Monday, March 4, 2013

Where will the funds for infrastructure finance come from?

Theoretical wisdom on financing infrastructure projects would have it that these long-gestation projects be funded through long-term debt. Such debt is raised primarily from the bond markets since banks are constrained by potential for asset liability mismatch arising from their business model (their deposits are short to medium term, making them borrow short and lend long).

However, India's nascent infrastructure sector growth story goes against this wisdom and relies mainly on bank loans for project funding. The last decade saw a massive increase in private sector investments in infrastructure, especially in power and roads, mostly financed with domestic bank loans. In the wave that swept the sector, many banks lend disproportionately to the sector. This has predictably had the effect of raising concerns about the un-sustainability of bank's exposure to the sector.

Consider these figures from a recent report in Mint,
Infrastructure is the sector to which Indian banks have the greatest exposure... Among the banks that have significant exposure to the power and infrastructure sectors are Central Bank of India (34% of its loans), IDBI Bank Ltd (32.9%), UCO Bank (32.3%), Canara Bank (22.4%) and Andhra Bank (24.5%)... At least 50% of the highway projects in the rated portfolio scheduled for completion in 2013 have already reported three-six months delays due to land/right of way not being handed over by the concession grantor
The outstanding bank loans to infrastructure projects stood at Rs 6.9 trillion as on 31st December 2012.  Of this, Rs 3.8 trillion dollars are to the power sector (mostly generation) alone and Rs 1.26 trillion to road sector. A number of these projects, which are due for commissioning now, are delayed and are likely to request for debt restructuring. The close relationship these projects have with the fluctuations in the business cycle makes debt restructuring even more likely.

Interestingly, both these sectors are very long gestation projects, with returns generated over 23-30 years. Evidently, the most efficient way to finance such projects is through long-term debt. Further, these projects, with distinct project assets and operational contours, are ideally suited for project finance.

The RBI norms stipulate that bank lending to a borrower should not cross 15% of its capital and to a borrower group should not exceed 40%. But most banks have either crossed their sectoral exposure limits to infrastructure or are close to that point. This is important in light of the ambitious $1 trillion infrastructure investment estimates for the Twelfth Five Year Plan (2012-17). Since banks are currently the primary source of funding for infrastructure projects and are close to reaching their lending limits, the source of funds to meet the Plan targets becomes a matter of great concern.

In the circumstances, there are only two other alternatives. One, encourage foreign capital investments in infrastructure. Two, sharply increase the depth and breadth of India's long-term corporate debt market. The second assumes great significance and urgency if we are to have any chance of even achieving half the 12th Plan target. It is also critical to enable banks to securitize and off-load the infrastructure loans from their balance sheet and rectify their unsustainable asset-liability mismatches.

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