Overview of Indian Infrastructure Sector

Investment in Infrastructure development is a key enabler for sustaining the growth momentum of the emerging economies like India. The strong growth of the Indian economy over the past two decades has been possible primarily because of growth in Infrastructure linked investment. These investments grew from 5% of GDP in the Tenth Five Year Plan period (2002 – 2007) to 7% of GDP in the Eleventh Five Year Plan period (2007- 2012). In absolute terms, the total actual investment in infrastructure during the Eleventh Five Year Plan period stood at INR 27.29 trillion which was about 94% of the budgeted amount. The Infrastructure investment target for the Twelfth Five Year Plan period (2012-2017) is INR 30.94 trillion, which is an increase of 13.4% over the Eleventh Five Year Plan period and is projected at 5.71% of the GDP over the this period. The trend of investment in Infrastructure sector during the Eleventh and Twelfth Five Year Plan period is depicted below:


Source: Planning Commission, Government of India

Alongwith the increase in Infrastructure investment, the share of private investment in total Infrastructure spend which stood at 36.9% in the Eleventh Five Year Plan is also projected to increase to 39.2% during the Twelfth Five Year Plan period.

Financing Indian Infrastructure Sector – Current Scenario

In line with the usual funding pattern for Infrastructure projects, about 2/3rd of the investment by the private sector is estimated to be debt funded, which would significantly increase the demand for long term Infrastructure debt in the coming years. Historically, a major portion of debt funding for Infrastructure projects has been through commercial banks and specialised Non-Banking Finance Companies (NBFCs focussed on infrastructure finance. The NBFCs in turn primarily depend on bank funding for meeting their funding requirements. The source of infrastructure debt financing in India is depicted in the chart below:


Source: RBI, CRISIL and IL&FS IDF Estimates

As may be observed, historically banks have been the primary source of debt funding for the infrastructure sector. This reliance on bank funding for financing infrastructure has resulted in increasing share of infrastructure exposure in the overall mix of bank credit and consequently, higher concentration risks, as depicted below:

  Source: RBI

Going forward, the ability of banks to meet the financing requirements of the Infrastructure sector shall be constrained on account of the following key reasons:

  • Asset liability mismatch: Infrastructure projects typically require long tenor funding whereas the major funding source of banks, viz. bank deposits are of a relatively shorter tenor. The increasing exposure of the banks to Infrastructure sector is therefore resulting in an asset liability mismatch for the banking system, constraining their ability to meet the funding requirement of the Infrastructure sector.
  • Higher concentration risk: The share of Infrastructure in the total gross advances of the banking sector has shown a steady increase from ~9.7% in FY 2009 to over 14% at present, increasing the concentration risk for the banking system as a whole. Consequently, several large banks are close to the industry and borrower group exposure ceiling limits, thus limiting their ability to meet the future funding requirement of the Infrastructure sector.
  • Implementation of Basel III Regulations: The impending implementation of Basel III Regulations and the resultant additional capital requirement of the banks shall further restrict the incremental ability of banks to lend to the Infrastructure sector

In view of the above, given the importance of the Infrastructure sector in the economic growth of the country and the constraints in meeting the financing requirements from the traditional sources such as banks and NBFCs, it is imperative that effective steps are taken for channelling long term pools of capital from alternative sources such as provident and pension funds, insurance companies, etc. into Infrastructure sector

Financing Infrastructure Sector – Global Perspective

It has been observed globally, especially in the mature economies, that Infrastructure has emerged as an attractive asset class for investment by long term institutional investors seeking low risk, stable annuity like returns over a longer tenure. The long investment horizon and inflation-hedging characteristics of Infrastructure assets are well suited to large institutional investors with long term liabilities, such as endowment and pension funds, insurance companies, etc. As a result, they have emerged as significant investors in this asset class, as shown in the chart below:

Breakdown of Institutional Investors in Infrastructure by Investor Type (2015)

Unlocking Domestic Capital Pools
Traditional funding sources, such as banks and non-bank financial companies, are constrained by risk-aversion and regulatory considerations, which limits their ability to fund the infrastructure sector. Hence, there is a vital need to unlock alternative domestic pools of capital identified below. The nature of these pools is such that they are well-suited to assuming the risks and rewards of infrastructure funding.

