ProblemIdentification Post 1991(liberalization), our country has seentremendous growth in its GDP through the spurt in growth in the manufacturingand service sectors owing to the influx of foreign players.
This along with therise in population and growth in the economy has increased the purchasing powerof the country’s population. The increase in per capita income of the people,the rise in manufacturing output coupled with other factors has put enormouspressure on the country’s ageing and inadequate infrastructure. The need forextensive investments in the infrastructure sector was felt by the governmentas it was proving to be a major hindrance towards economic growth.Infrastructure also has a cascade effect on other sectors of the economy as itincreases or decreases their productivity and creates or eliminates bottlenecks.
But, to address the serious lack of infrastructure in the country, thegovernment, with its limited funds alone would not be able to meet therequirements. Hence, a need was felt to source financing support from privateparties to plug the gap. As a requisite to this, the cap on foreign directinvestment in the infrastructure sector was partially lifted to lure foreign investorsto invest in India which had by the late 90’s become a very lucrative investmentdestination. This laid the foundation of the increased penetration of private investmentin the Indian infrastructure sector. As on 2012, the FDI on infrastructuresector alone was $386.28 million.
Realizing the fruits and the huge potentialin infrastructure growth through private investment, the government of Indiahas completely lifted the cap on FDI on select infrastructure sub-sectors like Greenfieldairports, ports, harbors, roads and highways and mass rapid transit systems. Review ofInfrastructure Debt Funds Thevehicle for the funneling of private investors and other bank and non-bankfinancial institutions to fund infrastructure projects is known as the IDF(Infrastructure debt funds). This would be supported or taken up by banks andnon-bank financial institutions. Sponsorship, in this particular contextessentially means a participation by the bank or NBFC in the equity of the IDFin a range of 30%-49%. In these IDF’s, offshore investors especially insurancecompanies and private investors can participate by investing in units and bondsgiven out by these IDFs.
An IDF can be setup as a company or maybe as a trustin some cases. If the IDF is setup as a trust then it would be rolled out as amutual fund or an IDF-MF which will be regulated by SEBI and in which any bankor NBFC can invest. On the other hand, if the IDF is setup as company, it willbe called as an IDF-NBFC which only banks and infrastructure finance companiescan invest in.
In this case, the IDF is regulated by RBI. The route that IDFvehicles take to execute infrastructure projects is the Public, PrivatePartnership route (PPP). PPPs can be simply defined as contracts (usually longterm) signed between a public authority like NHAI and a private party like GMR,GVK, L&T etc. where the private party executes a project or service ofinterest to the public party (e.g. building national highways etc.
). Thegovernment supports the capital investment partly or through provision ofcapital subsidies to the private player so that the project becomeseconomically lucrative for them. In further detail, some projects may also besigned on the BOT (build, operate, transfer) model where the private partytakes responsibility of execution of the project and its operation for astipulated period of time forth which the project is handed over to thegovernment. The RBI has chalked out certain criteria for the sponsors of IDFsand the investors in such IDF-MF/NBFC. The sponsor of the IDF has to sign atripartite agreement with the concessionaire and the project authority to participatein a particular PPP project. This would bind all the three parties and providea consensus for the following:· IDF and the project authority mutually agrees on a fee that the IDF hasto pay the project authority.
· Any default by the concessionaire shall lead to the termination of theexisting agreement between the concessionaire and the project authority.· The IDF shall take over a part of the debt of the concessionaire.· The project authority can redeem the bonds by the IDF to fund theproject.
Essentially, what this means is that the IDF gains stake in theproject due to lending financial support to the project authority. This isreferred to as a compulsory buyout. Thus, this means that the IDF also takes upthe risk as well as the benefits associated with the project. Inshort, Infrastructure Debt Funds is a successful vehicle for fundinginfrastructure projects in India. As per the RBI and the union financeministry, the main purposes of IDFs are to supplement lending forinfrastructure projects and act as a tool for the refinancing debts incurred bythe private player for the project which were previously funded by commercialbanks.
