New dawn for India(2)

As the Bandra Worli Sea Link in Mumbai opens for traffic, Varun Jain examines what India's recent election means for the country’s infrastructure.

“Infrastructure is a fundamental enabler for a modern economy and infrastructure development will be a key focus area for the next five years. Public investment in infrastructure is of paramount importance. Bottlenecks and delays in implementation of infrastructure projects because of policies and procedures, especially in railways, power, highways, ports, airports and rural telecom will be systematically removed. Public-private partnership (PPP) projects are a key element of the strategy. A large number of PPP projects in different areas currently awaiting government approval would be cleared expeditiously. The regulatory and legal framework for PPPs would be made more investment friendly.”


These words were part of president Pratibha Patil’s welcome address to Houses of Parliament after the Indian elections in May 2009.


Montek Singh Ahluwalia, in his first press conference after being reinstated as Deputy Chairman of the India’s Planning Commission, said there would be both budgetary and extra-budgetary resources available for infrastructure spending. Meanwhile Manmohan Singh, the prime minister returning to office, challenged his newly elected government to provide a social and political environment in which new investment can be made.


The Indian elections


The Indian political landscape is no stranger to unexpected outcomes and shock results, and the re-election of the United Progressive Alliance (UPA), the Congress-led coalition, in May 2009 was no exception. While most commentators were expecting a long-fought battle, the UPA’s almost simple majority in the world’s largest democracy came as a welcome surprise to the economy. India’s benchmark index, the BSE Sensex, rose by over 17 per cent on the first day of trade after the declaration of the electoral ballot. There could not have been a more positive reaction by the market to the arrival of a stable government – perhaps the most stable in over two decades.


Bandra bridge: Ten years in the making

But what lies ahead is an uphill battle for the UPA. It has made several promises which it must work towards fulfilling as expectations to deliver are high – especially now that the Congress party no longer needs the support of the Left to sustain its parliamentary majority, as it did during the previous term. The excuse that implementing liberal reforms is being made difficult by the Leftist parties is no longer available to the Congress party.


Immediate hopes include the turnaround of the worsening fiscal deficit, disinvestment in several PSUs, oil price deregulation, increasing Foreign Direct Investment (FDI) in the insurance and retail sectors and most importantly, a substantial increase in infrastructure spending to stimulate the economy.


As far as political will and motive are concerned, there is plenty – the bold statements by those in charge clearly reflect it. Supplementing this will is another crucial factor critical in Indian politics: continuity. With key members of Manmohan Singh’s cabinet having retained their responsibilities, they now have the opportunity to build upon the progress achieved in the previous term. All these positives add to case for the government delivering on its bold promises. The key question is whether it can.


Catch 22: infrastructure spend vs. fiscal deficit

There exists an investment need of $500 billion in infrastructure [1] over the period of the Eleventh Five Year Plan [2] for India to sustain its forecast growth rate of 9 per cent of GDP. Of this ambitious target, 30 percent [3], or $150 billion, is expected to come from the private sector.

India’s limited dependence on exports compared to other emerging markets, its buoyant domestic demand and high savings rate will likely see it weather the current economic climate better than most others. However, the state of the nation's infrastructure is seen as the biggest impediment in India’s growth and if not tackled efficiently it could stall the nation’s recovery once the global recession has surpassed.

Another key element in the case for the infrastructure spending is India’s demographic profile. With over 50 per cent of India’s 1.2 billion population under the age of 25 and per capita income to increase by 100 per cent [4] over the next decade, the nation will see the emergence of a new middle class that will put amplified pressure on existing infrastructure. Backed with increased purchasing power, the changing mindset of the Indian masses will demand higher quality of living and improved facilities. All these dynamics will result in increased demand for infrastructure with the subsequent spend itself acting both as a cause for, and a consequence of, economic growth. 

However, while the economic and long term rationale suggests increased infrastructure spending, the country is grappling with one of the largest fiscal deficits in the world, which is expected to reach a staggering 11 per cent [5] of GDP in FY2008-09. In light of this, the government is considering divesting stakes in as many as 16 Public Sector Undertakings (PSUs) as a means to reduce the glaring deficit. Other remedies being hinted at include oil price flexibility and reduced spending on energy and fertilizer subsidies. But the bottom line remains that despite these initiatives, it will take some time to bring the fiscal deficit back to manageable levels, and for the time being at least, the country must follow a prudent fiscal policy. 

The conflux of the increased infrastructure spending requirements and the burgeoning fiscal deficit leaves India with only one viable option to meet its forecasted growth: substantially stimulate the private sector’s participation in infrastructure.

The government, therefore, is keen to invite private capital into infrastructure. The Public Private Partnership (PPP) route is being touted as the best bet at leveraging private sector participation into the sector.

