Indian Infrastructure

A Trillion Dollar Opportunity

5th PEVCAI ANNUAL CONVENTION

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Contents

ASSOCHAM Foreword……….....………………………………………………………………………………………………………...3

Trillion Dollar Opportunity A Perspective ................................................................................................................... 4

Availability of finances ............................................................................................................................................ 8

Private sector investment ....................................................................................................................................... 9

Financing Trillion Dollar Investment Availability Aspect ........................................................................................... 10

Debt Financing ..................................................................................................................................................... 11

Commercial Banks ............................................................................................................................................... 11

Infrastructure Non-Banking Finance Companies (NBFCs) .................................................................................. 12

Insurance Companies .......................................................................................................................................... 12

Overseas Market: External Commercial Borrowing ............................................................................................. 13

Measures to enhance fund availability ................................................................................................................. 14

Bond market ......................................................................................................................................................... 14

Banking reforms ................................................................................................................................................... 15

Insurance reforms ................................................................................................................................................ 16

Recommendations for ECBs ................................................................................................................................ 18

Financing Trillion Dollar Investment Private Sector Investment .............................................................................. 19

Assessment of FY2013 Infrastructure Investment ............................................................................................... 20

What ails the infrastructure sector ....................................................................................................................... 20

Policy response to infrastructure issues .............................................................................................................. 21

Modifying the policy/regulatory framework ........................................................................................................... 22

Facilitating project clearances .............................................................................................................................. 25

New investment cycle on anvil ............................................................................................................................. 29

Equity Financing A Perspective ............................................................................................................................... 30

Global Infrastructure Investors market ................................................................................................................. 31

Infrastructure private equity in India ..................................................................................................................... 33

Going forward scenario ........................................................................................................................................ 35

Way Forward ............................................................................................................................................................ 37

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ASSOCHAM Foreword

India needs private equity more than ever to push forward the Infrastructure agenda.

But to be most effective, the right partnerships are critical – to seize market

opportunities, open up new markets, and to share Market knowledge.

India could become the second – largest economy in the world by 2050. The key

growth drivers are investments in infrastructure, domestic consumption, and a hub for

global outsourcing. This is further supported by growth – oriented policies by the

government. The favourable environment has led to the growth of the private

equity market.

On the other hand, entrepreneurship has long been considered crucial for the economic development. An

important element of entrepreneurship is the willingness and ability to mobilize private capital from both

domestic and foreign sources thereby creating of new business that proposer and create jobs.

Private equity can not only help companies grow and raise productivity but at the same time, it can also

be a powerful driver of change by raising standards, fostering growth and promoting new opportunities for

business.

Private equity represents a modest share of the USD 1 trillion to be spent on infrastructure in 2012-17,

about half of which would come from private sector funds, compared with a target of one-third in the

previous five years.

This paper prepared by Deloitte and PEVCAI Teams, gives an overview of the Twelfth Plan financing

scenario and highlights the role of the Private Sector (and in turn of Private Equity as an asset class) in

driving the private investment into the infrastructure sector and further fuelling the growth of the Indian

economy.

I convey the Teams and the 5th PEVCAI Annual Convention my good wishes.

D. S. Rawat

Secretary General

ASSOCHAM.

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Deloitte Foreword

Achieving a sustained growth trajectory averaging at 9 percent entails robust

physical infrastructure i.e. electricity, roads, ports, irrigation, water supply and

sanitation and creation of such infrastructure required mobilization of funds for

financing such projects.

Notably, funding of domestic Infrastructure is in a period of flux. On both sides of the

equation —supply and demand — there are positive and negative influences

resulting from the economic slowdown as well as credit scarcity. While demand

remains strong from the users of finance, suppliers have traditionally gravitated towards ‘quality’ projects

with little to differentiate.

In this context, ability to meet infrastructure investment target of USD 1 trillion (INR 65,000 billion) as

envisaged in the Twelfth Plan has two aspects to it. Firstly, availability of funds from sources from various

sources including budgetary support, internal generation and borrowings. Secondly, ability of private

sector to execute infrastructure projects and take up new investments under public-private partnership

model

Availability of finances for such huge investment would largely depend on the Government's ability to

successfully increase reliance on the bond market as an alternative source of financing to bank loans and

their ability to implement fiscal consolidation as a means of freeing up bank lending and reducing upward

pressure on interest rates.

