Globally, Royal Bank of Scotland's focus is to raise capital from public and private markets and selectively do asset equipment and shipping finance. In Indian infrastructure industries, structuring a project is a problem. Many practitioners and bankers believe they need somebody who can guide projects from concept through implementation. Aware of long tenures and potential asset-liability mismatches in infrastructure project finance, RBS has assumed a largely advisory role in India. In this interview, the bank's Country Executive (India) and Chairperson of RBS Business Services Meera H Sanyal, with inputs from Head—Origination (India) Brijesh Mehra, explains to Shashidhar Nanjundaiah why banks stay away from lending to infrastructure projects and why RBS has chosen the advisory route.
Infrastructure finance in India lacks public investment. What would your solution be to this problem?
Meera Sanyal (MS): In the global financial markets long term infrastructure projects are typically funded through capital markets and by long term institutional players such as Pensin Funds. I personally have a somewhat out-of-the-box view on how this could work in India. Small savings, in a country without a social security net, could be routed through long term infrastructure funding.
The middle class and those at the bottom of the pyramid have a need for long term savings, ideally through fixed-rate, long term instruments that they can count on to yield them money 15- 20 years from now, either in the form of a lump sum for expenses such as a daughter's wedding, or as an annuity, such as pension, etc. But such instruments don't exist today and a small saver cannot count on such a future yield, partly because of interest rate volatility. Now let us look at it from an infrastructure perspective. Typically such projects have a long gestation period, after which there is a steady stream of annuity income deriving from tolls etc. Thus the savings and future security requirements of the Indian small saver and the long term funding and gestation needs of Indian infrastructure project are closely linked and match perfectly. With a savings rate of 37-38 per cent, the funding needs of Indian infrastructure can largely be met through domestic savings. If we have efficient capital market intermediation and proper structuring, we can get the desired outcome.
Successful examples of this mechanism are the Konkan Railway, MKVDC, and Deep Discount Bonds issued in the 1990s, which used the small savings route and for which the bonds were repaid a few years ago.
The government has been exploring public finance for infrastructure through the bonds route, but hasn't been hugely successful. Why?
The corporate bond market needs to develop further. The product described above is a retail bond, whereas this discussion is about participating in the 'building of India', where investing for long gestation periods is acceptable. Pension funds and insurance companies should also be encouraged to invest in infrastructure projects instead of putting their money in government bonds. Their asset-liability profile also matches the cash flow of an infrastructure project.
On the other hand, banks should not lend to infrastructure projects because of an obvious asset-liability mismatch (ALM).
What reforms would you suggest in that respect?
MS: If you reconstruct the project risks from a financing perspective, infrastructure is really about project finance. We need to disaggregate the risks of each project -risks related to land acquisition and construction, risks related to politics, or the environmental, and risks concerning market-based or future demand-based cash flows of the project. We need to quantify each of them. Globally for sophisticated infrastructure finance, one would disaggregate different parts of the risk, price them differently and sell them down to buyers who would be comfortable with those risks. Infrastructure finance is structured to pay for itself; the toll annuities of airports, roads and bridges for example. The cash flows from such projects in India, given the growth in demand for quality infrastructure are always likely to be sufficient to pay for the infrastructure. Question like, “What is the risk of time lags? How long will it take to complete? What is the certitude of the date of completion?”, add the element of uncertainty.
Brijesh Mehra (BM): With ratings, SPVs have credibility as well as a clear definition of the risk-reward relationship of any specific infrastructure project.
So, while public debates are of little help, infrastructure projects, through the formation of SPVs, are logically aligned, and we need second generation reforms that involve the aam aadmi, to resolve issues such as land acquisition. Genuine, single-window clearance mechanisms are needed to speed up these projects, which would otherwise languish like Vedanta and Posco.
The risks can sometimes be time-divided. Would you, as a bank, take this into consideration in managing the risks at different stages of a project, such as differential interest rates or deciding the kind of financing to offer?
MS: Absolutely, yes. Many people compare China and India—and this is interesting, because while feedback and decision making is typically much quicker in China, other delays emerge subsequent to the completion of projects. In such cases, the rules of the game are not necessarily that clear. In India, it is an inverse situation .Delays are front-ended but once a project is in operation, the tail risks are much clearer, because all the stakeholders have had their say and the rule of law applies. Regretfully, some of projects become completely open-ended in timelines, making it almost impossible to price them [in the way I have described above].
BM: Overruns and delays force Indian companies look at overseas projects. This results in capital outflows, underutilisation of talent, loss of time etc. For example, we need talent to build hundreds of smaller airports. The opportunities are here.
So how do you advise your clients on smaller airports? The argument is that over a period of time, the airports will drive development and will therefore become viable. But how are developers and investors reacting to it now?
BM: Larger companies are looking at big airports only because the management time involved in any single airport does not vary linearly with the size of the airport. You will not see large, more experienced companies looking at small airports, but smaller regional players see the small airport as a real estate play.
