How to increase infrastructure financing in India

Given the massive funding requirement of infra sector (>$500b in the next decade by some estimates), the domestic banking sector is feeling the constraints in meeting these large debt requirements:

• Reaching the Prudential exposure norms for a particular industry; govt. unwilling to increase the equity capital

• Asset-liability mismatch: Infra companies typically need long-term debt (10+ years) while most of banks’ funding is short/medium-term

• Demands for credit from other parts of the economy

While there would be no dearth of demand for funds, notwithstanding the recent issues with certain sectors like telecom and energy, we shall focus below on the supply-side measures which can boost the availability of financing.

Credit Enhancement

Indian banks are not allowed by RBI to provide financial guarantees. Only multilaterals are allowed; however there haven’t been any notable transactions due to tight rules governing such guarantees.

Recently, ADB has approved the first project under this structure, where it is, alongside IIFCL (an Indian govt.-owned infra financing institution) providing an unconditional first-loss default guarantee of 24% of a 12.5 year bond of up to INR3.2b (US$59m), to GMR Jadcherla Expressways Pvt. Ltd. a toll road operator. The bond will be used to refinance an existing rupee loan.

The govt. should allow more international entities to provide such guarantees. From an offshore entity’s perspective, it does not need to give a full guarantee. India’s credit rating is BBB-, and we can assume for the purpose of this discussion that the offshore guarantor’s rating is better than BBB-. However, rating of a local entity
for an INR instrument can never be better than the sovereign; in other words, an international rating better than BBB- would at the most take the local rating up to AAA. Hence, the offshore guarantors can increase the rating of a local instrument to AA or AAA, without really needing to provide a full guarantee. For instance, ADB and IIFCL are guaranteeing 24% of the above issue, which has increased its rating to AA (ICRA, a rating agency).

Benefits:

• Allows offshore entities to take financial exposure in local infra sector
• Allows foreign parents to provide credit support to Indian subsidiaries
• Helps development of Indian bond market by letting lower-rated entities to also raise funds through bonds

An area of concern could be the recourse available to offshore guarantors in case the guarantee devolves on them. Suitable changes should be made in the statute to enable offshore guarantors to enjoy the same status as a domestic guarantor/lender in such a situation.

Relaxation of ECB policy

The govt. has been coming out with relaxation of norms for infra companies to raise ECB. It should reduce the threshold of minimum average maturity of 5 years for amounts higher than $20m, for infra companies. International banks will be more willing to provide term loans for a shorter duration, especially in the current climate of risk aversion. Also, infra companies should be allowed to use ECBs for rupee expenditure without any linkages to prior years’ export earnings, as is the case for other companies.

For the purpose of ECB and other financing related policies, the govt. should expand the definition of ‘infrastructure’, to include the larger ‘infrastructure services’ sector as well. A number of mid-size Infra Services firms are growing rapidly and need regular medium-term financing. Examples are logistics, management of telecom
passive infra, airport ground handling services, etc. Growth of these companies is essential for the growth of the overall infra sector, and easier availability of funds to them would be a significant help.

Currency Risk is expected to be borne by the offshore investors in most of the above structures. However, given the wide differential today: LIBOR at < 0.7%, and the base rate of most Indian banks around 10%, there is sufficient leeway to accommodate the hedging cost (~6%).

Development of INR Capital Market Options

Pension funds and insurance companies, given the nature of their business, are always looking for long-term investment options; and infra sector needs long-term funds. To put these two together, govt. should create a specific bucket for insurance companies and pension funds (say, 5% of their investible funds) which can be
invested into paper issued by infra companies. Further, the trustees should be persuaded to relax the rating and tenor requirements for such investments.

Securitisation

After the GFC, govt. significantly tightened the norms for loan securitisation. This has almost killed the securitisation market, which had been an efficient route for balance sheet management for lenders. The Indian debt market is heavily skewed in favour of loans, whilst a number of investors who can invest only in bonds do not have sufficient opportunities available. To develop a vibrant bond market and to provide additional funding sources, govt. needs to show more flexibility in norms for loan securitisation, especially for infra companies.

A related innovation could be Tranching of long-term loans; there should be an ability to slice a, say 15-year loan into 3 cash flow tranches of year 1-5, year 5-10 and year 10-15, and distribute the slices to different investors.

Take-out financing

IIFCL has been mandated for this purpose, though it has had only limited success so far, due to the take-out mechanism, and tight stipulations on the eligible projects. There is need for more flexibility in the scheme, to facilitate banks using IIFCL actively to manage their sector exposure.