Overview: A lot done – much more to do

India’s infrastructure market continues to entice and, for some, to disappoint. While the government has made infrastructure development a priority and there are pockets of opportunity, the country still isn’t an easy market to invest in, finds Siddharth Poddar

The numbers are all out there. India will need $4.5 trillion for infrastructure development by 2040, driven by a growing population, rising income levels and greater economic prosperity, according to the government’s Economic Survey 2018. And if India is to realise its desired GDP growth of more than 9 percent per year, it needs to double its infrastructure spend to about 10 percent of GDP, Deloitte says.

Excluding what may be needed in future, the current infrastructure deficit is already costing the country up to 5 percent of GDP every year, according to S&P Global Ratings. The ratings agency recently called India’s poor infrastructure the “biggest hurdle” to government initiatives such as ‘Make in India’, an initiative aimed at turning India into a global manufacturing hub.

Sushi Shyamal, a Mumbai-based partner for infrastructure, industrial & consumer at EY, says India’s industrial sector – which includes manufacturing, gas, electricity, water supply, utilities and construction – contributes 24 percent to Indian GDP. But, while the compound annual growth rate of India’s GDP is about 7 percent, the country’s industrial sector clocks in at about 5.5 percent.

In Shyamal’s view, “the inability of infrastructure development to keep pace with economic growth has an impact not only on employment creation, commodities demand and the overall industrial output, but also a much larger impact on the economy by impacting trade, agricultural and industrial development activities.”

“To stand a chance of meeting national infrastructure needs, most Asian governments – where public financing has historically made up more than 90 percent of infrastructure investment – must consider alternative financial solutions,” says Blair Chalmers, Singapore-based director at the Marsh & McLennan Companies’ Asia Pacific Risk Center. This underscores the need for private investment (and foreign investment) in India’s infrastructure development, simply because the government cannot foot the bills by itself.

But Chalmers adds that, while there is an increasing appetite for emerging market infrastructure investments among institutional investors, global investors have global alternatives, and “it is therefore important that national governments step in to incentivise investors considering assets in their country, by helping reduce risk”.

DEALING WITH RISK
There are several risks that still must be considered when investing in Indian infrastructure, although these are not exclusive to the country. The first is political or regulatory risk, which “is mainly driven by the lack of clarity and co-ordination among state government, central government and other government agencies”, explains Anuj Singh, practice leader at Marsh India’s infrastructure practice.

Allard Nooy, chief executive of InfraCo Asia, says one of the challenges is “understanding the similarities and differences between federal and state rules and regulations”.
Market risk also remains a challenge, because, as Singh highlights, one industry can sometimes depend greatly on another. One example is the power industry, which is dependent on manufacturing. Since manufacturing has slowed down substantially across India, that has an impact on investments made in the power sector.

The third risk infrastructure investors point to is financing. Nooy says that “as a foreign direct investor, it’s challenging in terms of how you structure your investment; and particularly how you structure your investment efficiently in terms of tax. It is complex – we have completed an investment on the basis of a convertible debenture and that requires a lot of work to get right, so it is a hurdle.”

Additionally, project structuring remains a challenge and must be re-examined, particularly as investors have become wary about projects’ risk-return profile, Anuj Singh says.

Separately, many infrastructure companies in India are faced with financing constraints, as they find it hard to raise funds from banks which themselves are loaded with a high amount of non-performing assets on their books. That, in turn, has forced banks to cut or restrict their exposure to many sectors, including infrastructure.

MASSIVE NEEDS
There are many infrastructure sectors in urgent need of investment. In the transport sector, while the development of roads and highways has been promising, railways, airports and urban infrastructure need urgent attention, industry participants stress.
Shyamal says immediate investment is needed to build newer airports to address the underpenetration and capacity challenges at major Indian airports, especially given the growing consumer demand for air travel, with domestic traffic increasing by about 17 percent in 2017.

Rail transport is an area where India is faced with crumbling infrastructure that is among the most obsolete globally, with Shyamal pointing out the sector is in need of urgent investment.

Then there are urban infrastructure requirements. Ritesh Kumar Singh, a corporate economist and former assistant director of the Finance Commission for India, says there are opportunities in urban transportation, such as metro lines; healthcare, particularly hospitals; affordable rental housing; and smart city projects.

This is not surprising, given that today three in 10 Indians live in urban areas and this share is going to continue increasing. With growing urbanisation, India will witness a higher demand not only for affordable housing, hospitals and urban transport, but also clean water supply, water and waste treatment, and sewerage treatment. According to Nooy, there are significant opportunities for investors in the water and waste management space, particularly municipal solid waste management.

“The waste management sub-sector is challenging, but offers a lot of opportunity given India’s size and economic growth,” he says.

From a business perspective, Kumar Singh says that, while the supply of power from conventional and renewable sources has improved – and cost is also going down – power supply varies significantly from state to state.

“For instance, there are power cuts in Uttrakhand and UP, but almost 24/7 supply in Gujarat and Maharashtra.” Moreover, the quality of supply remains a problem for industrial consumers, “so we have frequent load shedding”, he says. “Though open access in power purchase is allowed, state governments are imposing levies and charges to cross-subsidise the household consumers that increase the cost for industrial consumers, especially in the power-intensive manufacturing sector,” he adds.

One other interesting investment opportunity, according to ICICI Venture, which manages an India-focused infrastructure fund, is in the logistics sector, which acts as in infrastructure enabler. With the implementation of the Goods & Services Tax and the commissioning of the 3,342km Dedicated Freight Corridor, the logistics sector is likely to provide greater investment opportunities, the firm says.