Advantages of IDFs Thishas helped in accelerating the execution of PPP infrastructure projects inIndia. The main hindrance was because of the inability of the banks to sanctionloans to the private players due to the high asset liability mismatch. For amammoth infrastructure project, a huge loan requested by a private partyrequired a huge collateral of some form or other that needs to be produced tothe bank as a guarantee. This was often a challenge. Through IDF which issuesbonds, credit enhancement which is an attribute of the PPP projects is present.This lowers the credit risk significantly and leads to a higher credit rating.If the IDF issues units then the credit risk will be borne by the investorsparticipating in the IDF.
Consequentially, the investors can also seek higherreturns owing to the risk borne by them. Theother benefit of IDF is its refinancing strategy. This essentially means an IDFtaking over the debt issued by a commercial bank on an ongoing project. Bytaking over huge volumes of banks loans, IDFs are essentially opening upsimilar volumes of capital with banks for fresh lending to other newinfrastructure projects. This further accelerates the infrastructure growth ofthe nation. Analysis in Indianand Global Context IDFfinancing of infrastructure projects is a fairly new phenomenon in India.
Theregulations for the same were rolled out SEBI and RBI in late 2011 and thefirst such IDF was formed by a contingent of banks under an MoU. The effects ofthe IDF on Indian infrastructure growth needs to be analyzed post 2012-2013. TheFDI inflows on the construction(infrastructure) sector alone on the year2012-13 was $283.89 million. Over the years, this number has risenexponentially to reach $4.57 billion in 2015-16. This is an increase of 15 timesin a span of just 4 years.
Thus, it can be concluded that the commencement ofthe IDF as a vehicle for financing infrastructure projects has certainly led tothe increase in foreign direct investment in the sector. This has led to thelaunch of more and more projects by the project authorities like NHAI, Shippingand others and the influx of FDI is only expected to rise in the coming years.Also, speaking in terms of proportion, the share of Infrastructure sector inFDI was only a meager 1.2% in 2012-13. Compared to this, in the year 2015-16 itwas a stellar 11.2% of the total FDI. This shows that infrastructure has becomea lucrative sector for investment in India and more and more players areinvesting in infrastructure. Apart from this, the national clean energy andenvironment fund is another infrastructure fund to finance innovation anddevelopment projects on clean energy.
The government of India has been raisingthis fund through a cess on the production of coal in India. The funds collectedare being used for green projects across the country and improve the level ofresearch and development in the renewable energy sector. In terms of the global context, Infrastructure debt funds are a betteralternative to government bonds which provide relatively lower returns. But,the success of IDFs heavily depends upon the growth prospects of infrastructureprojects across the world. Thishas put a tremendous pressure upon the IDFs to perform and provide healthyreturns to their investors.
Despite this companies in the US have beenovershooting their IDF targets and raising huge amounts of money. Investorshave shown interest in these funds in the simultaneous presence of pension andinsurance funds. Constrained financing from public funds has provided a hugeopportunity for private investors to indirectly invest in huge publicinfrastructure projects across the world. However, there is a long way to goand it is very important that there is a constant reform in the regulatoryframeworks and risk assessment pertaining to these funds across the globe. Recommendations · IDFs are vital components to act as a source of long term financing ofinfrastructure projects in India. Equity infusion by government & privateinvestors has to be complemented by IDFs through NBFC and Mutual Fundstructures· IDFs have acted as a tool for attracting significant FDI ininfrastructure projects in India. The government should continue with itsreforms on the ease of doing business and assessment of the regulatory frameworks so as to incentivize FDIthrough this route· IDFs are vital to plug the infrastructure financing gap for all thedeveloping economies across the world. There is a limitation of the governmentsto raise debt and widen the fiscal deficit for financing infrastructureprojects.
IDFs can act a substitute in order to fund this shortage of funds fornation building activities· Infrastructure project credit ratings should be improved so as toattract the investors to put their money in infrastructure debt funds. Reducingthe risk and increasing the rate of return on the investment would motivateinvestment in this area· Infrastructure sector risks including land acquisition laws,environmental clearances can stall projects which may increase the risk ratingof the funds. These legislative reforms have to be addressed in order toincrease the project viability and hence the quality of infrastructure debtfunds· Global factors including market slowdown, liberalization, governmentpolicies, are some of the areas of concern which can affect the growth of IDF.These factors should be taken into consideration while incorporating andlaunching these funds