Infra lender faces the risk of execution and regulatory uncertainties

As the country's most experienced lead finance arranger for infrastructure projects, SBI Capital Markets, turned 25 this year, S Vishvanathan, MD and CEO, projects what
the journey for infrastructure finance and project structuring means, and says uncertainties and other hurdles are temporary in the long run.

What are some of the biggest differences between the infrastructure investment scenarios 25 years ago when you started, in the troubled 2008-09, and now? For example, gas infrastructure finance become simpler, more complex, more difficult, or more evolved?
Infrastructure investment in India through the private sector route, or PPP, is really a recent phenomenon that started only in late 1990s, and the story is less than 15 years old. Earlier, all the investments in infrastructure in areas like power, roads, airports, ports etc, were through the government route and very few private players even existed.

In spite of having started quite late—compared to western economies that have always encouraged private sector in infrastructure—we have travelled very rapidly over the past 15 years. Private sector has taken the lead in development of infrastructure projects in areas such as national highways, power plants, ports and so on. In fact the downturn of 2008 did not affect India at all as the infrastructure story continued unabated, given the substantial demand-supply gap.

Let me cite our own experience as an example. SBI Capital Markets (SBICAP) has been the largest project finance Mandated Lead Arranger (MLA) globally for the past two years, and is leading for the half year 2011 by a considerable margin. As per a Thomson Reuters Project Finance International, SBICAP syndicated more than $10 billion of project finance loans in the period January-June 2011, while the next closest competitor (Mitsubishi UFJ) was at $4.5 billion and Societe Generale was third with $3.5 billion. We hope to continue our leadership position for the rest of the year and so will have the unique distinction of being Number One MLA globally for three years in running. This achievement is a clear reflection of the maturing of Indian infrastructure market.

Does India now have enough experience in infrastructure to be called stable and low-risk?
The infrastructure deals being structured in India are as complex and refined as anywhere else in the world. For example, the bidding in power and roads sectors is absolutely transparent and requires a high level of financial structuring. We were advising Tata Power for its bid for 4,000 MW Mundra Ultra Mega Power Project (UMPP) and after having won the bid, losed it financially with a combination of rupee loans from the Indian banks and financial institutions (led by SBI) and foreign currency loans from two multilaterals, IFC and ADB, and two Export Credit Agencies, K-Exim and KEIC. This was as complex a transaction as you would find anywhere.

Having said that, for many international banks, companies in India are still not the prime borrowers as these companies are often constrained by sovereign ratings. Additionally, in some sectors such as telecom and power, there are regulatory uncertainties and other issues that force foreign players to not classify us as low risk. For example, in the power sector, most international players—both developers and commercial banks—have largely stayed away due to the precarious financial position of most power distribution companies (Discoms). In some states, independent power producers (IPPs) are facing considerable delay in getting payments from these Discoms. A second wave of reforms, focused on the distribution segment, is required urgently to attract foreign capital into the sector. Overall, there are plenty of ground level issues such as land acquisition, environmental clearances, uncertainties around coal, Power Purchase Agreements (PPAs), and so on, that differ from international practices. Many foreign investors would not really classify the sector as low risk, owing to these reasons.

What is the single biggest post-investment risk an infrastructure finance company faces in India today?
Although SBICAP is only an arranger and not really an infrastructure finance company, in our view, any infrastructure lender faces the risk of actual ground level execution as well as regulatory uncertainties. For example, in many states, IPPs are facing considerable delays in getting payments out due to the precarious financial health of the Discoms. We have seen that most regulators in India are loathe to increasing retail tariffs, even though not increasing tariffs only burdens the Discoms and makes them financially unviable. This approach is certain to impact investments in the sector.

Additionally, there is a regulatory uncertainty surrounding the issue that imported coal costs have to be made a pass through in PPA and ultimately passed on to the consumers. The regulators have to take this step for the long term viability of the sector.

Similarly, there have been ground level issues in acquisition of land, environment clearances etc, that take a long time and sometimes the entire land is not in place before the disbursement starts. So, there is the risk of a project getting stalled midway.

Infrastructure would pass off for the essential services, which means a business plan often follows, not initiates, the project. Does that come in the way of viability?
Any infrastructure is an essential service; but at the same time to attract private capital and bank funding, it has to demonstrate commercial viability. In case commercial viability is not established, it has to be taken up by the government only. For example, water sector in India is still a hugely subsidised sector with retail tariffs set at way below cost of water—which is understandable. Thus the sector is likely to be substantially in government (mostly local bodies) control in the near future.

What are the emerging opportunities for private equity (PE) players in infrastructure in India?
There is a considerable gap in infrastructure demand and supply in India, and we are way below even global averages. Further, there is a high correlation of infrastructure growth with GDP. So, there will be continued demand for infrastructure services for the next few years. For example, power consumption per capita in India is only about 800 kWh per annum, while in China it is 2,500 kWh. In a developed economy like the United States, the consumption is 14,000 kWh. Therefore, it is clear that we need to build a lot of infrastructure.