Emphasis on private sector participation and policy / regulatory measures to attract private capital cannot

be undermined given the huge pressure on capital rationing and funding requirements. In order to

incentivise the large scale use of private sector participation in infrastructure, it would be useful to link the

Government funding to the effort of developing projects as PPP.

Further, there are credible reasons to believe that the Indian private equity market would make important

contribution in this endeavor. Our GDP continues on it’s upward trajectory, bringing continual increases in

new investment opportunities in the infrastructure which would be required to maintain the growth

momentum. Plenty of opportunities and long term potential in the infrastructure would keep attracting

private equity to invest in it.

We trust the report provides an ample background for helping identify practical solutions to address

concerns holding back investments in the infrastructure sector.

Kalpana Jain

Senior Director

Deloitte Touche Tohmatsu India Private Limited

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Trillion Dollar Opportunity

A Perspective

The rapid growth of the Indian economy in recent years has placed increasing stress on physical

infrastructure i.e. electricity, railways, roads, ports, irrigation, water supply and sanitation, all of which

already suffer from deficit in terms of capacities as well as efficiencies. The pattern of inclusive growth

averaging at 9 percent per year as conceived under the Twelfth Five Year Plan (2012-17) can be

achieved only if this infrastructure deficit is overcome and adequate investment takes place to support

higher growth and an improved quality of life for both urban and rural communities.

Based on projections provided in the Mid-Term Appraisal of the Twelfth Plan, in order to attain a 9 percent

real Gross Domestic Product (GDP) growth rate, infrastructure investment should be on average almost

10 percent of GDP during the Twelfth Plan. This translates into INR 41 lakh crore at 2006-07 prices (real

terms), as estimated by the Planning Commission of India. At an annual inflation rate of 5%, this

translates into an equivalent to INR 65 lakh crore in current prices.

Projected Investment in Infrastructure during the Twelfth Five Year Plan

Year FY13 FY14 FY15 FY16 FY17 Total Twelfth Plan

GDP at FY07 Prices (INR Billion) 68,825 75,019 81,771 89,131 97,152 411,900

Infrastructure Investment as % of GDP

9.00% 9.50% 9.90% 10.30% 10.70% 9.95%

Infrastructure Investment (INR Billion in current prices)

8,885 10,734 12,803 15,245 18,125 65,794

Source: Mid-Term Appraisal Twelfth Five Year Plan, Planning Commission

Note: WPI inflation used to convert to current prices; FY12 inflation based on Prime Minister Economic Advisory Council (PMEA C)

projection

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The sectoral allocation of infrastructure investment as a proportion of GDP stands highest at 2.9 percent

for energy sector (comprising electricity, renewable energy and oil & gas) followed by transport (railways,

MRTS, ports, airports, roads & bridges and storage) at 2.8 percent.

Sector-wise Investment Pattern: Eleventh and Twelfth Plan (INR Billion at current prices)

Eleventh Plan (2007-12)

Twelfth Plan (2012-17)

Private Sector Participation Ratio

Sectors INR Billion

As % GDP INR Billion

As % GDP Eleventh Plan

Twelfth Plan

A. Energy (1 to 3) 8,802 2.6% 23,242 2.9% 56% 61%

1.Electricity 7,285 2.2% 17,724 2.2% 43% 48%

2.Renewable Energy 892 0.3% 3,760 0.5% 88% 88%

3.Oil & Gas Pipelines 625 0.2% 1,757 0.2% 37% 48%

B. Transport & Storage

(4 to 9)

7,948 2.4% 22,446 2.8% 40% 56%

4.Raiways 2,012 0.6% 6,128 0.8% 5% 19%

5. MRTS 417 0.1% 1,466 0.2% 13% 42%

6.Ports 445 0.1% 2,335 0.3% 82% 87%

7.Airports 363 0.1% 1,035 0.1% 64% 80%

8.Roads & Bridges 4,531 1.3% 10,793 1.3% 20% 33%

9.Storage 179 0.1% 689 0.1% 55% 72%

10. Telecommunication 3,850 1.1% 11,140 1.4% 78% 92%

11. Irrigation 2,435 0.7% 5,953 0.8% 0% 0%

12. Water Supply &

Sanitation

1,208 0.4% 3,013 0.4% 0% 3%

12. Grand Total (1 to 12) 24,243 7.2% 65,795 8.2% 37% 48%

Source: Planning Commission.

