Monday, April 11, 2016

More thoughts on infrastructure financing

Governments view the policy framework on infrastructure financing primarily from the lens of off-loading risks and limiting fiscal commitments. These regulations often also seek to achieve multiple other policy goals with one instrument. In this pursuit, it loses sight of its fundamental objective of creating good quality infrastructure assets with a life-cycle cost-effectiveness and burdens developers with risks that they are unable to bear.

It is no surprise, therefore, that infrastructure bond markets have remained still-born. Instead,  a more practical approach would entail the government assuming certain risks so as to make long-term infrastructure financing an attractive enough investment option for private investors. The former assumes a massive Que of investors waiting to snap up anything available while the latter assumes the need to nudge investors to bite the bullet. The underlying regulatory enablers for both are of a qualitatively different nature. 

There are at least five clear areas of reform.

1. Construction risk is far higher in India than any other large emerging economy. No private investor is positioned to bear this risk. There is, therefore, a compelling argument for supporting construction financing with some form of credit guarantee which is in turn supported by arms-length public finance. 

2. If construction financing is separated (from life-cycle financing), creditors run the risk of not being able to replace capital providers after construction is off-loaded. This should be mitigated with a form of a market buyer of last resort underwriting, supported again with partial public credit guarantees. Enabling loan syndication and takeout financing is a form of backstop that can provide the time for off-loading construction risks. 

3. Even the post-construction phase has its share of risks. The political economy of tariff increases may come in the way of toll road or power plant's commercial viability. This is another risk that may be effectively underwritten only with a public guarantee.   

4. In nascent markets, as PPP is in countries like India, given the immense risks and uncertainties involved, regulations should preferably refrain from capping the upside. This is all the more so since infrastructure projects suffer from cyclical downturns when revenues fall far short of projections.

5. Finally, it should also liberalize exit norms for capital providers, including equity holders, so that liquidity is not constrained. However, this should be complemented with adequate safeguards against skimping on construction quality and other forms of asset stripping. 

The danger with all such measures is the moral hazard it can potentially engender which would encourage reckless bidding. A well-thought-out and incentive compatible market design would be necessary this moral hazard. For example, the markets should be encouraged to offer these credit guarantees, with only the residual risks endowing on the public finances. Even here, the public support should come through entities like IIFCL and NIIF and not directly from the government. 

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