be even more wary in the months ahead as the six-month covid-related regulatory forbearance period—an extended moratorium for businesses and individuals—has veiled the extent of financial instability. The RBI says bad loans could rise to a 20-year high by March once the moratorium lifts. Banks are simply not going to take on new project risk at a such a time, except for a few notable exceptions.

Look at the roads sector, Axis Bank’s Anand said. “One of the reasons why new road projects are still regularly taking off is because the NHAI (National Highways Authority of India) has introduced new financing models like hybrid annuity (where the government, banks and the private developer all put in money). Thanks to this, banks are amenable to taking on risks in road projects. In water supply or urban infra, you have to create new financing models for banks to be interested."

Ms.Sitharaman, it would seem, has little choice but to spend her way out of this crisis. How much would be enough though? In 2019-20, states spent a combined 2.9% of GDP on capex, while the Centre spent 1.6%. Govinda Rao, a public finance expert and a former Finance Commission member, believes that in 2020-21, states’ aggregate capital expenditure would fall to just 1.5% while the Centre’s would hold steady at 1.5%. “The states’ capital expenditure will have to go back to the 2.5% mark to give the economy a fighting chance to grow," Rao said. This means the Centre will have to spend more on its own and also transfer more money to the states so that they can spend as well.

Reviving DFIs

Another possible workaround to the problem of scarce government funding, and one that’s quickly gaining favour among commentators, is the creation of a new development finance institution (DFI). There are a couple of reasons why this seems possible at the moment. One, it is built into the NIP as a possible new funding source and two, financial services secretary Debasish Panda hinted during the course of a media interview in December that a new DFI is in the works.

DFIs are relics from pre-liberalised India, used to route domestic savings into patient capital for infra projects. A DFI’s loan period can last close to a decade, allowing it to wait till a project is financially sustainable to repay, unlike a traditional commercial lending that needs to be fully repaid in three to five years. With DFIs losing favour since the 1990s because of corruption or bureaucratic red-tape, large ones—notably IDBI and ICICI—turned into banks.

In 2015, the Modi government created the National Investment and Infrastructure Fund (NIIF), an infrastructure investment platform for the domestic and global investors. But given its commitment to investors to earn returns, the NIIF’s investments are few and far between and they are yet to place any big bets on large greenfield projects.

“DFIs can typically leverage on their equity up to 9-10 times, much like an NBFC," Burla of Icra said. “So, if the government injects ₹20,000 crore into a DFI, that’s one way to raise about ₹2 trillion through debt that can then be used to fund projects." Rao recommends merging the NIIF with the proposed DFI or converting NIIF itself into a DFI in order to avoid creating too many lending/refinancing institutions.

Yet another recommendation doing the rounds is a swifter sale of public assets, whether it is through the disinvestment route (LIC, BPCL) or by recycling asset ownership to the private sector in order to raise funds.

In this, the NHAI can teach a thing or two to other government agencies. The agency debuted its toll-operate-transfer (TOT) model in 2016, which allowed investors to make a one-time payment to win toll collection rights on public highways for 30 years. “I’m sure there are assets to monetise in power transmission, gas pipeline, and oil storage too," said Suresh Goyal, MD and CEO of NHAI’s Infrastructure Investment Trust (InvIT).

“Global investors are looking for stable yields from operating assets and we have a large quantity of such assets available. But because this is commercial capital, assets should have the pricing power to generate a return on investment. Asset classes where the pricing is subsidised are harder to monetise," he added.

The reason roads are a bright spot within the public infra space is because of the huge funding liabilities that the NHAI has taken on its own balance sheet, and not the government’s. Awards of road projects jumped 111% to 6,764 km in April-October 2020 despite rising covid infections. This aggressive pace has pushed the NHAI’s projected total debt to ₹3.5 trillion by FY23 compared to ₹75,385 crore in FY17, rising 4.5 times in a five-year period. Once the bills come due on the projects it is now contracting out, the NHAI will need massive budgetary support as well.

For now, the former Finance Commission member Rao recommends a simple approach: lowering one’s sights and focussing on a list of infra projects that are already under implementation. A December report from the ministry of statistics and programme implementation showed cost overruns of ₹4.34 trillion in a fourth of the 1,671 ongoing infra projects it studied.

“There are too many (projects) stuck in implementation now," Rao said. “But ultimately, the Budget is a political document. And there are always constituencies seeking new projects."