Current PPP initiatives

The Indian government has had its share of problems in making PPPs a viable option for private participants, but the administrators have learnt from their mistakes and are taking a more systematic and integrated approach to the problem. Over the last couple of years a lot of groundwork has been put in place to invite foreign capital. This includes raising the FDI limit to 100 percent for almost all infrastructure and related sectors, as well as easing the External Commercial Borrowing (ECB) norms. These are interesting developments from the point of view of strategic players looking to enter the sector. From a project-specific perspective, the government has established a Project Development Fund to finance preparatory expenses of PPP projects and a Viability Gap Funding Scheme to grant assistance of up to 20 per cent of the project capital costs for competitively bid infrastructure projects that can be justified in social returns but carry an ‘unacceptable commercial rate of return’.

Apart from these measures, India has also established the India Infrastructure Finance Company Limited (IIFCL), a body to help provide long-term debt financing and refinancing to infrastructure projects. The IIFCL was recently allowed to raise  $8 billion through tax free bonds for funding infrastructure projects [6]. There are ongoing talks to allow even existing projects as opposed to just new projects to tap into the refinance window opened up by the IIFCL. 

Current perspective

Thus far, despite these initiatives aimed at stimulating private investment, the big wave of private funds expected to enter the Indian Infrastructure sector from foreign shores has gone amiss. However, there remain encouraging signs that the efforts are paying off and things have finally started moving in the right direction. 

During the period August 2008 to January 2009, the government had accorded approval to 37 infrastructure projects worth $14 billion. In terms of PPPs, it provided in-principle approval to 54 central sector infrastructure projects with project costs of $14 billion and final approval to 23 projects for viability gap funding amounting to $6 billion [7]. From an FDI perspective, the period April – December 2008, saw FDI grow by 45 per cent year-on-year with $23 billion in commitments.

Meanwhile signs of a capital market recovery are surfacing as firms have used the recent rally in the secondary markets resulting in improved valuations to tap the primary markets through the less regulated Qualified Institutional Placement (QIP) route. A recent report released by PricewaterhouseCoopers (PwC) urged Engineering and Construction (E&C) companies to look to India for growth as domestic markets contract [8]. Finally, recognising India's promise, the United Nations Conference on Trade and Development (UNCTAD), has declared it the second most-preferred global location for foreign investment during 2008. 
Challenges and solutions

While there are positives, there is no doubting the fact that major impediments still remain in the Indian infrastructure sector, with the availability of finance being the most significant. For infrastructure projects to be viable, they require long-term debt financing at stable rates below a certain threshold as a perquisite. This hold true even more for projects in India, which apart from being very debt heavy, have seen a rise in debt-to-equity ratios in recent years [9], making the sector even more susceptible to interest rate risk. 

Given this backdrop, one would assume the bond market in India to be flourishing. However, that is not the case. Despite being amongst the largest in Asia, India’s bond market is still a nascent one and faces various regulatory and legislative challenges. As a result of this, financing projects through bonds is an expensive option, increasing the overall cost of capital for projects.

All these points make a very strong case for introducing bond market reforms, but the turbulent markets of today make this an extremely difficult proposition. Most experts believe it will still take some time before these reforms can be introduced, but once the bond market does open up, it could prove to be the tipping point for infrastructure finance in India and provide a major impetus to the large projects being planned by the administration.

However, until that is realised, the government must consider other options to provide capital. Funding of these projects has relied heavily on the still strong domestic banks, with availability in many cases depending upon the banker-promoter relationship. Unfortunately, the source of funds for most of India’s banks remain savings and term deposits with maturity profiles of 0 to 5 years, leading up to a substantial asset-liability mismatch.

One option to make up for the asset-liability mismatch faced by banks and the unavailability of bond finance is to allow long-term savings mobilisers such as pension funds and insurance companies to invest a portion of their assets under management into infrastructure. The long dated liabilities of these institutions make them ideal investors for the asset class. Another option could be to allow banks to raise long term bonds exempt from statutory reserve requirements. Finally, more institutions that can complement and co-invest along side private capital, such as the IIFCL for example, will also help feed the much starved sector.

While the financing issues might be the biggest hindrance to project uptake, India also faces a barrage of regulatory, legislative and bureaucratic hurdles that result in suboptimal project implementation and execution. The government must work towards addressing these issues in order to establish confidence in the minds of all stakeholders if it hopes to attract the amounts of private capital it envisages. Despite the long to-do list, the judicial framework needs to be made more efficient and the company law framework needs strengthening.

In a country known to be awash with red tape, the government must address various challenges affecting project implementation such land acquisition and contract enforceability. Persistent delays in mega infrastructure projects primarily due to these hurdles and poor planning have led to time and cost overruns in their implementation. As per the Ministry of Statistics and Programme Implementation, out of 552 projects [10] in the central sector at the end of March 09, about 280 projects have witnessed delays in their execution due to varied reasons. With only 146 projects on schedule and 8 projects ahead of schedule, these projects have already overrun costs by 12 per cent. 

