Debt Financing of Infrastructure Projects

Abstract

“Infrastructure projects remain a major source of India’s growth and this can be seen by the measures taken, both by the Government and the Reserve Bank of India, in trying to prioritise the sector and increase more investment in this area. However, debt financing has been one of the major problems for this sector, where projects are often left in a precarious situation due to high-stress assets and numerous risks. This article aims to analyse the various reasons for debt financing problems in the infrastructure sector, along with trying to understand the measures taken by the Government and RBI to handle the same. Further, the article tries to provide suggestions to encourage long term financing in the sector.”

“Infrastructure can deliver major benefits in promoting economic growth, poverty alleviation and environmental sustainability, but only when it provides services that respond to effective demand and does so efficiently.”                                                                                                                                                                                                                                        –World Bank

Similar to many other countries, infrastructure development remains a major aspect of India’s growth strategy. Today, banks dominate the financial system of India, and the Non-Banking Financial Companies (NBFC) further play a part in the infrastructure financing. There exist NBFCs which specialise in infrastructure financing, along with some other more specific NBFCs present in the government sector. A trend of higher growth rates has been seen in the flow of bank finance in the infrastructure sector. This can be seen in the increase in outstanding bank credit to the infrastructure sector from 95 billion in March 2001, to 9,853 billion in March 2016, having 39.31% as the compound annual growth rate (CAGR) over the course of the last 15 years. The same has been captured in Chart 1 below: 

However, there were consequences to this phenomenal growth, like high stressed assets. There are a few economic characteristics that are used to differentiate between infrastructure assets and other asset clauses. These differences further make it difficult to match investment demand with financing supply. Some of these differences include:

• Infrastructure projects contain a large number of parties and are comparatively more complex in nature than other assets. They often include natural monopolies like water supply and highways, which is why the government tries to retain its control and prevent any abuse of monopoly power, which is the reason behind them including intricate legal arrangements for the proper distribution of risk-sharing and payoffs, in alignment with the incentives received by the parties involved in the contract.
• Considering that infrastructure projects are for the long term, they are subject to numerous risks like delays in clearances, changes in policies, etc. Each delay results in cost and time overruns, which further sway the techno-economic viability of the project, and eventually lead to the requirement of revision in the end-product prices.
• As the banking system dominates the debt financing of the projects, the problem of asset-liability mismatch becomes critical. India has a dominance of Public Sector Banks (PSBs) which are capable of offsetting this risk, provided that the government assurance gives the required backing to the required flow of deposits to such projects.

Due to the above reasons, financing infrastructure projects is prone to challenges. However, considering that these projects act as the key drivers for the Indian economy, the Government provides high priority to them, which itself paves the way to massive potential for the financing of these projects.

Types of Financing by Banks

The banks take care of the financial requirements of infrastructure projects by providing capital finance, project loans, term loans, and by acquiring shares as part of their project financing package. These banks finance the infrastructure projects in thefollowing manners:

• Takeout Financing: Banks enter into this arrangement through the India Infrastructure Finance Company Ltd (IIFCL), which is a government-owned Indian company. IIFCL provides financial assistance to infrastructure projects for the long term.
• Inter-institutional guarantees: According to RBI instructions, banks can issue guarantees in favour of other lending institutions (including other banks). This arrangement is subject to the guarantee-provider bank having a share of up to 5% in the funding of the overall project cost. Further, they must accept normal credit appraisals and monitoring, along with regular follow-ups on the project.
• Financing promoters’ equity: This arrangement includes the promoters of a company sharing their own resources to contribute to the company’s equity capital. They are not allowed to take up shares of other companies. 

Measures Taken by the Government

In his 2019 Independence Day speech, Prime Minister Narendra Modi launched the National Infrastructure Pipeline (NIP), which shall be functioning from FY 2019 to FY 2025. An initial amount of Rs. 100 lakh crores has been set aside for the development of economic and social infrastructure projects in India. According to theNIP, about 7400 projects are included under the NIP, of which 1800 are already under development.

For the successful completion of the NIP, huge capital inflows are required, considering infrastructure projects mostly have longer life spans and are more capital intensive. Classically, the necessity of long-term financing is due to the 15-30 years payback period for infrastructure projects. However, there are only finite long-term financing sources available, which, unfortunately, do not completely address the financing requirements. Moreover, the sectoral limits on lending, along with the limited availability of bank capital add to the trouble.

