Covering over the potholes

Indian infrastructure has invited meaningful attention from private investors and developers for almost a decade now. This was essentially owing to key developments such as the enactment of the Central Electricity Act, 2003 – which ensured de-licensing and open access for private power developers; privatisation of major airports; and the kick-starting of a national road development programme, for which the Indian government employed the public-private partnership (PPP) model.

Until these key events invited private capital interest in core infrastructure sectors including power and transportation, infrastructure investment in India as a percentage of gross domestic product (GDP) used to be well below 4 percent. The sheer size of the opportunity available, therefore, meant a number of private developers and financiers, domestic as well as foreign, making a beeline for it.

Before the global financial crisis in 2008, a number of marquee financial sponsors were able to raise an India infrastructure fund or a global/regional fund with a significant India allocation. Today, private capital committed/invested in Indian infrastructure through the fund route can be estimated at approximately $8.3 billion.

However, the sector has not remained without inherent challenges. In an emerging market like India, the fundamental risks associated with infrastructure development are more pronounced owing to the evolving/developing state of the sector. Not surprisingly, therefore, at a time when these first-time efforts from funds are due for performance evaluation, results are a mixed bag with not many able to deliver the targeted returns so far.

The reasons have varied from an inadequate and inappropriate overall infrastructure development framework; a lack of local knowledge and experience; a lack of governance across the value chain; and aggressive deal-seeking on the part of developers and investors alike. A few which understood the associated risks and were prudent in their approach have been able to deliver on stated targets through appropriate structuring of their investments.

The road development programme in India has been fairly successful with more than 250 concessions operating under the PPP model sponsored by the National Highways Authority of India (NHAI – the central government-sponsored concessioning authority for the road sector in India). However, in an evolving regulatory environment, and despite several rounds of progressive changes to the model concession agreement, the sector has had virtually no bidders for projects of late.

There’s also been a recent debate around whether PPP is the right model for the road sector. The Indian government, with its limited finances will, however, be ill-advised to forgo the PPP model. It can only seek to improve its implementation.

Both the government and the private sector need to acknowledge their roles with the responsibility required for a long-term fruitful partnership, delivering societal good. Recognising its responsibility, the NHAI needs to honour its obligations in a meaningful manner in getting requisite rights of way for the private sector to construct and operate the roads. The concessioning authority should invite private sector participation to bid only when all the basic ingredients like land acquisition, environmental issues and forest clearance – which are its responsibility by statute – are obtained.

Similarly, it should provide a slightly longer period of construction with enough of a concession term to make it deliverable and attractive for private sector participation. There are often disputes with the concessioning authority around the scope of work and compensation for delays, with much to be desired in terms of an effective dispute resolution mechanism. Notwithstanding inefficiencies and lack of technical capacity at the NHAI, the road sector in India is yet to have a regulator.

The bidding process needs to be made more robust and should seek quality and experienced developers with a long-term interest in running the concessions profitably. For instance, the existing two-stage process can have more muscle if it asks for more technical competence, greater balance sheet strength, and signed term sheets/letters of comfort from lenders to ensure the avoidance of aggressive bidders with a short-term construction-contractor like interest in the project.

India’s power generation capacity has doubled in the last ten years to circa 245 gigawatts (GW). Yet these power plants are running at abysmally low plant load factors (PLFs), causing peak demand deficits touching double digits. On the other hand, while the transmission and distribution (T&D) losses have reduced from historical highs, these still remain high at about 24 percent. Correcting these anomalies alone would mean no additional capacity requirement to meet the current demand. Notwithstanding challenges around land acquisition and obtaining key clearances regarding the environment and forests etc., one key input that has failed the sector significantly, of late, has been availability of fuel.

Domestic coal production can be significantly improved both in its availability and quality by: one, reorganising Coal India Limited, the largest coal producer in the world, with around $10 billion of cash sitting idle on its balance sheet; two, inviting competition from reputed domestic and foreign private players in coal mining; and three, improving the connectivity of identified/developed mines through an efficient rail and road network, employing the well-proven PPP model.

Some Indian developers sought to own mines in foreign destinations like Australia and Indonesia, but with limited success – largely on account of political risk associated with the sector. It’s concerning that based on such assumptions around assured availability and quality coal at low cost in host countries, some of the developers made aggressive winning bids for the large power plants to be developed at home. Expectedly, these developers failed on their commitment, seeking remedy in tariff hikes from the government after having signed the power purchase agreements (PPAs). Better diligence while pricing in the associated risk could have avoided such a situation. On the other hand, the model PPA does provide for fuel cost as a pass-through with adequate safeguards for consumers.

WAY FORWARD

As the Indian economy looks to reboot, the government on its part, in the short period it has been around, has undertaken incremental yet significant steps in ensuring the revival of the investment cycle with clear emphasis on infrastructure, manufacturing, urbanisation and skill development.

Equally, the present government, backed by a huge mandate, has not lost sight of fiscal discipline – sticking to the deficit targets as set by its predecessor.

This involves attempting to revive growth while containing inflation. This promises to be good news for the central bank and the government of India to work together in ensuring a structurally strong Indian economy in the long run.

Some of the measures undertaken that should help improve implementation include: the continuation of fast-tracking of project clearances started by the previous government, through transparent and accountable processes using information technology; an emphasis on the delivery of coal through an efficient transportation system; an extension of tax incentives for the power sector; allowing domestic banks to borrow and lend long term to infrastructure projects, without having to allocate capital towards statutory reserves; attempting to improve tax administration; a higher budgetary allocation for roads and agri-infrastructure development etc. Further, simplifying the existing long-drawn and onerous land acquisition process will help the revival of the overall industry in a significant way.

For a long-term institutional investor seeking new markets, it’s important to feel comfortable around macro-economic and political stability within a consistent policy and regulatory environment. The Indian economy provides these basic ingredients in addition to its unique strengths around demographics fueling domestic demand and high growth, with different state governments in the country competing for capital.

However, risks around execution and governance remain. A knowledgeable investor employing smart investment and governance structures while respecting local experience and culture, may find the challenge an attractive investment opportunity for the long term. Such an investor thinks of a “quarter” as 25 years and not 90 days, as suggested by the Canada Pension Plan Investment Board’s Mark Wiseman recently.

Ajay Jain is managing partner at investment management and advisory firm Indusbridge Capital Advisors LLP in Mumbai (Ajay.Jain@indusbridge.com)