As an example, the roads sector, the largest constituent of the infrastructure PPP projects over the last year in terms of the number of projects, has had a dismal performance. Of the 60 new road projects the National Highways Authority of India (NHAI) is seeking to build under the PPP model, it did not receive a single private bid on 38 of them. The Model Concession Agreement (MCA) that the administration has been working on for some time now, drafting and then re-drafting it again last year, has been blamed by many for this failure.

Officials have pointed out that the excessive emphasis on a one-model-fits-all format presents serious problems. However, the NHAI, which has the right to submit proposals in context to changes in the MCA, ignored to do so. Further, the NHAI did not invite any bids for close to a year and chose instead to bunch together a large number of bids in December 2008, by the time the financial crisis had really taken its toll on the already over-leveraged sector.

All of these problems are now being systematically addressed by the new minister in charge, Kamal Nath, who after recently taking charge called a meeting of all stakeholders including the deputy chairman of the Planning Commission and his principal advisor to discuss the way forward. Given the way things are shaping up, a revival of sorts is expected for the NHAI.

Lack of planning and unsystematic approaches are now being tackled in other infrastructure sub-sectors, and private sector expectations are heightened for the ministries to come through on promises made by the Planning Commission of the Government of India.


In her visit to Spain in April 2009, the president said India needed to spend $700 billion over the next five years to strengthen its infrastructure. She urged Spanish infrastructure firms to take a closer look at opportunities unfolding in India’s infrastructure market. For infrastructure firms and concessionaires, the opportunities present are plenty and varied.

But India is also a market where local knowledge and expertise are just as important as technical know-how and experience. Therefore, an ideal route for infrastructure developers to enter the market is through joint ventures with domestically established management teams with proven execution skills.

India’s unique demographic also throws up some interesting takeaways. For example, large segments of the 1.2 billion strong population require professional training in order to develop the workforce, leaving a large gap in the education sector. So in addition to opportunities in core infrastructure assets, there exist great opportunities in non-core, social, tangential and infrastructure-related sectors. India is actively exploring extending the PPP model to social sectors such as health and education.

Further, while urbanisation in India continues to grow by leaps and bounds, 70 per cent [11] of India’s population still lives in its rural areas, making rural markets another big avenue for growth in the years to come. 

Many private investors have shied away from the Indian infrastructure space up until now. With the existing opportunities in the developed markets in the OECD nations drying up – at least for the time being – a diversification strategy into an Indian business or asset might be an interesting play.

For funds targeting IRRs in the teens, opportunities in the OECD may be enough to satisfy their appetite, but for investors targeting returns in excess of that, the Indian infrastructure opportunity warrants close inspection. The massive build out provides some excellent greenfield opportunities to capture excess returns, with both 3i and Warburg Pincus, established players in the Indian private equity market, picking up stakes in the ports sector inover the last year.

While due diligence may be complex, operating environments not completely predictable and bureaucratic hurdles for investors difficult to navigate, cherry picking the right investments in the infrastructure and related sector over the next couple of years, many believe, will lead to excellent results over the next five to seven years and more. 

An compelling comparison

An interesting debate is the one around public acceptance towards private investment in infrastructure. Lazard’s recent survey highlights the growing acceptance of private investment in infrastructure in the US. However, the events of the past year – including the Chicago's Inspector General’s Office’s report a few days back on the privatization of the Chicago Meters leave no doubt about the fact that there are pockets of growing public resentment, especially in the US, against the use of PPPs.

What most people will realize soon is that given the investment needs of India, contrary to resentment, there is in fact, an eager anticipation for private funds and structures such as PPPs. This view is mirrored in the attitude of the masses on the ground – the end users of these assets – who are willing to pay that extra sum to enjoy never before seen world class infrastructure. This leaves the administrations with little choice but to make conditions surrounding private investment in infrastructure a viable and profitable activity.

Establishing a PPP is now considered to be the default option for major infrastructure projects in sectors such as roads, railways, airports, ports and other transport segments.

Varun Jain, CAIA, is a member of the global infrastructure team of UBS and is based in India.

[1] Infrastructure comprises electricity (including non-conventional energy), telecommunications, roads and bridges, railways (including MRTS), ports, airports, irrigation (including watershed development), water supply and sanitation, storage and gas distribution sectors
[2] Planning Commission, Government of India; Plan Period: Financial Years 2007-08 to 2011-12
[3] Eleventh Plan, Planning Commission, Government of India
[4] Goldman Sachs Economic Research
[5] CEIC, Government of India; Total Fiscal Deficit comprises Central & State Government Fiscal Deficits and Off Balance Sheet Bonds
[6] Based on an exchange rate of INR:USD = 50:1
[7] Interim Budget for the Financial Year 2009-10
[8] PwC: Infrastructure in India – A vast land of construction opportunity
[9] Gridlines, December 2008 – A report by the PPIAF on Indian Infrastructure
[10] Projects over $20 million (based on an exchange rate of INR:USD = 50:1)
[11] Goldman Sachs Economic Research