To address this problem and improve the availability of long-term financing options, the government has taken certain steps:

• Infrastructure Debt Funds (IDFs): These are special vehicles for infrastructure investment that extend long-term financing through Public-Private Partnerships. This option has completed more than one year of successful commercial operation. However, it is yet to be considered as a popular financing structure for infrastructure projects.
• Credit Enhancement Scheme: Partial credit enhancements to corporate bonds, which are issued by the private entities for infrastructure projects, have been allowed by RBI. Moreover, IIFCL also provides credit guarantee to improve the credit rating of bonds, which are then issued by infrastructure companies for the refinancing of their existing loans.
• Infrastructure Investment Trust (InvIT): InvITs in India are registered and regulated by the SEBI (Infrastructure Investment Trusts) Regulations, 2014. InvITS are like mutual funds in infrastructure. InvITs can be established as a trust and registered with SEBI.
• Relaxation of External Commercial Borrowings (ECB) Policy: ECBs are commercial loans raised by eligible resident entities from recognised non-resident entities and should conform to the parameters laid down in theMaster Directions by the RBI. 

Measures Taken by the Reserve Bank of India (RBI)

Numerous measures have been taken by RBI to extend financial support to infrastructure projects:

• The implementation of projects takes a long time, which gives rise to interest costs within the project cost, and thus, it becomes important to have a specific commencement time for commercial operations. Considering the reasons for the delay in the implementation of projects, RBI has allowed for an extension of time for the completion of projects. This is, of course, subject to conditions, along with no loan classification change. Further, the limited cost overrun financing has been permitted.
• RBI has allowed banks to issue guarantees in favour of other banks and lending institutions for infrastructure projects, given that the bank which is issuing the guarantee gets a funded share in the project of up to 5% of the project cost. This is specific to infrastructure projects only, and such guarantees are not allowed for other cases.
• Even though it is expected that the promoter’s contribution to the equity capital of a company will come from its own resources, banks have been permitted to extend capital for funding promoters’ equity, if the proposal is related to the acquisition of shares in a company operating an infrastructure project in India.
• RBI has allowed banks to provide flexible structure loans (also called 5/25 schemes) to make the repayment schedule in alignment with the cash flows. This enables the refinancing of loans every five or seven years
• Banks are allowed to raise funds from the market through infrastructure bonds. Assets financed through such bonds are exempted from priority sector lending requirements, and the funds are exempted from any reserve requirements.
• To raise funds for the infrastructure sector, it is important to have an efficient bond market. Several measures have been taken in this regard, where the banks have been allowed to provide credit enhancement for bond issuances.
• Construction risk compensation, especially at the pre-construction stage, is important to be included for financiers. Measures like allowing the setting up of Infrastructure Debt Funds (IDFs) have been taken.

Further, additional toolkits have been provided by the RBI to help banks deal with stressed assets. The framework of dealing with stressed assets was announced in February 2014. Moreover, additional time for completion, if there is any change in management, was given. Over time, the thresholds for these toolkits have been reduced to attract more entities within its ambit. Moreover, the construction sector (which helps in the execution of projects for the infrastructure sector) has been brought within the horizon of a flexible restructuring scheme, to help the sector deal with less stressed assets.

Estimates and Challenges

According torecent estimates, India requires Rs. 50 trillion (US$ 777.73 billion) in infrastructure by 2022, to ensure sustainable development in the country. Moreover, a myriad of opportunities are needed to attract foreign investment in infrastructure development. Moreover, according tothe estimate by the Department for Promotion of Industry and Internal Trade (DPIIT), the Foreign Direct Investments (FDIs) stood at US$ 17.22 billion in September 2020, which is still not very high.

Considering the current market scenario, the Indian Governmentfurther plans to spend USD 1.4 trillion during 2019 – 2023 for infrastructure, wherein USD 750 billion shall be directed to railway infrastructure by 2030. However, the pandemic has resulted in intimidating situations for the infrastructure companies which are trying to recover from their all-time low. Therefore, it is important to come up with impactful strategies at the earliest, to stimulate growth in the sector.

Considering that infrastructure projects require massive capital inflow, the effective deployment of capital resources by the government is a crucial strategy to stimulate sector growth.According to the recent budget, the government has allocated about Rs 1.07 lakh crore to the Ministry of Railways and Rs 25,933 crore to the Department of Telecommunications for capital expenditure. These allocations are expected to increase the tenders, which have been announced and completed. This is expected to lead to an increased number of projects and higher demand for infrastructure firms, eventually leading to an increased cash flow in the country.

Another test for infrastructure companies is the sourcing of raw materials like steel. Previously, the procurement of steel was done by primary producers who charged a premium in return and drove up the costs of the industry. However, the ministry of steel has recently released a clarification which stipulates that the procurement of raw materials can be done from any producer. However, the implementation of such an order requires the reduction of cost of raw materials to boost industry growth. Further, the price fluctuations experienced by the raw materials often delay the completion of infrastructure projects due to cost issues, thereby delaying the growth of the entire sector. Hence,procurement relief for raw materials can accelerate the delivery of projects, and the growth of the sector.