MS: Interestingly, Indian infrastructure is not supply-driven, unlike in many parts of the world, where you build the infrastructure and then the users come in, and the region develops. In India, infrastructure growth is demand driven. You first have a city of 15 million people and then build out a world class metro to provide connectivity ! And increasingly that is the reality that we have to accept.
Is there is a scope for profit at smaller airports through aero and non-aero methods?
BM: Aero revenues are limited, and real growth comes from restaurants, hotels and real estate. But infrastructure cannot grow in isolation – you cannot get first class airports without approach roads and other related infrastructure of similar quality around them.
Meera, you said demand-driven infrastructure is a reality we need to accept. Do you see it as a continuing practice?
MS: Yes. But we have so far talked about hard infrastructure and I believe soft infrastructure is an equally important area for India. It includes critical fields like education and health, that will enable infrastructure to help India power ahead. I certainly would like to see a lot more focus on them.
Which infrastructure sector, according to you, would face maximum risk?
BM: It is challenging to have one metric to evaluate where the maximum risk is. Each sector has its peculiarities. For example, in the power sector today, merchant power plants are more attractive because of the spot market as opposed to power projects, where prices are much lower. But I do not rule out merchant power being priced lower than PPA power in the coming years.
Let's talk about viability in infrastructure, especially since much of the physical infrastructure is concerned with social development. Without huge amounts of viability gap funding (VGF), some of those developmental sectors will face a larger risk—for example, how much of our road infrastructure can work on toll? Is that a limitation on PPP in infrastructure?
BM: Road infrastructure was funded by the government as a necessary social cost. Privatisation reduces this cost. VGF can make any road viable–even if the earning potential is only 10 in 100, 90 can be the VGF, and the private sector can take care of the rest. Look at the way telecom changed the face of rural India by reducing costs and prices over time.
Telecom was the leader in commerce driving social transformation. Is infrastructure different to the extent that private participation must always be completely viable and aren't we making the social sector commercial? As a banker with experience in the social space, does it bother you?
MS: When telecom was deregulated in the 1990s, some in the banking industry had argued that unprofitable regions be opened up along with profitable regions for private participation. The private sector has been remarkably successful in converting that challenge into an opportunity. Our telecom providers provide service to our remotest areas at a cost that the poorest can afford. Our mobile telephony is the most affordable in the world, which in turn has given it greater penetration. It is a market with demand and if you tackle it correctly as an entrepreneur or a financier or as a service provider, you can leverage massive innovation. That is the beauty and challenge of the Indian infrastructure market.
Infrastructure stocks have taken a beating in recent months. Is public confidence lacking?
MS: The whole stock market is suffering at the moment from a crisis of confidence. Several major projects are delayed. There is also a concern regarding the 2nd generation of reforms . Are the labour and land reforms, GST, DTC and other promises going to materialise?
There is also a tremendous amount of global uncertainty and India is not completely immune to global trends. The Eurozone is facing a crisis and one cannot foresee the outcome. This summer could well be a turning point. Inflation is still not under control, and interest rates are rising, all of which could be adding to market sentiments.
It is said that these problems occur because we compare rather than build.
MS: During my visit to China in 2006, a group of Chinese businessmen said they feared India because of its growing IT prowess. So they brought a delegation to India. On arrival they took one look at our airports and didn't feel scared of the country anymore! Even though sometimes Indian hardware and infrastructure is inadequate the software, enterprise and energy of our people is world class. Hardware is easy to create but software and people skills take a much longer time. Today our airports are world class. We have design, construction, entrepreneurial and financial capability but we need to all come together and make it happen.
Urban infrastructure hasn't drawn as much participation as we would like to see. Is that a reason why our cities continue to flounder?
MS: Our cities are very large and growing each year. Unless we focus on urban planning to deliver amenities such as housing, water, sanitation, education, health, efficient public transport and adequate open spaces for all our citizens, our cities will become increasingly uninhabitable and unsafe. Countries like India and China have a special problem because of the sheer scale of our megapolises. Local stakeholders and environmental considerations must be accounted for. We must focus on both the soft and hard aspects of infrastructure.
THE INFRA ADVISOR
The Royal Bank of Scotland, one of the top-tier foreign banks, has had a presence in India since 1920. In the infrastructure space, it provides advisory services for companies looking to expand, raise capital and manage risks. As Brijesh Mehra says, “We believe our skills are better employed in the advisory capacity and look at a project from the structuring perspective rather than taking it on the balance sheet.” Over the years, RBS's infrastructure-related deals include, among others, Suzlon Energy's recent $175 million foreign currency convertible bond, GMR's successful bid to modernise the Sabiha Gokcen Airport in Turkey, the government's $2.4 billion disinvestment of the Mumbai and Delhi airports, and leading financing/capital raising for telecom companies in India.
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