N S Vishwanathan: Issues in infrastructure financing in India
Chief Guest's address by Mr N S Vishwanathan, Deputy Governor of the Reserve Bank of India,
at the 6th National Summit organised by the Associated Chambers of Commerce and Industry of
India (ASSOCHAM) on "Infrastructure Finance - Building a New India", Mumbai, 15 November
2016.
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I am happy to be here at ASSOCHAM's Sixth International Summit on Infrastructure financing.
Infrastructure plays a crucial role in economic development of a country. In India, too like many
other countries, Infrastructure development is a critical aspect of our growth strategy and
therefore, the sector gets the importance from all stakeholders commensurate with that role. As
you may be aware, Government has announced the target of Rs 25 trillion (US$ 376.53 billion)
investment in infrastructure over a period of three years, which will include Rs 8 trillion (US$
120.49 billion) for developing 27 industrial clusters and an additional Rs 5 trillion (US$ 75.30
billion) for road, railway and port connectivity projects. It is also instructive to note here that only
recently, in 2016, India jumped 19 places in World Bank's Logistics Performance Index (LPI)
2016, to rank 35th amongst 160 countries. Infrastructure like ports, roads and airports together
form one of the six parameters for this index. In the journey of a country's progress towards
economic prosperity, infrastructure plays a crucial role and obviously, the need for an effective
and efficient system that provides financial resources to this sector is just as important. It is
therefore only timely that ASSOCHAM is organizing this event.
India's financial system is dominated by banks. NBFCs too play a part in infrastructure financing.
There are NBFCs that specialize in financing infrastructure and certain sector specific NBFCs in
the Government Sector. Of course, banks are the predominant providers of finance to the
infrastructure sector. The flow of bank finance to infrastructure sector has clocked high growth
rates. The outstanding bank credit to the infrastructure sector, which stood at Rs. 95 billion in
March 2001, increased to Rs.9,853 billion in March 2016, a compound annual growth rate
(CAGR) of 39.31 percent over the last 15 years. This of course covers the period of excessive
exuberance when it was fashionable to lend for road projects, power and the like, without the
requisite due-diligence. A look at the data:
This phenomenal growth brought in its wake certain undesirable consequences, like high
stressed assets. More of this later.
A few economic characteristics differentiate infrastructure assets from other asset classes.
These characteristics also make it more difficult to match investment demand and financing
supply:
Firstly, infrastructure projects are often complex and involve a large number of parties.
Infrastructure often comprises natural monopolies such as highways or water supply, and hence
governments want to retain the ultimate control to prevent an abuse of monopoly power. This
requires complex legal arrangements to ensure proper distribution of payoffs and risk-sharing to
align the incentives of all parties involved.
Secondly, infrastructure projects are long term and are therefore subject to various risks
including those due to changes in policies, delays in clearances, etc. Every event that delays the
implementation of a project leads to cost and time overruns that in turn have a bearing on the
techno-economic viability of the project or would necessitate revision in the price of the
endproduct. Very often the infrastructure products are meant to serve public good which imposes a
limitation on ability to determine their price.
Thirdly, where debt financing is dominated by the banking system, the fundamental problem
posed by the asset-liability mismatch is critical. In India, the dominance of PSBs may partly offset
this risk because the perceived assurance of government backing provides the requisite flow of
deposits.
Because of these reasons, there are always challenge in financing infrastructure. At the same
time, infrastructure sector will be a key driver for the Indian economy. Given the high priority that
the Government is according to the infrastructure sector, there is no gainsaying the enormous
potential for financing the sector. As per an estimate, India needs Rs 31 trillion (US$ 454.83
billion) to be spent on infrastructure development over the next five years, with 70 per cent of
funds needed for power, roads and urban infrastructure segments. It is essential that the
stakeholders take the right steps to participate in this move and also make a decent return from
this opportunity.
Let me quickly recall here some of the important measures that the RBI has taken to help flow of
funds to infrastructure:
1. In view of the fact that projects take long time to implement during which the interest cost is
part of the project cost, the importance of a specified time for commencement of
commercial operations is high. Taking into consideration the different reasons due to which
project implementation can be delayed, extension of time for completion of projects has
been allowed subject to certain conditions without change in classification of the loan.
Limited cost overrun financing has also been allowed.
2. Banks are permitted to issue guarantees favouring other lending institutions in respect of
infrastructure projects, provided the bank issuing the guarantee takes a funded share in the
project at least to the extent of 5 percent of the project cost and undertakes normal credit
appraisal, monitoring and follow up of the project. In other cases, banks are precluded from
issuing guarantees favouring other banks/lending institutions for the loans extended by the
latter, as the primary lender is expected to assume the credit risk and not pass on the same
by securing itself with a guarantee i.e. separation of credit risk and funding is not allowed.
3. Normally promoters' contribution towards the equity capital of a company should come from
their own resources and they should not normally grant advances to take up shares of other
companies. However, banks have been permitted to extend finance for funding promoters'
equity in cases where the proposal involves acquisition of shares in an existing company
engaged in implementing or operating an infrastructure project in India, subject to certain
conditions.
4. Banks have been allowed to structure loans flexibly, (what is called as the 5/25 scheme) so
that the repayment schedule is aligned with the cash flows.
5. Banks can raise funds from the market by way of infrastructure bonds, and the assets
financed by such funds are exempted from the Priority sector lending requirements and the
funds raised are exempted from reserve requirements. More recently, we have allowed
banks to raise such funds by way of masala bonds, as well
6. An efficient bond market is an important requirement for raising funds for the infrastructure
sector. This will de-risk the banks' balance sheets as well. We are taking several measures
in this regard. As a part of this we have allowed banks to provide credit enhancement for
bond issuances, subject to certain conditions. In fact we have more recently allowed banks
to jointly provide CE up to 50 percent of the bond issue.
