Saturday, June 12, 2010

Infrastructure finance reforms in India

Despite considerable progress with reforms in the sector, infrastructure financing in India has been constrained by the limited depth and breadth of the long-term debt markets. Despite widespread recognition of the need to create large enough debt markets to help support the country's massive infrastructure investment needs, success in pushing through the desired reforms has remained elusive.

The Planning Commission had targeted an infrastructure investment estimate of %514 bn for the Eleventh Five Year Plan (2007-12), and nearly a trillion dollars for the next Plan. It is also estimated that 70% of investments will come from private companies, in stand-alone investments and through partnerships with the government. However, unlike in other countries where insurance and pension funds are key buyers of long-term infrastructure bonds, both are expected to contribute less than 7% to the total infrastructure investment for the current Plan period.

Experience from across the world indicates that long-term debt forms the major share of infrastructure finance. Banks and in recent years IIFCL, have been the biggest sources of domestic funds for the sector. However, the limitations of banks based financing has been exposed repeatedly, most recently with the luke-warm response to the "take-out financing" scheme announced in the 2009-10 budget. Long-term debt funds are therefore vital to ensuring that India achieves its ambitious infrastructure investment targets.

In this context, the recommendations of the Deepak Parekh Committee on India Infrastructure Debt Fund (IIDF), which submitted its report early this week, assumes significance. The central thrust of its recommendations are towards regulatory changes to permit foreign insurance and pension funds to invest in the proposed IIDF. Prevailing restrictions on capital inflows through external commercial borrowings (ECB) restricts the inflow of foreign debt. Apart from recommending a relaxation of this restriction (if need be by creating a special window for inflow of foreign debt with tenor of more than 10 years), the report also suggests that investment in IIDF should not form part of existing limit prescribed by SEBI for FII investment in corporate bonds.

It proposed that the IIDF be set up and managed as a trust, with an intial corpus of Rs 50000 Cr, approved and regulated by SEBI under the modified venture fund guidelines, and managing debt with tenor of more than 10 years. The report suggests that the debt fund should be set up by one or more sponsors - the major existing infrastructure financiers or investment banks or multilateral lending agencies (to increase the attractiveness for foreign investors) - who will have to invest atleast 10% of the total investment in the form of subordinated debt, and act as the General Partners (GP). It also recommended that the country's foreign exchange reserves may be used to source up to $ 2 billion for the Fund.

The report also recommends that the Fund refinance up to 85% of the outstanding debt from senior lenders, thereby enabling the project companies to substitute debt with long term bonds at comparatively lower interest rates. It is hoped that this restructuring of project debt will release a large volume of present lending capacity of the commercial banks, thus enabling them to lend more to new projects.

The recommendations are in line with similar practices for financing infrastructure assets across the world. The US recently set up three institutions - National Infrastructure Bank (NIB), a National Infrastructure Development Corporation (NIDC) and a subsidiary National Infrastructure Investment Corporation (NIIC) - to raise money, mainly from the market as long-term debt, through sovereign guarantee, and then fund public and private investments in infrastructure. The logic being that government sponsored entities are better positioned to raise capital in larger amounts and at lower cost than the private sector.

In the US, most of the federal government’s programs for surface transportation are financed through the Highway Trust Fund, about 90% of whose revenues come from two taxes on motor fuels.


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