We can’t shy away from PPPs

PR Jaishankar, Chief General Manager, India Infrastructure Finance Company Ltd (IIFCL) says that old models of development financing need a complete overhaul. He feels while development financing still holds relevance, it needs to be viewed in the context of the dynamic needs of the emerging environment.

With the government proposing a significant outlay of nearly Rs 4 lakh crore for infrastructure development in Union Budget 2017-18, do you foresee any marked rise in your capex for this year?
Actually, the required amount of infrastructure outlay was assessed quite some time ago. Looking at certain parameters like the exchange rate or current project pipeline, I think it is going to be higher. Of this requirement, I expect a large portion to be in sectors like energy, roads and highways and urban transport; which, as per the Department of Economic Affairs (DEA) data, had together accounted for nearly two-thirds of the total infrastructure projects in the country in the past.

However, such an investment might be constrained by the fact that the inflows are still sticky due to a number of issues relating to impaired assets. Problems relating to bank capitalisation and the impending Basel-III norms will also take their toll on the investments. But if we need to sustain our economic growth, we need world-class infrastructure.

With respect to IIFCL’s capital expenditure, as a financial institution, our main job is financial intermediation. We have assessed our annual disbursements to be between Rs 8,000 to Rs 10,000 crore annually. So far, our loan book has crossed Rs 32,000 crore and our net worth is over Rs 7,000 crore.

We have the appetite to borrow more and depending upon the flow of projects to IIFCL, we can also look at higher levels of lending. With the present level of capitalisation, we have the capacity to grow our loan book by up to Rs 60,000 crore.

However, we are constrained by our mandate called SIFTI (Scheme for Financing Viable Infrastructure Projects), which poses some restrictions on us, like our funding to projects cannot exceed 20 per cent of its cost. These are in addition to the RBI’s prudential norms that we are already complying with, being an NBFC. Also, our mandate restricts us from having an active treasury. This limits our ability to circulate our funds and also to invest in a number of instruments. In the absence of such restrictions, IIFCL would be able to make a much greater contribution to the sector.

Prime Minister Narendra Modi had earlier urged the capital and bond markets to focus on infrastructure spending to spur development. Has the industry responded well to this suggestion?
As a developing sector, infrastructure is about one-and-a-half decades old. We have seen ups and downs, with more of downs in the recent years.

But then again, there have been a number of achievements as well. The kind of infrastructure we have today is because of the financing that has been done by banks. With this government coming into being, greater emphasis has been accorded to infrastructure, particularly in resolution of various issues that have dogged major projects through formation of special committees monitored directly by the Prime Minister’s Office (PMO).

That has helped resolve issues pertaining to projects worth over Rs 5,000 crore. The advantage of such high-level monitoring is that multidisciplinary issues involving a number of ministries and stakeholders can be resolved in one sitting. This is something which was never seen before, and has helped revive numerous stalled projects.

Secondly, the regulatory environment has also become stimulated due to a number of recast schemes announced by the RBI. There are certain issues with some of these schemes, but they have at least helped revive projects in the short- and medium-run. IIFCL has also contributed to the development of schemes like the 5/25 scheme, which have been implemented successfully and have seen a lot of interest in the market.

New products have also been introduced. The corporate bond market for the infrastructure sector has been a longstanding demand. With ratings being in the range of BBB and BBB-, infrastructure developers have not been able to access the bond market effectively. To bridge this gap, IIFCL has successfully brought out a product called ‘credit enhancement’ to further help develop the corporate bond market. We also have banks looking to address their non-performing assets in conjunction with joint lenders.

We will face a big challenge once banks start retracting on account of the Basel-III norms that require higher amount of capital, particularly for greenfield projects. This will impact cost economics. Secondly, there will be some challenges with respect to project inflows because the investment climate will continue to be a major concern unless we get the private sector interested to invest in the infrastructure sector.

Credit growth is again dependent on both banking exposures and new investments and inflows. In my view, government, banks, concessionaires and developers must adopt the partnership approach on new projects and resolve the structural issues on the fiscal side to achieve long-term objectives.

Which model of finance will be flavour of the season this fiscal? Do you think public-private partnership (PPP) projects will pick up traction anytime soon?
PPP has been a learning experience for us, and we can’t shy away from it. Historically, governments across the globe have kept infrastructure with themselves because it is for the public good. But looking at the higher rates of growth and requirement of world-class infrastructure, private sector participation became inevitable.

Today in India we have some of the world’s largest projects underway, and new concepts and technologies which require huge investments. We, therefore, need very active participation by the private sector. As long as you have the requirement of private sector funding, you will need public-private partnerships.

In the context of dynamics of the emerging environment, you need to tweak around and reform the PPP process, with more emphasis being given to the third ‘P’. Unless we have that kind of an approach, the private sector won’t feel confident enough to invest. To answer your question, PPP is here to stay, and will need to be developed further. You just can’t have a controlled approach that concessionaires were following so far. It has to be instead a 50:50 result and market-oriented partnership.

Moving on to the topic of credit enhancement, there is a growing view that commercial banks might no longer be the best bet for infrastructure financing. What is your own take on this issue?
Commercial banks are not the best vehicles for financing the infrastructure sector because of their legacy in raising funds. They have mainly short-term sources and innumerable depositors, with depositor protection being a very important domain of the banking regulator. In the 1990s and early 2000s, working capital was the major financial domain of commercial banks insofar as core industries were concerned.