Reasons for Higher Level of Stressed Assets in the Infrastructure Sector:

• Due to the need to properly structure the financing of the infrastructure projects, they need a mix of loan funding and equity, along with their timelines being more realistically upfront. This helps in ensuring that the Date of Commencement of Commercial Operations (DCCO) is pragmatically fixed. Even though a conservative estimate of time for the completion of the project helps in reducing project costs, it leads to an increase in the stress due to cost and time overruns. Some reasons for extending time are not included under the ambit of force majeure which further adds to the stress.
• Often, the repayment schedule drawn is not proportionate with the cash flows. This strains the entity, and leads to repayments being managed by fresh borrowings, which further adds to the building and cost stress, creating an endless debt loop. 

Markets After the Pandemic

Until the pandemic, India had sought to become a $5 trillion economy by 2025. Unfortunately, the pandemic pushed the plan a little back, making the Indian economy bear the brunt of the pandemic first, before resuming its chase. However, even before the pandemic came into the picture, the government had been prioritizing the infrastructure sector within its main economic growth agenda. Even after the pandemic, the infrastructure sector shall play a major role in the economy.

The priority of the sector can be understood through several schemes and mechanisms that the government has been introducing, such as the ₹100 trillion National Infrastructure pipeline, National Investment and Infrastructure Fund Establishment, etc. According tocertain estimates, a 1% GDP investment in the infrastructure sector is capable of providing a 2% GDP growth to the overall economy.

Unfortunately, it is the central government that has been handling the maximum financial burden of infrastructure projects in India. This can be understood from thefigures which show that between 2012-13 and 2018-19, an increase from 26% to 41% was seen in the government’s share of infrastructure investment. In the same period, there was a decline in the share of states in infrastructure investment from 45% to 32%.

During the pandemic, the government had been forced to shift priorities from infrastructure to other critical sectors including health, employment, and education. This further led to an increase in stressed assets in the infrastructure sector, while simultaneously stressing government budgets extensively.

Overall, it is important for India to spend an estimate of Rs. 235 trillion in the period of 2021-30 for infrastructure development in the country. Thisvaluation is more than thrice of the previous decade’s valuation which was nearly Rs. 77 crores. To fill this gap, the government has been pushing stakeholders from private sectors, banks, state governments, foreign investors, and development finance institutions (DFIs) to help increase funds for large infrastructure projects. However, it has only achieved limited success.

Looking at the private sector, there has been adecrease in private investments from 34% to 23% between 2011-15 and 2015-20. This is mainly due to the delays in the project executions, limited access to debt financing, and low revenue realization. Similarly, domestic banks, due to rising non-performing assets, asset-liability mismatches, and delayed statutory clearances, have reduced lending to infrastructure projects. This share hasfallen below 10% in 2018-19. In 2019, when ICICI Bank announced the closure of its project finance division, the aversion of domestic banks to lend truly came to light, considering the fact that ICICI Bank was usually at the forefront of credit lending to the infrastructure sector.

How Do We Ensure a Robust Funding Mechanism for India’s Infrastructure Sector?

With the world facing a pandemic, it has become important to set up a robust financial institution, to contribute to the growth of India’s infrastructure sector. This bank can be formed with a vision of achieving 3 main aims:

• To provide flexible and long-term funding to infrastructure projects in order to match the tenure requirements.
• To act as a platform to attract more private excess global debt capital.
• To bring more market-centric financial solutions, leading to a reduction in risk and stress by improving return profiles.

This has been utilised by many countries over the past few years.The Canadian Infrastructure Bank, which was set up in 2017, has been able to raise more than $35 billion, and has helped Canada in accelerating their infrastructure projects, along with helping them in their transition to a low-carbon economy. Furthermore, UK hasannounced the establishment of an infrastructure bank in November 2020.

For India, the setting up of a National Infrastructure Bank can lead to a further boost in the sector, when complemented by the existing favorable public policy and the robust project pipeline.

Judiciary and Law Ministry Interventions

Rapid MetroRail Gurgaon Limited Etc. v Haryana Mass Rapid Transport Corporation Limited & Ors.

This judgement has laid a positive outlook for all stakeholders. With the uncertainty of government contracts and poor credit quality in many infrastructure assets, the right of the lender to receive ‘debt due’ in pursuance with the provisions of the concession agreement between the borrower and the concessionaire authority for the development of 2 metro projects, was reaffirmed by the Hon’ble Supreme Court.

In this case, the Hon’ble Supreme Court adjudicated on the issue of ‘debt due’, while also analysing the impact of a regulatory delay on public interest, for two concession agreements awarded by the Haryana Shehri Vikas Pradhikaran (“HSVP”) to Rapid MetroRail Gurgaon Limited (“Rapid Gurgaon”) and Rapid MetroRail Gurgaon South Limited (“Rapid Gurgaon South”) for the development of 2 metro links.

