Recently, US based banking giant Citi Group and private equity player Blackstone, joined hands with India’s public sector infrastructure finance companies IDFC and IFCL to set up a fund with a corpus of $ 5 billion to finance infrastructure projects. Each of the partners will invest $250 million for the same. The rest, says IDFC managing director Rajiv Lall, is expected to be raised abroad.
Over the next five years, India will require around $320-350 billion to fund its infrastructure needs. This translates into a rough average of $70 billion or Rs 31,500 crore per annum in investment requirements. According to IDFC chairman Deepak Parekh this money is not available in the domestic market. Investments from foreign players will then be the key. Clearly, the joint investments by IDFC, Citi and Blackstone are just the beginning of a long process.
With India’s growing infrastructure needs and increasing global ambitions that have fuelled billion dollar takeovers and acquisitions, there is a demand for more and more high value and long term debt from Indian companies.
As most Indian banks do not have the financial muscle to finance many such projects, increasingly Indian companies are turning to foreign lenders and institutions.
Traditionally, these lenders have been averse to investing in long term projects in emerging economies on account of the risks associated with such countries.
In India’s case, they have burnt their fingers often. The country’s power sector is replete with such examples. The Enron project that started in 1996 and is still not complete is an example. Exits by other companies like Cogentrix that pulled out of the Mangalore power project and China Light CMS Energy, that exited from three power projects in 2001 are some other examples.
Equally, domestic projects that are stuck are also unnerving. For instance, NHAI has had huge problems in land acquisition, the Tata controversy mars its expansion in West Bengal, delayed port and airport projects all prove that investing in India is still fraught with risk.
This reflects in foreign investment flows into India. The majority of such flow is still in the form of FII investment, which is primarily short term, rather than being FDI based which is generally for a longer term. “Attracting investments from foreign lenders is still a tough job,” says Avendus investment bank’s executive vice president Gaurav Deepak.
According to a paper by Montek Singh Ahluwalia, chairman, planning commission, the key risk associated with India remains the uncertainty over the very execution of the project. These would include construction risk and operation risk.
ICICI Securities head of infrastructure Ketan Shah holds that India still has to prove that its companies have the abilities to deliver. “The number of companies with a proven track record are few, though they are increasing. International bankers will look at management competencies closely before investing in India,” he says.
The other problem may arise from India having reneged on some contracts earlier. Globally contracts are sacrosanct, but reneging on the Enron contract has given the world some reason to doubt India’s intentions, says Deepak. The companies may also face operating risks.
For instance, the disruption of fuel is a major operating risk for power plants. Indian companies are looking at innovative ways to handle this risk. GVK for instance, relies on GAIL India to supply natural gas for its 235 MW gas based plant in Andhra Pradesh. If there is a fuel interruption, it can switch to imported naphtha even though it is more expensive. In this scenario, the higher cost will be accommodated via a new higher tariff.
Investors in India also have to bear in mind market risk related to not having been able to achieve conditions for making a project viable.
Says KPMG’s head of financial services, Sanjay Aggarwal, “Customer preferences are becoming a driver across sectors. Their needs are changing faster. Infrastructure goods may also victim to competition.” One could take the telecom sector as an example. With more providers, there has been immense competition resulting in lowering of tariffs. A viable project will have to keep these factors in mind.
ICICI Securities’ Shah points out that the long term financial viability of the project will depend on being able to assess demand and costs correctly. Employee turnover rates have risen fast in the past few years. Salaries are rising on average 15-20% per annum. Project managers will have to keep these things in mind.
Long term financial structuring taking in interest risk and exchange risk is another worry. Long term debt carries higher interest risk than short term debt. Debt then needs to be taken in carefully.
According to KPMG’s Aggarwal, companies will need to leverage carefully. “Excessive leveraging increases risk significantly particularly in case of dynamic interest rates and the ability to spend the funds as planned.” At the same time there has to be headroom for considering the downsides.
Says Deepak, companies will definitely have to mange exchange risk better to be able to attract foreign lenders and manage their debt effectively. While Indian CFOs are getting active on the front, those like Shah believe that it is only 20-25% of the lot that is managing risk effectively.
He says that the undeveloped derivatives market does not help either.
Infrastructure derivatives could help manage these problems effectively, he adds.
Anjan Das, chief economist at FICCI points out that India’s economic fundamentals also have to be brought in order with the containment of fiscal deficit. High deficits when monetized lead to inflation, discouraging savings. If these are not monetized, they put pressure on interest rates discouraging investment, especially in projects with long gestation periods, such as infrastructure. Foreign lenders will thus be watching the domestic Indian economy closely for its fiscal and market reforms, rate of inflation and interest rates.
The last two risks, regulatory and political, remain the most worrying factors for the private sector. Ahluwalia in his paper on risk in infrastructure projects says, “private investors may be concerned about risks stemming from lack of clarity of government policy, the absence of a credible regulatory system, and the possibility of arbitrary political action.” Experts say that these factors led to the failure of the projects started in the 1990s.
It was not as much a case of demand not being there but regulatory hurdles and the lack of the political will to change policy that led to these projects not being viable. Tariff regulation is a key to these risks. The government and the private sector need to strike the difficult balance between ensuring project viability and ensuring fair tariffs that are not too high to the consumers. The recent competitive tariff based bidding for the ultra mega power projects seem to be the way out. Says Shah, “I would not worry too much about the projects that have gone through the competitive bidding process. If a bid is made, generally, the costs are factored in.”
Fortunately, the tide seems to be turning in India’s favour. Recently, S&P lifted India’s sovereign rating to investment grade. Moreover, Indian companies have proved their ability in making profits out of the infrastructure sector. With companies like Suzlon, Gammon India, GVK, Reliance, JP group and Tatas showing an interest in infrastructure sector and making profits out of it, foreign lenders have sat up to take note of the development.
This comes with robust domestic demand and global companies looking at making India an outsourcing destination. However, India still remains a risky investment. Investor concerns range from return on investments, India’s economic and political fundamentals, its regulatory environment and the ability of companies to execute and deliver. Shah rates India as a medium rate destination. “We are on our way to being low risk over the next three to five year period,” he adds. The rest depends on the signals India sends out to the international investor community.
Source : Financial Express