Addressing Infrastructure Financing Needs

The National Investment and Infrastructure Fund (NIIF) is a fund of funds aimed at promoting infrastructure development.

Infrastructure and Indian Economy
After liberalisation, the government´s primary focus was on reducing the fiscal deficit to restore macroeconomic stability, reforming trade and exchange rate policies and liberalising foreign investment policy. Infrastructure was never a growth constraint in the short term, considering the low utilisation of the existing infrastructure then. The scenario changed post -2000 as the 10th Five-Year Plan brought the urgency of efficient infrastructure for increasing productivity and enabling the country to compete effectively in the world market.

The Planning Commission, in its midterm review of the 11th Five-Year Plan, noted that India has been adversely impacted on an average by 1 to 2 percentage points due to infrastructure bottlenecks. High transactions costs arising from inadequate and inefficient infrastructure prevents the economy from realising its full growth potential regardless of the progress on other fronts.

Existing infrastructure investments
India has invested ~5 per cent of GDP in infrastructure in the 10th Plan; this has increased to 7.22 per cent in the 11th Plan. In the 11th Plan, a total investment of ~ Rs.29 lakh crore (11th Plan – 2011/12 prices) was made towards infrastructure development. This sharp increase in total infrastructure investment was largely due to the rapid rise in investment by the private sector, especially in power and telecommunications. (Around 70 per cent of the private sector investment was made in power and telecommunications.).

A substantial private investment in the telecom sector helped in over-achieving the target during the 11th Plan. A combination of private and government funding gave the oil & gas sector a massive push, resulting in significant over-achievement against targets. The power sector also saw a major investment from the private sector. Ports, railways, storage and water supply sectors lagged behind in development and did not meet their investment targets. There may be a greater need to enable private funding for these sectors to meet investment targets for the next Five-Year Plan.

Challenges in Infrastructure Funding
The Ministry of Finance estimates that infrastructure projects of ~ Rs.1 lakh crore have been delayed. Apart from time and cost overruns in implementation of projects, one of the key reasons critical for the future is the availability of funds.

Under-developed financial markets for infra-financing
It becomes risky and limits the lending ability of banks when they engage short-term funds for long investment in infrastructure projects having long gestation period (above 5 years). To offset this, banks lend on floating rates. Eventually, the project cost may escalate as it becomes susceptible to interest rate fluctuations;
ECB imposes all in cost ceiling that allows access only to highly rated companies.

Institutional Constraints
Most of the life insurance players except LIC have limited non-ULIP liabilities that they can deploy in infrastructure. Thus, they face an asset-liability mismatch in investing over the long term
Low ratings of infrastructure SPVs: The level of ratings achieved by SPVs restricts the flow of foreign funds in the form of debt. High levels of risk attached leads to equity investments in place of debt financing. SPVs normally do not have a proven credit history and strong balance sheets. This further affects their ability to secure financing from outside.

Infrastructure financing need for the 12th Plan
The Planning Commission provided initial estimates of infrastructure investment for the Twelfth Five Year Plan of ~ Rs.65 lakh crore in order to sustain a real GDP growth rate of 9 per cent. This is almost double the amount proposed under the 11th Plan in real terms.

Around 50 per cent of the total funds required will come from government sources, while the balance will come from the private sector. Within the private sector, a major source of funds will come from foreign equity/FDI and commercial banks. There is a significant gap in the funding infrastructure, which the government plans to address with budgetary allocation and through NIIF.

NIIF: An infra finance mechanism
The National Investment and Infrastructure Fund (NIIF) is a fund of funds aimed at promoting infrastructure development by maximising economic impact in commercially viable projects. The projects could be greenfield or could also be brownfield.

NIIF could also consider investing in stalled projects.
A total corpus of Rs.40,000 crore ($6.2 billion) has been envisaged to bridge the investment gap in the Indian infrastructure sector.

The NIIF will raise debt to invest in the equity of infrastructure finance companies like the Rail Finance Corporation and the National Housing Bank. NIIF will also raise money from a number of other agencies like provident funds, overseas pension funds, endowment funds and other sources. The government has said that other sovereign wealth funds and governments have shown interest in investments in the NIIF. New Development Bank (NDB), the multilateral lending institution set up by BRICS countries in Shanghai, will be an important partner in the NIIF´s investment plans.

Structure of the NIIF
NIIF is a fund of funds typically structured as a Category II Alternate Investment Fund (AIF). Total corpus of the fund is Rs.40,000 crore. The government will invest Rs.20,000 crore into it from the Budget, while the remaining Rs.20,000 crore is expected to come from private investors. The government´s stake has been fixed at 49 percent. This stake structure (49 per cent government, 51 per cent private) will help NIIF to be seen with characters of both a sovereign fund as well as a private sector fund.

Governance of the NIIF
NIIF has been set up as a Trust registered under the Indian Trusts Act. The activities of NIIF will be overseen by a Governing Council, which is to be headed by the Finance Minister and which has been formed to oversee the activities of the fund. Further, there are five members of this council as follows: Secretary, Department of Economic Affairs; Secretary, Financial Services; Arundhati Bhattacharya (Current Chairman of SBI); Hemendra Kothari (Investment Banker); TV Mohandas Pai (former Infosys Director). The mandate of the Council is approval of guidelines for investment of Trust property/Corpus of NIIF and parameters for appointment and performance of investment managers/advisors. Further, India Infrastructure Finance Company Limited (IIFCL) has been appointed as the investment advisor to NIIF for a six-month period, while IDBI Capital Market Services has been selected as advisor to NIIF Trustee for a period of one year.

Key Success Factors
NIIF has been proposed by the Finance Minister in the Union Budget of FY2016 and has been operational since December 2015. India and the UAE signed a pact to mobilise up to $75 billion long-term investment in NIIF in February 2016. NIIF will play a key role in channelising private funds into the infrastructure sector including telecom and oil & gas, which has already experienced huge private sector investment.

Majority of the investments in infrastructure has been by banks, which are not ideal institutions to fund long-term infrastructure assets. Recently, with 29 banks in the banking sector writing off huge NPAs of around Rs.1 lakh crore during 2013-2015, much higher than what they had done in the previous nine years. Moreover, the sectoral cap on investments has put limits to bank funding in the infrastructure sector. In such a scenario, NIIF plays the role of a springboard in enabling funds for infrastructure development in India.

Although NIIF does not fill the funding gap completely, it definitely is a mechanism/ enabler for further private investments into the infrastructure sector in India. NIIF´s success could further enable larger amounts of funding being channelised into Indian infrastructural development.

Although NIIF is on its way towards success, it must maintain certain checks, which other development funds have failed to address in the past:
1.Develop and implement strong project assessment capabilities, thereby reducing the chances of NPAs;
2.Attract appropriate talent and properly implement the governance structure;
3.Frame stringent accountability and compliance guidelines;
4.The government should eventually make the funding mechanism an independent organisation with a self-financing capacity;
5.A suitable return benchmark must be arrived at, that decides a hurdle rate which must be in line with the return of the sector and also lucrative enough to attract large investors.

With the above key points in mind, NIIF is expected to kick-start the infrastructure sector by addressing the most important question of infrastructure development i.e., channelising of funds.

(This article has been authored by Jagannarayan Padmanabhan, Director-Transport, CRISIL Infrastructure Advisory).