IDFs come as a new solution to debt finance to long-term, high-value infrastructure sectors. Eligibility norms for IDFs are rather stringent but justified given the risks and quantums-typical of infrastructure investment-involved. DK Vyas introduces, explains and evaluates the new norms for IDFs.
Infrastructure Debt Fund (IDF) is perhaps an idea whose time has come, especially when the government envisages a growing role of private investment in infrastructure. Dedicated debt funds have been a preferred mode for infrastructure creation in many parts of the world. In India, the IDF has been conceptualised as vehicles to attract both overseas and domestic investment. It is also expected to infuse life into the moribund Indian debt market and to create a deeper secondary market for long-term papers.
Under the broad guidelines for IDF issued in June, a fund may be set up either as a trust or a company. If controlled as a trust, the fund will function as a mutual fund, issuing units to investors and regulated by the equity market regulator, Securities and Exchange Board of India (SEBI). Set up as a trust, the IDF would issue rupee-denominated units, which will mature in five years and will need to invest at least 90 per cent of its investible resources in debt securities of infrastructure projects. Such IDF would need to certify that its investÂment is in infrastructure projects alone, and submit investment statements to SEBI on a regular basis.
Regulatory boundaries
When IDF is set up as a company, it would be regulated by the Reserve Bank of India (RBI) and can raise resources through rupee- or dollar-denomiÂnated bonds with a miniÂmum maturity of five years. The overseas bonds would have to be bought and sold outside India whereas bonds issued in India would be traded only domestically. NBFCs, infrastructure finance companies and banks can set up an IDF as a company. In that case, essentially the IDF would function as an NBFC.
RBI has also stipulated that NBFCs and banks will conÂtribute 30-49 per cent of equÂity when they establish coÂmpanies that float infraÂstructure funds. According to the RBI regulations, any IDF started as an NBFC must have minimum net owned funds of Rs 300 crore and miniÂmum capital adequacy ratio at 15 per cent of risk-weighted assets. RBI has also mandated that the Tier II capital of an IDF-NBFC must not exceed its Tier I capital. In addition, the IDF-NBFC will require to obtain a minimum 'A' or equivalent credit rating from CRISIL, Fitch, CARE, ICRA, or equivalent by any other accÂredited rating agency. Any IDF-NBFC is allowed to take maximum exposure of 50 per cent of its total capital funds to a single borrower or a group of borrowers. An additional 10 per cent will be allowed at the discretion of the board of the IDF-NBFC. However, for any additional exposure over 60 per cent, approval is needed from RBI. The eligibility criteria look quite stringent.
Given that infrastructure financing is an area where financial entities with better resources and risk manaÂgement skills prefer to tread cautiously, there is perhaps merit in keeping the eligibility criteria stringent. That explains the RBI's additional requireÂment that IDFs should invest in greenfield projects which are executed in Public-Private Partnership (PPP) mode and for investment in purely private sector project the IDF should lend to only those which have been in commercial operation for at least a year. Thus, IDFs (and the take-out financiers) will step in only after the banks lend, and bear the attendant risks, at the start-up stage.
The carrot
Currently, most infrastructure bonds are rated BB or thereabouts, thereby rendering themselves below invÂestment grade for insurance and pension funds. The IDFs intend to bypass this problem by getting ratings of AAA or thereabouts. The real risk in any infrastructure project is in the construction phase. By mandating that IDFs can only invest in projects with at least a year of satisfactory commercial operation, this part of the risk is summarily nullified. A company that borrows from the bank, can after a year of its Commercial Operational Date (COD), can issue bonds for 90 per cent of the origiÂnal debt and sell these to an IDF. This will free up bank to lend more to other infrastructure projects.
Loans to infrastructure sector carry a risk-weight of 100 per cent. Once a project is one year past its COD, paper issued on it carries a weight of 50 per cent. This will incentivise more investors to park their funds with IDFs.
Supplement, not panacea
However, in a country like ours which needs infrastÂructure investments of $200 billion per year for the next five years, IDFs alone cannot address all needs. The goveÂrÂÂnÂment has taken a slew of other initiatives. Two imporÂtant iniÂtiatives are the take-out financing scheme and the credit enhancement scheme. Under the credit enhÂanÂceÂment scheme, which IIFCL is evolving with the help of Asian Development Bank (ADB), guarantees for long-term bonds for infrastruÂcture comÂpanies will be provided, thereby enhancing credit rating for such bonds and making them eligible for investment by insurance and pension funds.
Another positive step taken was to raise the annual cap of raising external commercial borrowing per compÂany from $500 million to $750 million on autoÂmatic basÂis. Amid the growing trend of Chinese imports in infrastÂructure sectors like telecom and power, raising of YuÂanÂÂ denominated overseas debt worth $1 billion has been another positive move.
In its Union Budget 2011-12, the government increÂased the FII investment limit in infrastructure corporate bonds from $5 billion to $25 billion per annum. FIIs were also allowed to invest in unlisted infrastructure bonds with a minimum lock-in period of three years; those bonds were allowed to be traded among themselves within that three-year period. As of now, FIIs are allowed to invest in bonds floated by infrastructure companies. Previous experience suggests investors usually prefer bonds with shorter maturities, and so even the $5 billion annual cap was not breached. Till August this year, FIIs had invested just about Rs 600 crore. This prompted an overhaul of the scheme.
In the reworked scheme, government earmarked $5 billion for bonds floated by infrastructure companies on more liberal terms than those available for investment in regular corporate bonds. The lock-in period and residual maturity was reduced from three years to one year, and FIIs were allowed to trade among themselves within that one-year lock-in period. As a result of this move, FII bids for those bonds overshot in an auction in October. Within the $25 billion limit, government has earmarked $3 billion for IDFs.
Recent experience shows that financing is not as much an issue in infrastructure as are the policy uncertÂainties relating to areas such as land acquisition, input linÂkÂages, tariff-setting, etc, where policy-making is influeÂnced by populist politics. Lack of clarity is hindering investments. Private investment through IDFs and other initiatives will be more forthcoming if the government can address the politics of infrastructure.
The author is CEO at Srei BNP Paribas.
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