Now, as the Metro Projects were meant for public use and were funded by public banks, the terms of the contract and ‘public good’ aspect was also examined in this decision by the Court. The Hon’ble Supreme Court held that the government authorities are not permitted to delay or obstruct compliance with their obligations, mainly for three reasons:

• First, the responsibility to credit 80% ‘debt due’ (because of termination) originates from the provisions mentioned in the respective concession agreements.
• Second, the responsibility to credit 80% of ‘debt due’ has been voluntarily assumed before the High Court, and as public bodies, they cannot be allowed to retract.
• Third, it is a public interest element to ensure that monies, as committed by financial institutions for the financing of infrastructure projects, are secured in the provisions of the concession agreements.

The Supreme Court clearly highlighted that, “…deterioration in loan recovery not only leads to higher provisions and diminished profitability but also constrains banks’ lending capacity, thus affecting the economy adversely. Unless the dues which are assured to financial institutions as part of the arrangements which are envisaged in Concession Agreements are duly enforced, the structure of financing for infrastructure projects may well be in jeopardy.” Therefore, the sympathy of the Supreme Court on the bankability of such concession agreements is clear, considering they are extremely important for the development and growth of the country.

Therefore, it is advisable for the parties to enter into direct agreements, depending upon the nature of the project, to create a direct agreement between lenders and project participants. Moreover,special attention should be given to contract provisions, especially to clauses related to ‘debt due’, ‘termination of payment’, escrow mechanism, and substitution, which can help in the protection of lender rights.

The Law Ministry Intervention

Under alaw which was amended two years ago, the Law Ministry had asked states to set-up special courts to settle infrastructure-related disputes, considering that it is essential to improve the ‘Ease of Doing Business rankings for both India and the Indian states. By taking examples of the Hon’ble High Courts of Karnataka, Madhya Pradesh, and Allahabad, the Ministry has further encouraged other High Courts to allocate a special day for such Special Courts to deal with infrastructure project-related litigation.

The designated courts are provided for underSection 20 B of the Specific Relief (Amendment) Act, 2018. However, the Ministry has encouraged the courts to provide the functioning of the infrastructure-related Special Court on special days. The states of Karnataka, Madhya Pradesh, and Allahabad have set up Designated Special Courts instead of Dedicated Special Courts under the Specific Relief Act.

Section 20 B states that the state government, after consulting with the Chief Justice of the respective High Court, shall designate a civil court (one or more) as a ‘special designated court’, in the local limits of the court’s jurisdiction to try suits regarding contracts relating to infrastructure projects under the Specific Relief (Amendment) Act.

Conclusion and Further Suggestions

New mechanisms are required to encourage long term financing in the current provisions:

• For the private sector, the market must be developed for Long Term Infrastructure Bonds, which can happen only through long-term private investors participation such as insurance houses and pension funds. Further, the need for institutional vendors in the current legislation to hold all securities till maturity should be eliminated, and active exchange must be permitted. The private debt placement rules should also be less prohibitive in nature.
• The government could also create specialized financial institutions in line with the concepts of Power Finance Corporation (PFC) or Rural Electrification Corporation (RFC) for all large sectors. Even though the government has established IIFCL and IDFC to help infrastructure projects funds, considering that IDFC has converted itself into a bank now, it has moved out from being a pure infrastructure financing. Therefore, a sector-focused infrastructure financing institution can be created to help sectors look for large outlays and make funds available during infrastructure development phases.
• The infrastructure bond issuers can be helped in achieving their minimum credit rating by channelling funds from the provident/pension funds through some policy interventions. These interventions can include the creation of an institution for credit enhancement and/or by allowing investment in bonds, as issued by the infrastructure concessionaires, during the construction period.
• The Non-performing Assets (NPA) and liquidity issues of the banking sector can be solved through the creation of a ‘bad bank’. Currently, the Indian banking system has about 8.5% gross NPAs, which are expected to increase further due to the pandemic. Therefore, a bad bank can completely focus on the resolution of the normal banking system, by aggregating all stressed assets, and helping banks keep their focus on business.
• To focus on urban infrastructure development, the representation of municipal bonds in the overall debt market must be increased. This can be done through proper incentives and structuring in the municipal bond market development, which shall further lead to increased availability of funding for the urban infrastructure projects.

While these measures might not solve the long-term financing problem completely, when complemented with an increased focus on the existing mechanisms such as IDFs, InvITs, etc., the implementation and results have the to potential achieve optimistic targets. After the COVID-19 pandemic, the private sector shall play an important role in the revival of the economy, and therefore, private sector participation must be incentivised.

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