India needs funds for its infrastructure projects, but banks are overexposed to this sector. Miguel Gutiérrez explores some remedies.
After the Narendra Modi-led Bharatiya Janata Party won a clear majority in the Lok Sabha election, general sentiments and expectations are high that GDP growth will recover.
One of the drivers for this will certainly be the launch and completion of key infrastructure projects. In this regard the general notion is that the strong mandate of the incoming government will help to continue and even speed up the path of stalled project clearances aligned with necessary reforms already initiated by the past government.
Securing funding and reaching a timely financial close for the projects will play a paramount role for contributing to the success of infrastructure implementation and ultimately Gross Domestic Product (GDP) growth.
It is well known that following an average GDP growth of over 9.0 per cent during 2004-07, the Indian economy suffered a slowdown with the onset of the global financial crisis of 2008-09. The real GDP growth fell bellow 5 per cent during the last fiscal year and is expected to recover during 2014-15 onwards.
Obviously this situation in the recent years and especially during the last fiscal year, has led to a slowdown in the implementation of infrastructure projects in India in general.
Yet it is true that despite these headwinds some infrastructure projects saw the light of day in recent months, in particular in the power, oil & gas as well as the ports sector.
However the number of stalled infrastructure projects both in the public as well as the private sector is significant. In fact this has been well recognised by the last government which reacted inter alia by setting up a special Prime Minister's Project Monitoring Group (PMG) in June 2013. The PMG fast tracked priority projects and hence helped start the de-bottling of the backlog.
Initially there were about 215 such priority projects identified by the Ministry of Finance alone, where banks had already funded more than Rs. 7 lakh crore, but were still awaiting certain clearances resulting in time and cost overruns. The Federation of Indian Chambers of Commerce and Industry had also compiled a list of further 52 projects in the private sector, with investments greater than Rs 1,000 crore, which were delayed due to various reasons.
All in all PMG had finally identified over 435 stalled priority projects worth around Rs 20 lakh crore, pending for years. Until March 2014 Project Monitoring Group (PMG) had cleared around 147 projects, entailing an investment of around Rs 5 lakh crore. In retrospect, the reasons for such backlogs are without doubt vast and not only attributable to bottlenecks at the Central government levels. Whatever the reasons are on a case by case basis, as of today it is evident that the significant size of the backlog will require tapping different sources to assure sufficient funding. It will require measures to attract sufficient equity and tap capital markets on the ground as well as abroad. However a prevailing role for financing will still plague domestic and foreign banks.
Banks generally either have been struggling or are still struggling with a rising portfolio of non performing assets as an outcome of the financial crisis and the cooling of the economy in recent years.
It is only reasonable that in such a situation banks will become more prudent in their risk assessments - or at least, they should. Going forward in an environment where lenders might be less aggressive and opportunities for potential allocation of their funds is positive, in the mid and long term, lenders will become more selective when lending to infrastructure projects.
Therefore tapping bank financings will also mean to overcome some of the excesses of the past such as aggressive bidding, weak and inexperienced sponsors, poor project planning, high leverage and weak finances. In this regard specialised banks with particular sector and product expertise could play a more vital role for infrastructure financing in the future.
Projects and banking consortia will benefit from financiers with a deep sector as well as product know-how, as this will help avoiding pitfalls at early stages. In fact engaging with specialised financiers will also help to reach financial closure in a timely manner helping to avoid delays in arranging financing.
Approaching these banks at early stages allows also for exploring possible innovative and favourable ways of financing in line with the project requirements. This holds especially true when tapping banks from abroad.
Due to the tremendous funding requirement, many of the infrastructure projects will require funds from international lenders. These are often lien to provide tied financings along a cover from an Export Credit Agency (ECA). On a case by case basis such ECA covered buyer's credit can indeed be very beneficial for infrastructure projects.
ECA covered buyer's credits offer from a borrower's point of view and offered several benefits other than simply the diversification of funding possibilities. ECA covered financing for infrastructure projects open an attractive alley to obtain funding during the construction phase and long term financing thereafter. In India we have further also seen a strong appetite for financing along with financial supported interest rates schemes under the ECA buyer's credits. The Arrangement for Officially Supported Export regulates the Commercial Interest Rate (CIRR) from which an ECA loan can benefit. In fact these CIRR loans are fixed interest rate loans. The borrower therefore does not carry any interest risk for the tenor of the loan. Due to the financial support element, they further come along at attractive long term rates which are publicly available and transparent. These types of loans can make a lot of sense, especially to borrowers with a natural hedge, on an all-in cost basis taking into account the insurance premium for the ECA.
For more complex infrastructure projects, ECA buyer's credits can be construed as shopping lines or multi-cover structures where several supplies could be bundled and therefore maximising the overall allocation towards an ECA financing.
A more pragmatic alternative towards the typical ECA covered buyer's credit are the ECA-covered onlending structures or "2-Step Loans". Such structures allow for a relative fast financial close as international banks typically already have framework agreements in place with most of the relevant domestic lenders.
As the project risk remains with the fronting bank these structures give banks with comparatively low sector know-how the comfort to participate in an infrastructure project, which they would otherwise not have entered into, whereas the project itself benefits still from an ECA covered loan. However as each ECA has its own peculiarities, borrowers need to assess which financier can not only offer the most attractive financing conditions but would also bring in enough expertise assuring a smooth and efficient approval process for availing the ECA cover and ultimately assuring a timely financial close.