Insurance and pension funds are best suited for infra investments

Since infra projects are long term projects, Infrastructure Debt Fund (IDF) can bring in the big push in the sector as innovative means of credit enhancement is expected to provide long term, low cost debt, says D. V Prasad, Head-Finance, Essar Projects, in an interaction with Sumantra Das.

Do you think IDF can catalyse infrastructure growth in the country?
Yes, absolutely. Setting up of IDF will accelerate and enhance the flow of long term debt and attract offshore funds into IDFs that withholding tax on interest payment and on the borrowings by the IDFs would be reduced from 20 per cent to 5 per cent. It requires long term financing in order to be sustainable and cost effective. However, banks which have been the main source of funding for these projects are unable to provide long term funding given their asset-liability mismatch (ALM) and also banks are approaching their exposure limits. Finally, IDFs provide long-term, low cost debt for infrastructure projects by tapping into the source of savings like insurance and pension funds.

Will Parekh Committee report be able to create a sustainable environment for infrastructure sector?
The high-level committee has recommended for 100 per cent Foreign Direct Investment (FDI) in the telecom sector from the present level of 75 per cent, and also recommended for prompting Public-Private Partnership (PPP) for developing projects in sectors such as rail, ports and airports. We all know that the power tariffs will have to be set at a sustainable level and improve collection efficiency and reduce losses. In addition, the Committee has suggested that the progress of projects, award of contract in the infrastructure should be monitored on monthly basis by the Cabinet Committee on Infrastructure (CCI). In my opinion, on implementation of the Parekh Committee report, the infrastructure sector will definitely receive a boost.

Where are we lacking, policy paralysis or lack of funds?
I believe this is because of policy frameworks prevail in the system only in a bureaucratic form. The government has been unable to implement a clear cut policy for faster infrastructure growth yet. The 11th Plan has originally envisaged investments of Rs 20.6 trillion, while investments worth only Rs 7.8 trillion (38 per cent) have been channelled in the sector till March 2010. Frequent change of regulations, alteration of tax regime, monitoring economic developments etc, may affect the revenues and returns due to long term of projects. Already, execution of projects has slowed down mainly due to land acquisition, environmental clearance, restrictive regulations and consequent litigation. For example, the major delays in the road sector stemmed from frequent management changes, capacity constraints at National Highways Authority of India (NHAI), finalisation of the Model Concession Agreement (MCA), restrictive policy frameworks, and instances of single-bid projects not being awarded.

The major stumbling blocks are conflicts of interest, termination clauses, and caps on the number of bidders that led to considerable litigation. The execution of infrastructure projects is very slow also due to pressure on budgetary resources, bank funding, long term tenure loans, and restrictions on external commercial borrowings (ECBs). Debt financiers perceive infra¡structure financing as risky because of its non-recourse or limited recourse nature.

Analysts suggest that 50 per cent of development and growth can be attributed to infrastructure investments in any developing country. Do you think introduction of IDF will bring a big push in the sector?
IDF will definitely herald a big push to the sector as innovate means of credit enhancement is expected to provide long term, low cost debt which is not possible through banks. By refinancing the bank loans of existing projects, IDFs are expected to take over a fairly large volume of existing bank debt that will release an equivalent amount for fresh lending to infrastructure projects. The IDFs will also help accelerate the evolution of secondary market for bonds.

How do you see implementation of IDF in India’s infrastructure story? Do you find any loophole?
IDFs may be set up like a mutual fund (MF) that will issue units, while a company-based IDF would be normal form of Non-Banking Finance Company (NBFC) that would issue bonds. In case of IDF as a trust-based mutual fund would be governed by Securities and Exchange Board of India (SEBI) and IDF as a company-based would be governed by Reserve Bank of India (RBI).

The industry believes that IDFs set up through NBFC as a companies will only allow them to invest in PPP projects after one year of commencement of the projects, thereby restricting the number of projects available through IDF route. In addition, a cap of 49 per cent promoter’s stake is also delaying the process for companies to find partners as a biggest challenge for raising the funds at competitive rate. In case of an MFstructure, the loopholes are the entire credit risk with the end-investor with no opportunity for credit enhancement guarantees. The funds will also be rupee denominated units resulting in currency risk for foreign investors due to hedging cost.

Recently, the government has taken some steps to invest money into the sector. According to you what other policy initiatives need to be taken?
In my opinion, the government has to take initiative in removing the bottlenecks. Budgetary support is required for development of infrastructure projects. Though banks are the largest source of funding, they have to come with flexible interest rate (through annual resets) and longer tenors to match the requirement of the projects.

Bonds are source of low-cost long term funds but Indian bond markets are under-developed and ill-liquated and also the country’s sovereign rating needs to be upgraded to attract foreign financial institutions. Due to lack of adequate information with government agencies and regulatory issues, many projects suffered from clear-cut implementation, schedules and targets. It results in time or cost overturns, significantly increasing the project cost.

Is there any other avenue from where the funds can be generated and utilised in infrastructure sector? Do you think money can come from offshore pension funds too?
Funds from insurance and pension sectors are best suited for infrastructure investments given their long term and low cost nature. However, so far, funding to infrastructure from these sources has been conservative due to the regulatory frameworks and the insurers’ own profit considerations. Infrastructure projects are executed through formation of Special Purpose Vehicles (SPVs) that have equity capital on their balance sheets. These companies raise funds through loans and cannot access the bond market due to lower credit rating and not rated at all. Normally, insurance companies will invest in AA rating and most of the infrastructure companies will have lower ratings. Hence, it is recommended to make a suitable credit mechanism in place for the bonds. Some of the other avenues where funds can be generated and utilised in infrastructure sector are corporate bonds, take-out financing and introduction of new products like tax swaps, total risk swaps, partial risk swaps, preference shares as underlying securities, hedging instruments (interest rate swaps, credit default swaps, foreign exchange hedging instruments and commodity hedges).