BRIGHT SPOTS
There are, of course, pockets of the infrastructure sector that are doing particularly well – both from the standpoint of improving the lives of the public, as well as providing opportunities to private investors.

Nooy singles out two sectors in which there has been significant progress on the back of a strong government push. “One is the transportation sector, which still offers good opportunities, though more brownfield than greenfield; the second is energy, and in particular the renewable energy sector including wind, solar and hydro.”

The roads sector has experienced policy and regulatory evolution, most industry participants will tell you. One global infrastructure investor with interests in India says the National Highway Authority of India has been proactive addressing India’s highway issues and, in doing so, has started implementing programmes and initiatives that are garnering significant interest from foreign investors.

One recent example is Macquarie Group’s winning bid to manage 648km of highways for 30 years, in what is India’s first Toll-Operate-Transfer project, a deal worth 96.8 billion rupees ($1.4 billion; €1.2 billion). There was strong global investor interest in the deal, with the Australian infrastructure investor beating bids from the likes of Brookfield, IRB/Autostrade and Roadis/NIIF.

This is a landmark deal in the Indian infrastructure sector, as it could mark the start of an asset-recycling programme across the country. It also illustrates what can be achieved by government bodies through well-structured initiatives and thorough preparation. For the government, this provides a cash injection that can be used for the development of roads and highways.

“Encouraged by the success, the NHAI is planning to roll out more TOT bundles, which continue to attract attention from large bidders like Brookfield, IRB Infra, Atlantia, Roadis and many others who are evaluating entry strategies and financing,” Shyamal says. This has been a key achievement, he adds.

Another sector that continues to do well is renewables. One global infrastructure fund manager says that in the renewables space, India has displayed a strong policy and contractual record. There has been solid government support for the sector, which continues to grow. The fund manager adds that today India is one of the countries where renewables pricing is competitive, “so there’s a sound economic underpinning for investments in renewables”.

The Indian government has an ambitious target of achieving 175GW of installed renewables capacity by 2022. According to Shyamal, total renewable installed capacity was already at 69GW by April 2018, up from 23GW in 2012.

Sanjiv Aggarwal, Mumbai-based partner in Actis’s energy business, says India has “defined a clear renewable energy roadmap” adding the “Indian renewables sector offers an opportunity to build a scale business, which is very attractive to institutional investors. Not many countries offer this currently.”

According to Aggarwal, the Ministry of New and Renewable Energy and the Solar Energy Corporation of India are responding well to investor and independent power producers’ concerns regarding implementation issues on evacuation, land and tariff issues at state level.

InfraCo’s Nooy says: “The MNRE has done a fair amount of work on renewable energy targets and in creating frameworks whereby renewable energy power companies now have open access to the grid and can cross-sell.” And he adds that owing to the targets set by the government, it has been able to bring to market many projects “where the preparatory work has been very well done, including commissioning land, thus reducing the hurdle rate for investors”.

Aggarwal adds that the shift to competitive bidding from feed-in tariffs in wind over the past 18 months has been well implemented and is a good move that aligns with global best practices. He does add, however, that this shift slowed down capacity addition last year.
Finally, “the decision to make the SECI the counterparty, from the second bid onwards, is a good one, as it has a higher credit standing than most state distribution companies”, he adds.

While Aggarwal, like other investors spoken to, is optimistic about India meeting its 60GW installation target for wind before 2022, he cautions that grid evacuation and land could yet prove to be a setback. Distribution is a big challenge and could go on to a be a major limiting factor in the surge of renewables. There is a need for the government to continue investing in transmission and evacuation infrastructure to prevent it from becoming a bottleneck.

One other challenge is the regulatory uncertainties in the solar sector with respect to anti-dumping/safeguard duties. Aggarwal points out that investors need certainty in these aspects or else they will start pricing their risks in their bids, which, in turn, will imply that consumer tariffs will not fall as far as they can.

MANY BARRIERS REMAIN
Over the past few years, while India has attracted significant investment interest from various foreign investors, Shyamal points out the country is yet to see a continuous source of financing from global pension funds and insurance companies.

“One of the key impediments to attracting interest from long-term investors has been inappropriate risk-sharing mechanisms between private and public players,” he says. In his view, too much risk currently gets transferred to the private sector, risks it cannot easily insure – that is seen as a deterrent for investors with a low-risk appetite.

The stressed finances of public-sector banks, due to a high proportion of non-performing loans and now loan fraud, is limiting their capacity and willingness to lend to risky infrastructure projects. And issues related to land acquisition, forest clearances and time and cost overruns are also key challenges.

Shyamal zeroes in on land acquisition, an issue that has plagued Indian infrastructure for a long time now. “It has been one of the biggest deterrents for foreign developers investing in greenfield projects in India,” he says.

In addition to consistent policy and a regulatory framework, ICICI Venture argues it is important there be a focus on creating alternate channels of financing infrastructure projects, such as corporate bonds, especially considering the debt-servicing challenges faced by many infrastructure assets currently.

Robust rights to payment, the presence of strong and independent legal recourse, certainty over permits and access to land are all examples of factors that need to be in place for investors to invest in any emerging country, says Chalmers, as they provide a base level of investor confidence. In addition to that, investors will expect to see a clear pipeline of projects being committed to as part of a national infrastructure plan.

There is consensus that the Indian government is cognisant of these challenges, and of what it needs to do to draw greater sums of private (including foreign) capital into the Indian infrastructure sector.

Poor infrastructure can lower productivity, increase the costs of doing business and limit inward FDI. These are problems that India can ill-afford, particularly given that its economy is already growing at slower-than-expected rates. Given that it is in competition with other emerging markets for investment, it needs to up its game.