Assuming 50 percent of the investment will be met by budgetary resources, the balance INR 32.5 lakh

crore needs to be met through debt and equity. Until recently infrastructure investment in India was

financed almost entirely by the public sector— from the Government budgetary allocations and internal

resources of public sector infrastructure companies. However lately, the private sector has emerged as a

significant player in bringing in investment to build and operate infrastructure assets from roads to ports

and airports and to network industries such as telecom and power. Private investment constituted about

one third of infrastructure investment in the Eleventh Plan and this is projected at 50 percent for the

Twelfth Plan period. In these times of tight fiscal environment, private sector will need to play a greater

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role without which infrastructure development will not meet the growing demand and could fall far behind

current requirements impacting targeted GDP growth.

The public-private sector mix of investment varies across various infrastructure industries. For instance

private sector is expected to contribute more than 80 percent of total investment in the renewable energy,

telecom, ports and airports. These are the infrastructure industries where user charges can pay for the

investment. In case of roads, more than two thirds of the road network is in rural or in the less developed

and remote regions where low levels of development and industrial activity preclude high traffic volumes

necessary for commercial viability of toll roads. Hence, the contribution of the private sector is only one

third of total investment for this sector (INR 10,763 Billion) and the balance two third is to be made up by

public sector contribution.

The source of financing proposed infrastructure investment for Twelfth Plan is represented below.

Financing matrix of Infrastructure: Twelfth Plan (2012-17)

Source: Planning Commission.

Technically, there are two dimensions to above financing matrix for the Twelfth Plan. Firstly, availability of

funds form sources mentioned in the matrix including budgetary support, internal generation and

borrowings. Secondly, ability of private sector to execute infrastructure projects and take up new

investments under public-private partnership model.

Trillion Dollar Infrastructure Investment Requirement INR 65,000 billion (2012-17)

Public Sector

Contribution Private Sector

Contribution

INR 33,700 billion

INR 31,300 billion

Budgetary Support INR 16,143

billion

Internal Generation INR 6,869

billion

Borrowings INR 10,693

billion

Internal Generation INR 9,630

billion

Borrowings INR 21,670

billion

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Availability of finances

Of the three sources of public sector contribution mentioned in previous section, budgetary support for

infrastructure would depend on the fiscal space available to both Central and State Governments after

meeting contractual obligations like interest payments, wages and salaries and pensions. Besides,

Central Government has to contend with rising defence and security related expenditure which are driven

by threat perceptions and geostrategic considerations, subsidies and massive expansion of programmes

aimed at social entitlements. Higher levels of internal generation of resources largely depend on the

extent of freedom and autonomy enjoyed by public sector undertakings involved in rendering

infrastructure services to run their undertakings on commercial considerations. Scope for borrowings

would mainly depend on Government’s success in containing it’s fiscal deficit which would prevent

borrowings by the Government for financing revenue expenditure so that private sector investment is not

crowded out.

In terms of non-debt and debt sources, almost 50 percent contribution each from debt and non-debt

sources would be required. However, availability of debt is placed at INR 13,337 billion as against a

requirement of INR 32,363 billion leaving a funding gap of INR 19,025 billion to be addressed.

Debt source availability versus requirement (INR Billion)

Twelfth Plan (2012-17)

Debt requirement

Public Sector – Borrowing 10,693

Private Sector – Borrowing 21,670

Total Debt Requirement 32,363

Debt availability

Commercial Banks 7,435

IFC 3,844

ECB 549

Insurance Funds 1,507

Total Debt Availability 13,337

Debt Funding Gap 19,025

Source: Planning Commission.

Given the above gap in debt funding, the ability to meet infrastructure investment target of USD 1 trillion

(INR 65,000 billion) will critically depend on two factors. First, the Government's ability to successfully

increase reliance on the bond market as an alternative source of financing to bank loans and, second,

their ability to implement fiscal consolidation as a means of freeing up bank lending and reducing upward

pressure on interest rates.

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Further, India will need to borrow increasingly in the domestic market if it is to meet this target, since it has

limited fiscal space and faces ceilings in terms of instruments such as external commercial borrowings. It

faces a widening current account deficit - the latest figure reaching 4.9 percent of GDP (October-

December 2013) - that constrains it’s scope to expand domestic investment and it’s balance of payments

position. So far, banks have been the main providers of infrastructure financing. While this is not an

optimal arrangement, given the long-term financing required for infrastructure investment, banks have

been successful in financing greenfield projects. However, they now face a number of barriers to expand

lending to infrastructure, including concentration risk such as exposure limits to groups (infrastructure

companies) and sectors (e.g. power, roads) as well as to prevent build-up of asset liability mismatches in

the system.