Both core industries and the infrastructure sector require long-term financing. So, long-term financing and short-term sourcing doesn’t augur well for a commercial bank as it will eventually result in an asset-liability mismatch. But looking at it from the point of view of cost-effectiveness, commercial banks have been the best source for funding for the infrastructure sector, because they were easily accessible and their CASA helped to make this financing possible for up to 15 years at fairly reasonable interest rates.

However, going forward, that will not be possible because we are getting into an international regime. With Basel-III (norms) coming in, we are required to conform to global capital adequacy norms. We will have other monitoring parameters also kicking in.

Globally, project bonds are being increasingly used for financing infrastructure. As per a report issued in 2014, available on the website of the Reserve Bank of Australia, the ratio of bonds to loans over the past five years (2009-13) has hovered between 30 to 40 per cent. In case of India, the bond market will form the mainstay of infrastructure financing in the future; however, it is presently underdeveloped.

Since the infrastructure sector’s funding requirements are mammoth, banks can’t shy away from taking some stake there. But that can’t be like how it was earlier. This gap will have to be filled in by other institutions.

There is a need for large development finance institutions to start catering to diverse sectors. Sectoral expertise will be the mainstay in long-term financing of such specialised sectors. With the size of future projects expected to be very large, you can’t expect a consortium of 20-odd banks to take decisions on various parameters as that might cause unnecessary delays. What we need are five to six large players with the necessary wherewithal to appraise projects.

Banks can probably be the second-tier players, who can accept the down selling by major financiers. Secondly, banks can also take up the construction risks for the initial years. The bond market can take over once the Commercial Operations Date (COD) is achieved.

Structured finance is going to be the hallmark for future infrastructure lending in such areas. We can probably expect to see a number of new financial innovations.

Innovations will be in the way institutional credit is going to be structured. From the point of view of financial intermediation between the bond market and infrastructure projects, there could be huge scope for financial engineering and structured finance to help channelise funds from the bond market to the infrastructure sector.

You seem to be suggesting that in the future, different segments of infrastructure would be catered to by specialised financial products. Is that right?
Yes, that’s absolutely correct. You will need to know the revenue model for each infrastructure project. Now that will vary by sector. So, sectoral expertise, followed by revenue models, will become the indicators for determining that. These will have to be again factored into the development finance model for structuring credit flow into the new ecosystem. As a multidisciplinary aspect, it will have to involve engineers, valuers and research agencies to help in assessing project demand.

The Union Cabinet recently permitted financially sound state government entities to borrow directly from bilateral Official Development Assistance (ODA) partners such as Japan International Cooperation Agency (JICA) for implementation of vital infrastructure projects. How do you view this development?
Multilateral lending agencies are among the most important sources of funding for infrastructure projects, because they grant long-term project loans. There are challenges as well, because you have to be well aware of the compliance requirements. Looking at it from the global perspective, this will only serve to positively impact investor sentiment. Therefore, even if there is a certain cost to it, it is worthwhile. But government guarantees required for any multilateral loan might prove to be a dampener. As of today, the government charges about 1.20 per cent commission on such guarantees, which does not make the borrowing viable. For a government entity with credit rating of ‘AA’ or ‘AAA’, the cost of borrowing domestically works out to be much lower if you factor in the hedging cost as well as government guarantee fees for borrowings from these multilateral lending agencies.

If the government can look into this aspect and adopt a fairly reasonable structure, it will make such borrowings viable. Otherwise, state-owned entities, who are already ‘AAA’- rated, may not be very eager to solicit funds from multilateral agencies.

What facets must one look out for vis-a-vis development finance?
In one of his recent interviews, senior economist and former RBI Governor Dr C Rangarajan said that it would be premature to write off development finance. Although I completely agree with him, development finance is no longer relevant in the form it existed three decades ago. At that time, it was a direct credit regime, while today we are in a market-oriented environment. But as a concept, it is still valid because it can help a sector like infrastructure grow in a robust manner.

We need to focus on all the three major pillars of development finance, namely promotion, development and financing. The promotional angle mainly involves developing institutional capacities to integrate various multidisciplinary issues so that they can all be addressed under a single window.

For example, it could be about issues related to environment, energy, tariffs, land acquisition and other regulatory approvals. Development implies building of skills, training and research capacity to introduce more specialised personnel into lending. The third would be to help financial intermediation.

Again, in today’s environment, it is completely different from what existed in the past, which was more of a simplistic refinance. Today securitisation has to take the centre-stage in refinance, and for that a central warehouse is required. As a secondary market institution, it helps wholesale lenders to generate loans, and then assign those loans to the central warehouse under a single window for recycling.

The secondary market has to be developed to stimulate bond investors to contribute liquidity. Unless you have an active secondary market, you won’t be able to achieve a near-perfect primary market. It is a model that financial intermediation has to look at.

In all these three facets, a development finance institution, preferably with government support, has to be there. Other than IIFCL, there are other players like the Industrial Finance Corporation of India. Then there are players in other sectors too like Power Finance Corporation, Rural Electrification Corporation, Indian Railway Finance Corporation, etc.

These specialised institutions, which have government backing, could probably act as frontline institutions to their respective sectors. This could be the first step towards putting in place the new architecture of development finance that is required in the present environment.

– Manish Pant