Currently the availability of alternative domestic capital for infrastructure investment is almost negligible. This is detrimental, as more domestic capital will enable India to attract more global capital. Hence there is a need to unlock the following domestic pools:

  • Pension Funds (including EPFO) and Insurance Companies

The Investible surplus of Pension Fund and Insurance Companies corpus is projected to grow at a healthy rate in the upcoming years as depicted below:

Pension funds have long-term liabilities which need to be matched by long-term assets. They need to invest in a broadly diversified set of asset classes. In the U.S., pension funds began to invest in infrastructure in the late 1970s. Subsequently, pension funds in Europe, Japan, Malaysia, Singapore, South Africa and many other countries began to allocate a portion of their investible funds to the infrastructure sector. In several countries, pension funds are the dominant source of capital for infrastructure sector.

Similarly in India there is an urgent need for the Pension Funds to invest in the Infrastructure Sector

Insurance companies have long-term liabilities. There is also a time gap between receipt of premiums and the payment of claims. This gives rise to a substantial pool of long-term capital. Currently the insurance companies mainly invest in Government Securities and AAA rated bonds in the Debt Segment. Given the accretion of substantial funds during the year and a possibility to diversify their portfolio it is essential for the Insurance Companies to actively look to diversify their portfolio by allocating a substantial portion of their corpus in the Infrastructure sector.

  •  Charitable and Religious Trusts

Charitable & religious Trusts have been in existence in India for many decades. These are established for several purposes including building hospitals, educational institutions and the promotion of various social causes. These institutions are regulated under a variety of laws. Prudent cash flow and expenditure management of these organizations requires investing in a diversified set of assets.

Since these organizations have long term funds it would be beneficial for them to invest in long term assets like Infrastructure and help in nation building

Specialized infrastructure finance intermediaries - Infrastructure Debt Funds, Alternative Investment Funds – Infrastructure and Infrastructure Investment Trusts

Banks are facing huge asset liability mismatch due to funding of long term finance through short term deposits. Concerns have also been expressed about banks due diligence and credit appraisal of infrastructure projects. The Non-Performing Assets (NPAs) and the restructured assets in this segment have increased quite substantially of late.

Given the specialized nature of infrastructure PPP project structuring, due diligence and monitoring there is a need for specialized financial intermediaries/asset managers having the necessary skills and experience of making investments in Infrastructure assets

The Infrastructure Debt Funds provide an alternative financial intermediation mechanism for infrastructure financing and investment.  IDF’s makes debt investments in Infrastructure projects and companies. IDF’s also take out/re finance banks’ exposure to the infrastructure projects

The Category I Alternative Investment Fund (AIF) – Infrastructure provide an alternative platform to provide growth capital, structured debt and equity to the Infrastructure companies. AIFs are also tax pass through entities

Infrastructure Investment Trusts (InvITs) are created to aid/refinance infrastructure projects and help in un-locking tied up capital of promoters, lowering domestic financial institution’s loan exposure and attracting foreign capital

All the above three vehicles have the potential of generating attractive risk adjusted returns to an Investor on his diversified portfolio

Conclusion
It is now generally accepted that infrastructure projects require long term financing and life insurance and pension funds are the major sources of long term finance. Banks can at best be expected to provide short term financing during the construction period.

In view of the above, it is imperative for the government to provide requisite regulatory support by undertaking the necessary reforms such as removing the anomalies in the tax structure which act as a hindrance for the investors in making investments in Infrastructure sector through structures such as IDF/AIF mentioned above.   With a conducive regulatory environment and co-operation, the government can facilitate the flow of long term pools of domestic capital into the Infrastructure sector. Recently the Government of India launched the National Infrastructure Investment Fund (NIIF), which is a step in the right direction. Over a period of time, each of the above vehicles, viz. IDF, AIF and InvITs have the potential of becoming an attractive asset class for these long term investors

The success of these initiatives will now depend upon the ability of the government to make positive changes as envisaged in an environment of policy certainty.


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