7. Cost of funds is an important element for infrastructure. At the same time, the financiers at
the pre-construction stage need to be compensated for construction risk. Important
measures like allowing setting up of IDFs, both as NBFCs and Mutual Funds, to take over
the post construction assets from banks, allowing take out financing etc., have been taken.
8. We have allowed the debts due to the lenders in case of PPP projects to be considered as
secured to the extent assured by the project authority in terms of the Concession
Agreement, subject to certain conditions.
9. In view of certain safeguards such as escrow accounts available in respect of infrastructure
lending, unsecured infrastructure loan accounts which are classified as sub-standard attract
a provisioning of 20 per cent instead of the prescription of 25 per cent for other unsecured
sub-standard accounts. To avail of this benefit of lower provisioning, the banks should have
in place an appropriate mechanism to escrow the cash flows and also have a clear and
legal first claim on those cash flows.
The Reserve bank has provided additional toolkits to banks to deal with stressed assets. A series
of measures were announced after the framework for dealing with stressed assets was put out
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in February 2014. The mandatory need to form JLF in SMA2 exposures, determining a
Corrective Action Plan or alternative measures to deal with a stressed asset, application of the
flexible restructuring scheme in existing cases, the SDR, S4A etc., were part of the toolkits
provided to banks. Additional time for completion of project was given where there was a change
in management. We have recently reduced the threshold for applying these toolkits to the
existing cases to cover a larger number of entities.
Construction sector, which executes the projects for the infrastructure sector has also been
recently brought within the purview of the flexible restructuring scheme, so that they are in a
position to deal with stress.
I alluded to the stressed assets scenario in the infrastructure sector. The gross NPAs of the
infrastructure sector is about 8 percent of the total advances to that sector and accounts for
nearly 13 percent of the NPAs of the banking sector. Total stressed assets including restructured
standard assets of infrastructure sector was approximately 17 percent of the total banking sector
exposure to the sector and about 21 percent of the total stressed assets. It is only appropriate
that we take a look at this a little closely.
There are several reasons for the higher level of stressed assets in the infrastructure sector.
Firstly, there is a need to properly structure the projects and their financing. These are long
gestation projects that need to have a proper mix of equity and loan funding. The time lines for
completion of project needs to be assessed realistically upfront, so that the date of DCCO is not
artificially fixed without regard to the normal time taken for executing such projects. While a
conservative estimate of the completion time will reduce the project cost, it can potentially sow
the seeds for stress in the form of time and cost overruns. If one takes a close look at the
reasons for extending the time for achieving DCCO, many are anticipatable and would not be
good enough to be considered force majeure.
Second, in many cases, the repayment schedule was not drawn commensurate with cash
flows. There was the prevarication to recover the loan in a much shorter time frame than the
project's revenues would permit. This invariably stressed the entity, very often leading to
repayments being managed through fresh borrowings and the like. This in turn, adds to the cost
and builds stress. We have addressed this by making clear that banks can recover the loans
over 85 percent of the economic life of the project so that further stress is not built because of
how the repayment schedules were drawn in the past.
Third, there were some force majeure factors like change in policies, non-availability of raw
material, and the like.
So what should be done to harness this potential opportunity both to contribute to the nation
building and at the same time make it a win-win for all? I think the answer lies in avoiding the
pitfalls of the earlier experience.
We need to get the project appraisal done the right way. Ensure that all risks are identified
and the project schedule is reasonable. Financiers of infrastructure projects should have the
right risk appetite and also the ability to assess the fundamentals of a project, the
appropriateness of its design and the reliability of the projections.
It has to be ensured that there is a proper mix of financing instruments and sources, and the
right levels of leverage.
Use of corporate bond market to raise a part of the project funds should be encouraged.
Repayment schedule should be properly drawn up and aligned with expected cash flows.
Pricing of the loans should be commensurate with risk and provide for flexible financing that
recognizes the change in risk profile of the asset.
Way Forward
A paper on Infrastructure financing by BIS states as under:
"On financing side, challenges remain. Currently, infrastructure finance is dominated by direct
equity investments and bank loans. Boosting infrastructure finance will require the broadening of
the potential group of investors and the tapping of the vast financial resources of capital markets.
This, in turn, necessitates a broader mix of financial instruments. Both infrastructure funds and
bonds have great potential. The better and more widespread securitisation of bank loans seems
desirable to diversify risks. It may also assist the development of transparent capital market
instruments. For emerging markets, financial market development, trusted legal frameworks, and
the development of a long-term investor base are pertinent"
This is what we should work for. Hopefully, banks would soon move towards credit
enhancement, so that other players are willing to subscribe to bonds issued by corporates
executing infrastructure projects. It is also necessary that those with long maturity liabilities are
encouraged to provide funds to the infrastructure projects.
This apart, I feel there is a huge potential to raise money by way of issue of green bonds. India's
commitment to the Paris Climate Accord, makes it all the more important to work towards
implementing infrastructure projects that are environmentally sustainable because it is both the
need of the hour and there could be alternative sources for raising funds for projects that are
environment friendly. We will have to set benchmarks for evaluation/rating of the emission
prevention/avoidance/reduction that a project brings and harness the financing potential for such
projects.
Let me end by once again thanking ASSOCHAM for giving me the opportunity to share my
thoughts on the subject and I am sure that the deliberations during the day will throw up new and
actionable ideas to facilitate flow of funds for the infrastructure sector.
1Special Mention Account 2 - where principal and/or interest is overdue for more than 60 days.