Private sector investment

As established, nearly 50 percent of the Twelfth Plan target is expected to be contributed by the private

sector via public-private partnership (PPP) route.

PPP has emerged as the new success route in India’s attempts to build world-class infrastructure. As

planned infrastructure projects throw up funding and technological challenges, Governments are

increasingly turning to the private sector with PPP route emerging as the most favoured mechanism for

cooperation. It is not surprising then that the PPP concept has expanded across key infrastructure

segments ranging from roads and communications to power and airports. PPP in fact, could be the key to

policymakers’ attempts to create the requisite infrastructure for enabling double-digit GDP growth and

enhancing people’s welfare. Out of 50 percent to total infrastructure investments in India during the

Twelfth Plan, it will be no surprise if a large chunk of these investments are directed through the PPP

route.

However, achieving private sector investment target in the infrastructure sector during the Plan period is

challenging mainly due to delays in clearances and liquidity crunch faced by the players. Besides,

financial institutions are not willing to fund infrastructure projects. This results in developers facing liquidity

challenges. Therefore, instead of taking up new projects, developers are now focusing on completing

existing ones and addressing internal cash flow issues.

The paper details the aspects of availability of finances for the gigantic trillion dollar investment

projections and issues saddling the private sector investments in subsequent sections.

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Financing Trillion Dollar Investment

Availability Aspect

While infrastructure investment targets are ambitious, India’s domestic savings rate is very high and is

projected to grow. Much of the infrastructure investment need can be financed domestically. Still, such

high rates of infrastructure investment constitute over one-third of India’s financial savings and would

entail as much as 21 percent of the incremental financial savings being directed to infrastructure.

Savings and Infrastructure Investment Needs

Percent of GDP FY10 FY13 FY14 FY15 FY16 FY17

Infrastructure Investment 8.0 9.0 10.0 9.9 10.3 10.7

Gross Domestic Savings 33.7 37.8 40.6 42.9 45.5 48.2

Out of which financial savings 22.0 24.8 27.2 29.1 31.1 33.4

Incremental Infrastructure Investment 0.3 0.6 0.5 0.4 0.4 0.4

Incremental Financial Savings 2.8 4.1 2.4 1.9 2.6 2.3

Infrastructure Investment as % of Financial Savings

34% 36% 35% 34% 33% 32%

Percentage share of incremental infrastructure in incremental financial savings

21% 21% 20% 17%

Source: Mid-Term Appraisal Twelfth Five Year Plan, Reports submitted by Sub-Groups on Household Savings, Private Sector Corporate Savings and Public Sector Savings for 9% p.a. real growth and 5% p.a. inflation scenario

Yet, it is not just the adequacy of domestic financial savings that matters. These savings have to be

intermediated into infrastructure to achieve these targets. During the first three years of Eleventh Plan, the

infrastructure funding requirement has broadly been met through the channels mentioned above in the

proportion described below:

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Sources of funds during first three years of Eleventh Pan

Source: Infrastructure.gov.in

It is evident that budgetary support constituted ~45 percent of the total infrastructure spending followed by

debt from Commercial banks, Non Banking Financial Companies (NBFCs), Insurance Companies and the

external sources constituting ~41 percent of the funding while the balance 14 percent was through Equity

and Foreign Direct Investment (FDI).

Debt Financing

Until the mid-2000s, there was no major demand from the financial system to fund infrastructure

investment due to fairly low quantum – (around 3-5% of GDP). This was financed largely by budgetary

allocations and internal resources of public sector enterprises engaged in infrastructure. In the Eleventh

Plan, however, infrastructure spending picked up substantially with an important role played by the private

sector and greater recourse to the financial system. Most of the debt financing came from banks, NBFCs,

and external commercial borrowing (ECB), followed by insurance companies.

Commercial Banks

The financial system was able to respond to the rapidly rising demand for credit by infrastructure

companies largely because banks stepped up lending by unwinding their excess investments in the

Government securities maintained as Statutory Liquidity Ratio. Until the end of the Eleventh Plan, it is

estimated that banks were able to provide about half the debt finance needs of infrastructure investment.

However, this rapid growth in bank credit to infrastructure has resulted in a greater concentration of risks

in banks, asset liability mismatch and reaching exposure ceiling limits of the sector. Banks have prudential

exposure caps for infrastructure sector lending as a whole, as well as for individual sub-sectors.

