The right path for infra financing

It is evident now that the only way to revive the Indian economy from its long slumber is to kickstart infrastructure projects. While various policy initiatives from the Government hold the key to rev up stalled projects and revive the capex cycle, infrastructure spending is vital. Infrastructure Debt Funds (IDFs), which were conceived to provide an additional funding route for such projects, appear to be well on track, tapping into pools of private capital.

Given that the Government can cough up about half the amount needed to fund long-term infrastructure projects, and the slowdown in the economy has further crimped the flow of government funds, more participation from the private sector is imperative to sustain long-term infrastructure development.

Banks, particularly public sector banks, have been at the forefront, providing the necessary funding and taking on risks associated with these long gestation projects. But banks’ increasing exposure to the infrastructure sector has led to asset liability mismatches in their balance sheet and increased their stock pile of stressed assets.

IDFs will not only free up banks’ balance sheets to take on fresh lending but also provide borrowers a low-cost financing option. This, along with infrastructure bonds that banks are now allowed to issue, should see greater participation from the private sector.

The Finance Minister in his Budget speech for the year 2011-2012, announced the setting up of IDFs, and the RBI subsequently issued guidelines in September 2011 for setting these up.

IDFs are investment vehicles which can be sponsored by commercial banks and non-banking financial company (NBFCs) in India. Domestic or foreign institutional investors, specially insurance and pension funds, can invest through units and bonds issued by the IDFs.

An IDF can be set up either as a trust or as a company. A trust-based IDF is a mutual fund that is regulated by market regulator SEBI, and issues units to the investors. Under the company-based format, the IDF is an NBFC that issues bonds to investors. The IDF-NBFC is regulated by the RBI.

So far, three infra debt funds have been set up through the NBFC route and one through the MF route. For now, IDF-NBFC appears to be a preferred route for raising funds. The advantages of this route lie in the distinction between the two different formats.

There are three notable distinctions. One is the scope of financing. IDF-NBFCs are allowed to invest only in infrastructure projects which are created through the Public Private Partnership (PPP) route and have successfully completed one year of commercial production.

Hence these debt funds can finance projects under NHAI, ports, airports and metro rail . As they lend only to operational projects, they do not carry any construction risk.

The other risk mitigating features include a tripartite agreement between the project authority, the company and IDF-NBFC, and a compulsory buyout with termination payment, in case of a financial default.

However under an IDF-MF route, all projects — even the ones that are under-construction — can be financed. Hence the risk under this format is much higher.

The second distinction is more from an investor’s point of view. In case of the NBFC route, the money is raised through the issue of bonds, which is rated by a credit rating agency. The money raised is then lent for infra projects.

However under an MF route, each scheme lends to different projects, and investors in these schemes take a direct risk and exposure to such projects.

The last distinction is more technical in nature. IDF-NBFCs are allowed to issue bonds and hence can leverage themselves. Given that they need to maintain 15 per cent of risk weighted assets as capital, they can leverage themselves several times of equity of the IDFC-NBFC. Hence they can borrow more to lend more and so the costs of funds are cheaper.

In the case of IDF-MFs, since they issue units, question of leverage does not arise.

Hence the NBFC route is a lot easier to market, because it is easier to raise money through the bond market and pay a certain coupon rate. Under the MF route one cannot indicate rates and investors take a direct risk in the funded projects.

That said, one cannot ignore the merits under the MF route either. The market for an IDF-MF is larger as it can finance all projects. As this route gains acceptance among the more mature class of investors, it will play a vital role in infrastructure financing over the long-run.

While infrastructure debt funds may appear tiny in the larger context of banks’ lending exposure to the infrastructure sector, over the next three to four years, these can make a huge difference in pooling private funds.

Banking sector’s lending to the infra space is about ₹8.7 lakh crore. This is the entire market for IDF-MFs. But for the NBFC format, the market size may be a fifth of this. While this number looks small, it will still help free up some of the banks’ funds for new projects. Also as the MF route gains ground, more assets — even riskier ones — can be taken over. Currently there are three IDFs under the NBFC format. L&T IDF, sponsored by L&T Infra Finance, has raised about ₹750 crore so far, and expects to have an asset base of about ₹1,000 crore by the end of this fiscal.

India Infradebt is another fund that is sponsored by four leading financial players and is said to have raised about ₹300 crore. The third fund is sponsored by IDFC, which is now transitioning into a bank and will transfer part of its assets under IDFC to the debt fund.

The general expectation from industry players is that over the next three years, IDFs through the NBFC route will be able to fund assets worth ₹25,000 crore.

IDFs are also well on track in providing fairly cheaper finance. Corporate borrowers are lent money at 10.5-11.5 per cent. This will improve the financial viability of infra projects.

IDFs can thus complement banks in financing long term infrastructure projects. Public sector banks have been more active in lending to long gestation projects, which requires taking on the completion risk in the initial stages of the project. Banks are likely to increase their lending activity, given the regulatory leeway in raising funds for such projects.

The Reserve Bank of India (RBI) in July allowed banks to raise funds for lending to infrastructure sector without regulatory requirements such as CRR, SLR and Priority Sector Lending targets.

The RBI has now allowed banks to lend to very long-term projects, with an option to refinance it periodically. Banks can, say, lend for a 25-year project, with an option to roll it over after five years.

Hence, as the loan comes up for refinancing, it may be taken up by the same lender or a set of new lenders. This is where IDFs can step in and help banks free up funds for deploying in new projects. As the economy revives and the new capex cycle picks up, IDFs will play a central role in bringing in long-term funds for infrastructure project finance in the country.