India needs infrastructure
to grow, but there’s hardly anyone to fund it.
Over the years, banks — the largest financial
intermediaries — have slowly begun to withdraw from the segment after poorly
structured financing, corruption, regulatory loopholes and judicial
interventions inflicted losses that have held them back for nearly five years.
Alternative mode of finance — the bond market —
is shallow and is yet to evolve, making it difficult for anyone with an idea to
build a port or a power plant to find the financial resources.
That has led to the contraction of investments’
contribution in the gross domestic product growth to 29.2%in the second quarter
ended September 2018, from 38.69%in 2012-13, when the growth engine was kept
humming with huge credit from the banking sector.
The outstanding bank credit
to the infrastructure sector which was at Rs 9.85 lakh crore in March 2016,
after compounding an annual 39% for 15 years, fell to Rs 8.9 lakh crore in last
fiscal as banks turned averse to infrastructure lending.
“Form a CASA (current account savings account)
perspective, if infrastructure becomes a large part of a bank’s exposure, there
are chances of asset-liability mismatch,” says Ramraj Pai, president at Crisil,
a unit of Standard & Poor’s. Asset-liability mismatch arises if banks take
oneyear deposits to lend for five years.
One of the reasons for
banks’ infrastructure loans turning bad was that they mobilise one-year, or
even shorter-term deposits for building power and road projects that took five
years to build. This kind of funding became unviable for the projects and
unjustifiable for banks.
Who could fund India’s future? Insurers could be
the answer.
While funds that are lying with both banks and
mutual funds — which form 48% of household savings with the financial services
industry — are of short term in nature, it is the insurance companies which own
funds for nearly two decades as individuals save for their retirement.
“There is a definite win-win situation if
investment becomes a bit more open,” said Vineet Arora, chief executive at
Aegon Life. “There is a mandate of putting money into infrastructure. If we get
freedom to choose and increase the limit into infrastructure…. It is good if we
can get a paper of 20-30 years, whether it is infrastructure or government
securities. It helps us design our asset liability and that is why you see
insurance companies globally being big investors in infrastructure.”
But that needs a sea change in the way the
regulator looks at projects, especially the ones that take years to begin
payments.
INVESTMENT RULES
Insurance companies, which are custodians of the nest egg of
millions of middle class men, are guided by the rules laid down by the
Insurance Regulatory & Development Authority of India (IRDAI) where
prudence takes precedence over returns.
The IRDAI stipulates that life insurers invest
50% in government bonds, 35% in other approved securities and 15% in
infrastructure firms. It prohibits companies from investing in bonds rated
below AA.
That makes a substantial
portion of the bonds outstanding in the market as no-go area for insurers. As
far as top investment grade bonds are concerned, there are hardly any
infrastructure companies. How does one solve the issue where one segment is
crying for fund and the other that has it in plenty is unable to lend?
The regulator needs to relook at its investment
guidelines.
“A combination of more sophisticated oversight
to make sure that risks are not building up in the insurance sector, plus a
greater degree of liberalisation has to happen because at the end of the day an
insurance company is an asset manager,” says Jaideep Khanna, head of Barclays,
Asia-Pacific. “As the insurance sector becomes more sophisticated, they should
be offering different kinds of products and provide capital to fuel the growth
of the country.”
While there is a need for making long-term funds
available for long gestation projects, there is inherent worries about these
projects and the returns associated with them.
“Many infrastructure loans that have turned sour
have been covered by government guarantees,” said J Hari Narayan, the former
chairman of IRDAI. “The government has not delivered on its guarantees. Banks
can’t take on a government after it fails to honour the guarantee.”
ALL INFRA BAD?
Wild swings are part of the markets. Banks are no exceptions
to exuberance and depression. The publicprivate partnership was peddled as the
panacea for Indian infrastructure.
That led to influence peddling to win contracts
that paid for generations without much equity. This led to excessive leverage
that, in many cases, resulted in a company having a debtto-equity ratio of 10
times or even more. Furthermore, a large scale siphoning off of funds too made
many projects unviable.
“We need to get the project appraisal done the
right way,” RBI deputy governor NS Vishwanathan had told industry in 2016, when
bad loans crisis had crippled banks. “Pricing of the loans should be
commensurate with risk.”
Apart from unviable projects, the poor funding
structure added to the woes.
A successful infra project could be like that of
the Mumbai-Pune Expressway, that was conceived in the 90s and commissioned in
2002. Despite cost overruns, it was completed for Rs 1,630 crore. Sixteen years
later, the project is being bid out at Rs 9,000 crore for another 15 years of
toll collection.
Roads and other infrastructure assets may not be
viable at early stages, since they do not generate much cash to service debt,
but in the long run most of them turn viable with financial engineering.
Canary Wharf, the world’s
biggest financial district in London that sank Paul Reichmann’s Olympia & York,
is a testimony to how infrastructure projects even after going kaput can come
back to life with increased economic activity.
NEED TO CHANGE
On paper, the regulator has mandated insurers to invest 15%
in infrastructure. But the purpose is getting defeated in the absence of
relaxation of rating requirements for investments. These firms invest in
AAA-rated infrastructure bonds. Most of the target is met by lending to
government-owned infra financing companies like REC, PFC and IRFC making a
mockery of the intention. The definition was expanded in 2012 to include
housing finance companies, one of the .. safest segments for
infrastructure exposure.
“For private insurance companies, taking credit risk is hard,” said Prashant Tripathy, MD and CEO, Max Life. “If any project goes bust, the insurance company will go bust.”
The average under-construction project is rated BBB, which insurers can’t buy into. Once a project is complete and starts generating cash, the rating automatically gets upgraded, but begins to yield less and leads to a missed opportunity to own a higher yielding paper.
India needs $4.5 trillion to be spent on infrastructure developments over the next 25 years, estimates the latest Economic Survey.
In fact, rating companies proposed a different rating scale for infrastructure firms based on likely recovery of dues over the life cycle of a project by factoring in the possibility of refinance or restructuring. This would be on the scale of EL 1 to EL 7. But IRDAI is yet to take a call.
One way to begin could be with government beginning a ‘risk fund’ that could comfort the insurance regulator in relaxing the rules.
“The government should create a huge risk fund, which can be offloaded to pension and insurance funds when the date of commissioning is decided,” says Narayan. “Insurance companies do not take the initial risk as they are not designed to take risks of that magnitude unless it is properly shielded.”
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