According to the information available, most of the banks have almost reached the prudential caps for

power sector and other sectors like roads may not be far behind.

45%

14%

6%

4%

10%

21%

Budgetary support Equity/FDI ECBs Insurance NBFCs Commercial Banks

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Going forward, credit growth will be determined mainly by retained earnings and increase in banks’

capital. However, as most of the infrastructure lending is by public sector banks (PSBs), raising capital

can only take place if equity capital base is enhanced by the Government diluting it ’s shareholding or

infusing capital into the PSBs. In the projections described below, infrastructure credit growth is assumed

to be determined only by retained earnings. Assuming that retained earnings grow at 20 percent per

annum for PSBs, and at 25 percent per annum for private banks, and infrastructure credit is estimated to

rise to 15 percent of total credit, then the net incremental bank credit to infrastructure over the Twelfth

Plan is estimated at INR 7.4 lakh crore.

Infrastructure Non-Banking Finance Companies (NBFCs)

NBFCs also increased their lending sharply as the credit demand for power and roads expanded. The

major Infrastructure Finance Companies (IFCs) which could be considered for estimating infrastructure

finance are Power Finance Corporation (PFC), Rural Electrification Corporation Limited (REC), IDFC

Limited, India Infrastructure Finance Company Limited (IIFCL), L&T Infrastructure Finance Company

Limited and IFCI Ltd.

Going forward, high historical growth rates observed in the past may not be feasible since NBFCs would

need to take up further capital raising exercise to be able to lend significant amounts. Hence, for the

purpose of estimation the growth rate for FY11-17 is assumed at ~20 percent per annum which is at the

same levels as commercial banks.

Insurance Companies

Life insurance companies are required to invest up to 15 percent of their Life Fund in infrastructure and

housing. Although the Asset Under Management of life insurers in the Life Fund increased at a compound

annual growth rate (CAGR) of 16.31 percent p.a., the share of infrastructure investments during the same

period increased only marginally at a CAGR of ~1.25 percent p.a. Insurance penetration is estimated to

continue to rise, with the insurance premium growing from the current approximate 4 percent of GDP to

6.4 percent of GDP by the end of the Twelfth Plan. Investment in infrastructure by the insurance sector is

projected based on the past few years average investment by insurance companies (about 63 percent of

premium income) after deducting commissions and expenses, and the infrastructure investment as a

share of the total insurance investment flows (of 6.2 percent). Although there is much greater scope for

channelizing insurance funds for infrastructure (which needs long-term funding) there are various

regulatory constraints in the sector precluding this.

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Overseas Market: External Commercial Borrowing

Infrastructure companies have tapped external credit market, however the share of infrastructure

investments in overall ECB borrowings has gradually come down. The estimates of the external

borrowings during Twelfth Plan are based on the past five year averages (FY07-11) of the actual external

borrowings.

Total Debt availability projections

Commercial Banks- Projections (INR billion)

FY12 FY13 FY14 FY15 FY16 FY17 Total

Gross Bank Credit Outstanding

58,874 70,567 84,581 101,378 121,511 145,642

Yearly availability of funds 988 1,192 1,436 1,731 2,086 7,435

NBFCs- Projections (INR billion)

FY11 FY12 FY13 FY14 FY15 FY16 FY17

Credit (Infrastructure) –total outstanding

2,176 2,608 3,126 3,747 4,492 5,384 6,453

Credit (Infrastructure) – yearly growth

518 620 744 892 1,069 3,844

Insurance- Projections (INR billion)

FY11 FY12 FY13 FY14 FY15 FY16 FY17

GDP Projections 78,779 90,163 103,191 118,102 135,168 154,700 177,054

Premium % of GDP 4.10% 4.40% 4.70% 5.10% 5.50% 5.90% 6.40%

Total premium 3,229 3,967 4,850 6,023 7,434 9,127 11,331

Total Investment 2,045 2,512 3,072 3,815 4,708 5,781 7,177

Infrastructure Investment 125 154 188 234 289 354 440 1,507

Sources: IRDA; Subgroup Household Sector Savings

ECB- Projections (INR billion)

Total Borrowing 549

Total Debt Funding Available (INR billion) 13,337

Source: Planning Commission

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Measures to enhance fund availability

As observed, there is expected to be a shortfall in the available resources vis-a-vis requirement under

different growth scenarios. Total funding gap is estimated at INR 19,025 billion. Certain focus areas could

be:

Broad areas of reforms to enhance fund availability

Supplementing/widening the channels of

infrastructure funding

Regulatory reforms for Insurance companies and

Pension Funds so that more savings through these

important channels gets mobilized into infrastructure.

