“India is a big market; it has great opportunities and huge infrastructure needs. But, in general, [infrastructure] hasn’t been a great performing asset class for either domestic or foreign investors over the last five to 10 years,” says Mark Austen, chief executive of the Asia Securities Industry & Financial Markets Association, the trade body.
Banks have traditionally been the major source of debt financing for infrastructure in India, contributing up to 85 percent. However, they face an asset/liability mismatch as they try to finance long-term loans with relatively short-term deposits, and their ability to effectively appraise infrastructure projects has also come into question, with large parts of such portfolios currently under stress.
The government is turning to insurance and pension funds to plug the gap and is targeting 25 trillion rupees ($3.7 billion; €3.3 billion) of infrastructure spending over the next three years, of which half is expected to be financed through public-private partnerships.
However, few foreign investors have taken the bait, despite GDP growth forecast to reach 7.5 percent this year, according to Macquarie.
“The track record of Indian infrastructure projects over recent years has not been very good,” says Austen. “Many of them are delayed or they have had difficulties with approvals or even corruption issues. When you are asking foreigners to come in and invest, obviously they do their due diligence. With what is currently a poor track record, even if the project looks quite good, they will hesitate about investing.”
Equis is one of the firms ready to take on the challenge, with plans to establish a non-banking financial company (NBFC) within the next 12 months to finance infrastructure debt projects in India. The fund manager was founded in 2010 as an Asian energy and infrastructure specialist and has more than $600 million in assets under management and 230 staff in the country.
“Construction risk comprises a unique set of risks and certainly, in India, the longer the construction period the greater likelihood of adverse outcomes,” says chief executive David Russell.
EY estimates that 189 projects involving a total investment of 1.8 trillion rupees are stuck due to problems with land acquisition, forest and environmental clearances, non-transfer of defence land, and hurdles in approving rail over-bridges.
Khushru Jijina, managing director at Piramal Fund Management, the Indian asset manager, is aware of the issues. His firm teamed up with Dutch pension fund APG Asset Management to invest $1 billion in Indian infrastructure companies in 2014 and signed a $1 billion memorandum of understanding last month with Bain Capital that also looks partly at infrastructure debt in India.
“Although risks are significantly mitigated once the project is operational, infrastructure debt funding is largely non-recourse or at the most has limited recourse. Consequently, any shortfall in actual operational performance vis-à-vis projected performance can cause issues,” he says.
Operational risk in infrastructure varies from sector to sector. Many toll roads are making losses because traffic levels have been 20-30 percent lower than builders’ initial expectations, according to Indian research firm ICRA.
Such volume risk is difficult to estimate because the amount of traffic can be dependent upon commercial developments and political uncertainty. The ban on iron-ore exports in Karnataka has hit the revenues of New Mangalore Port and South Western Railway to the tune of 21 billion rupees.
Currency is also an issue. Most infrastructure debt in India is denominated in rupees, says Austen, and investors are taking significant exchange rate risk by investing in the local currency. Hedging, meanwhile, is an expensive and potentially uneconomic strategy.
But, amid the uncertainty, some infrastructure sectors in India are doing well, with experienced investors, such as the Asian Development Bank, finding their way into the market.
The bank has around 50-60 percent of its total infrastructure debt in India in renewable energy. It is planning to put another $500 million-$600 million into infrastructure debt next year, with approximately $400 million going into renewables.
“Right now it is really happening in renewable energy projects, especially wind power and solar power projects. That’s where the bulk of our activity is, because these are the projects that are very well structured in terms of the risk and return profile.
Plus, they are consistent with what ADB wants to do and there is a lot of activity in this sector,” says ADB’s Mayank Choudhary, senior investment specialist, private sector operations department.
Choudhary thinks renewable energy differentiates itself from other infrastructure sectors because investors are entering into a long-term proprietary agreement and face little or no market risk. They also get a defined tariff and consistent revenues.
Construction risk is also much lower in renewable energy projects because there is limited environmental, land acquisition and execution risk. The sector also benefits from government efforts to encourage private investment by removing key risks. One example is the success of Narendra Modi’s government in the solar generation sector and the mitigation of land and off-take credit risk.
And while banks struggle, the door is open for firms like Equis. “Traditional lending banks have been slow to follow the government’s lead and therefore opportunity for private investors awaits,” says Russell, who has seen his firm borrow more than $200 million with 14- 17-year tenors from NBFCs instead of local banks in India.
So while the roads await their drivers and until airports are cleared for take-off, investors hope that India may begin to live up to expectations. But there is still a long journey ahead. “[India] needs to accept international practices and understand what drives international investors to invest in countries. Whenever you need to provide funding for an asset, there has to be a market return for the risk incurred,” says Austen.