Clearly, domestic sources alone are not going to be enough to meet this requirement. Foreign capital, both in equity and debt, will be required. For example, the 11th Five Year Plan period (2007-12) envisaged a capacity addition of about 69,000 MW with a total investment outlay (including T&D) of about Rs 10 lakh crore. Of this quantum, equity requirement was estimated to be about Rs 3 lakh crore. It was predicted that there would be a shortfall of more than Rs 1 lakh crore in the equity space. This would have to be filled up by foreign capital through FII, FDI or PE. We have already witnessed a large number of PE players coming to India to help support the infrastructure growth. So the opportunities are immense.

A PE fund is usually high risk, high return, but by the nature of the way infrastructure operations are tied up, the risk is considerably lower. How good is that trade-off? What rates of returns do you normally advise?
It would not be fair to generalise that. Infrastructure investment in India may not be as risk-free as in other, more developed countries because of problems in execution and regulatory uncertainties in certain sectors. PE players would certainly demand a premium for those kinds of risks, both uncertainties around the infrastructure space as well as for the country's rating.

We must remember that global capital tries to find the best risk return profile. We are competing with countries across the globe for this capital. So an investment in a developed country may give lesser return but be perceived as less risky.

It's said the exit route for the private equity in infrastructure is limited—especially since big-ticket projects often entail Special Purpose Vehicles (SPVs). What are your ways to address that issue?
Most PE firms look at exit through listing and, fortunately, India has very robust capital markets. In the unlikely event of listing not happening, there are options for divestment to third parties or buy-back, but obviously the preferred option remains through listing.

Somehow, project advisory is a weak proposition in our banking system. Whether this is because there is a reluctance to invest or a genuine lack of talent, how important do you believe it is to guide a project to its logical conclusion?
I don't think that project advisory is a weak proposition at all in the State Bank group. We have a very experienced and robust project finance team at both SBICAP and Project Finance Strategic Business Unit inside the Bank and our appraisals have been accepted universally by other banks and institutions. In fact, even international banks on our appraisal, as happened in Mundra UMPP, where our term sheet and information memorandum were relied upon by IFC, ADB and K-Exim. PF-SBU and SBICAP are associated with the project right through the implementation phase.

A lot of your energy has gone into mega-projects in the O&G—especially the 15 MMTPA Paradip Refinery for Indian Oil—and power sectors (Sasan). How has your experience been with the really big-ticket projects?
It has been a mixed experience. As I said earlier, the ground situation in India is complex and sometimes there can be delays. For example, for Mundra UMPP, the first unit of project is ready for commissioning but the transmission line being built by Power Grid Corporation of India Ltd (PGCIL) is not, because of a delay in clearances for a small stretch. Nobody could have foreseen that but it is something we will have to live with and have better follow up for the next project. We are also learning about many of these issues as we go along.

What are the best sectors in infrastructure today for equity players to invest in?
I think there is a huge demand for infrastructure across sectors. I would say that sectors that seem slightly down right now—for example, power may give good returns as the valuations are very reasonable currently. You have to believe in the Indian infrastructure growth story and I am sure that temporary crisis will pass. You need to have a long term outlook (at least a couple of years) to realise these gains.

In your opinion, what (apart from what we normally hear—ALMs, tenure) has been the biggest stumbling block for infra project finance? How have you overcome that barrier?
Project finance in India—in terms of project structuring and projections—have evolved considerably over the last few years and is definitely not a stumbling block. This is reflected in mega financing in infrastructure that is being done by commercial banks either on their own or in collaboration with multilaterals and ECS. However, in India, most of the project finance is being done by commercial banks, with the participation from other financial players being minimal. Consequently, most of them are either over-exposed or have exposure to these sectors in excess of prudential limits recommended by the regulator.

It is necessary therefore, that there is greater involvement from other players and more so from those who have access to long tenor money, including pension funds, EPFO, insurance companies etc. These players need to play a more productive role by having specialised dedicated cells dealing in project financing infrastructure. Apart from that, certain regulatory changes in terms of their extent of lending to infrastructure sector is also required. IIFCL, which has been set up to finance infrastructure projects, may also need to play a guiding and leading role rather than following the lead financial institution. Further, they should increase their exposure to the private sector, which is expected to play a more prominent role going forward.

ABOUT SBICAP

SBI Capital Markets was established in 1986 as a wholly owned subsidiary of SBI. The company's expertise in structuring investments in the infrastructure has spanned the spectrum but has particularly been strong in energy and power. The company provides Project Appraisal, Project Finance Advisory, Securitisation and Funds Syndication.