India looking inside out for more efficient capital

While at home India’s central bank dictates corporate debt spreads across the institutional investor spectrum, Modi’s government looks abroad to encourage funding for the country's highway construction programme.

The Reserve Bank of India (RBI), India’s central bank, yesterday announced it had set the cap on banks’ allowance to buy bonds issued by other lenders to 2 percent of the purchasing bank's tier 1 capital, all the while requesting that at least 80 percent of corporates’ debt issuance be reserved to a diverse range of other institutional investors.

Concurrently, the Modi Administration was reported in the local press to be seeking support from Japanese and Malaysian export-import (EXIM) banks to fund India’s road transportation through preferential lending conditions to domestic private developers, as the country’s construction capacity lags behind due to developers’ indebtedness, the lending restrictions on banks, and persisting red tape in the way of more foreign direct investments.

“The debt market in India continues to be shallow. RBI’s announcement is a good step but it is not going to have a major impact immediately, since the market provides very limited access to the infrastructure companies and currently the limited activity is also restricted to largely funding annuity projects with no traffic risk,” noted Aditya Aggarwal, a partner at Mumbai-based asset manager IDFC Alternatives.

“The issue with toll based projects is that they are not able to procure investment grade rating owing to the risk associated with uncertain traffic growth. If the banks can indeed partially offer credit enhancement to these projects, at least a few large financially strong projects may reach investment grade and may be able to offer their debt in the corporate bond market.”

Prime Minister Narendra Modi has pledged to improve India's ageing infrastructure and is aiming to provide housing for all by 2022, a plan said to require approximately $2 trillion of investment.

Looking to the private sector at home, and acknowledging the need to allow banks to cross-hold each other's bonds, the central bank in April eased its ban on such holdings.

The institution however specified that no more than 20 percent of infrastructure bond issues could be earmarked for banks, while the rest must be spread across other diverse investor groups.

The RBI has also placed a cap on the investing bank’s ability to hold long-term infrastructure bonds at 10 percent of its corporate bond portfolio.

The bank has recently been issuing policy to develop a market for infrastructure bonds so as to encourage long-term investors such as pension, insurance and provident funds to buy securities issued by banks to fund affordable housing. The country's parliament has also allowed insurance companies to open up to 49 percent of their capital to foreign direct investment from 25 percent previously, in order to enable more equity to flow to infrastructure.    

As part of the governments’ efforts to enhance foreign consortia’s participation in the development of India’s road construction programme, Malaysian officials are expected to visit India soon to evaluate highway projects for investment under the hybrid-annuity model. Under this scheme, 60 percent of the project cost has to be borne by the private investor.

The remaining 40 percent will come from the National Highways Authority of India in five equal installments.

The government will also bear the revenue risk in projects where there is a low anticipation of traffic flow, the bank said. Highway projects covering an 8,000-kilometre stretch and worth ?1 trillion (€14.3 billion; $15.7 billion) were awarded during the financial year 2015. The government will be auctioning off road projects covering 5,000 kilometres and worth about ?1 trillion after they are completed. 

IDFC foresees that India will see a surge in activity around road building in the next few months. According to Aggarwal, the participation of EXIM banks will help expand overall debt availability for the sector. It is also expected to help correct the current issue of high-cost, low-tenor debt mismatched with concession lives.

“There is a transformation that is expected with financially and technically stronger developers backed by financial investors carrying out the second phase of growth in Indian highways build out provided that there is a reallocation of risks between the State and the private sector especially around permitting, right of way, land acquisition and environmental clearings,” Aggarwal said. 

“In that context, foreign EXIM banks’ lending to the international companies/ projects could help those developers, who for some like Malaysia and Thailand that have been active in India for over the last five to 10 years now, to continue undertaking new projects and expand more actively than in the past.”