Reforms which ensure higher ECB and other forms of

foreign capital inflows.

Development of financial products and

markets

Increase depth and width of the financial market.

Reforms in the area of development of newer financial

products for infrastructure financing such that a wider

variety of investor is attracted.

Creation of a growth enabling eco-system

Regulatory changes addressing replacement of

committed but unutilized debt capital extended by the

commercial banks with other forms of financing.

Development of a frame work that reduces the market

risk in infrastructure financing and asset liability

mismatch of banks.

Give commercial banks more flexibility to churn their

portfolio of Infrastructure assets at shorter tenors by

way of increasing asset classes.

Revitalising the market for takeout financing,

refinancing and securitisation.

Having the focus areas mentioned above as guiding principles, the following section describes some

regulatory, policy and financial stimuli required in the immediate to the medium term.

Bond market

In many countries across the world, long-term bonds form a major share of infrastructure finance.

However, the Indian corporate bond market is less than 5 percent of GDP. International bonds can

provide access to term financing (can be up to 30 year plus tenor) to an extent not available in the bank

market. However, Indian companies (even with high ratings) have been unable to tap the international

bond markets for funding their long term investments in the infrastructure sector.

Some measures that need to be undertaken for the deepening the corporate bond markets in India may

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include: (a) Financial: Implement uniform stamp duty across States; (b) Regulatory: (i) Allow banks and

domestic financial institutions to provide credit enhancement for the infrastructure bonds; (ii) Develop

regulatory framework for multi-asset collateralised debt obligations (CDOs) and (c) Creating robust market

infrastructure: (i) Establish an integrated trading and settlement system (like Negotiated Dealing System

(NDS) order matching system for G-Secs) and (ii) Move from a Delivery Versus Payment (DVP) I to DVP

III system for corporate bonds.

One of the reasons for lack of investor appetite for long term infrastructure bonds is withholding tax. While

a reduction in withholding taxes payable for overseas borrowing by infrastructure funds has already been

announced, the same withholding tax cap needs to be in place for infrastructure investments (with tenor

exceeding 7 years) made either through IFCs or directly in the infrastructure companies.

Also, Municipal bond market (“Munis”) in India has remained underdeveloped and relatively untapped.

There have been exceptions in the past, for example, municipal bonds were issued by Municipal

Corporation of Ahmedabad (INR 1 Billion in 1998). It is estimated that there is a potential o f USD 270

billion being generated through Munis provided the Municipal Bond Market is tapped properly.

This would, however, also require critical pre-conditions like transparency of corporate governance within

Municipal Corporations, levy and collection of appropriate user charges, innovative project structuring,

supporting tax regime, better framework for security creation and enforcement is equally or more critical.

This together with the PPP model could drive urban infrastructure and spur a new growth area. Like PPP

was well appreciated and important development of the Eleventh Plan, “Munis” and urban infrastructure

growth could be the most important theme of the Twelfth Plan.

Infrastructure Debt Fund and long-term resources: Government may facilitate Infrastructure Debt

Funds (IDF) through Mutual Fund route and NBFC route, and allow IIFCL to provide refinancing and

takeout finance to IFCs.

New Financial Instruments: Create a single regulatory window for clearing innovative debt products

typically in the mezzanine space. For instance, products such as Rupee denominated convertible bonds

or Optional Convertible Debentures (OCD) can help develop the corporate debt market .

Banking reforms

As on date, sectoral lending limits have been reached, increasing the systemic risks to the banking

system. There is an urgent need to develop take out financing schemes to ameliorate stress. Some of the

suggestions to adopt this are as under:

Allow commercial banks to reduce burden of Infrastructure debt financing: Like infrastructure

NBFCs, banks to be allowed to raise infrastructure bonds which qualify for exemption of Income tax under

Section 80CCF with an exemption limit to INR 100,000.

Refinancing Scheme with matching tenor needs to be devised. Current IIFCL scheme has only 10 year

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tenor and other restrictions making it unattractive for banks.

Provide banks more flexibility to churn their infrastructure loan portfolio: Since the sectoral cap for

lending to infrastructure has been reached, this prevents the banks from granting fresh sanctions. To this

extent, large lenders such as SBI need to start quoting two way quotes and create market in the

infrastructure receivables space.

Regulatory framework for multi-asset CDOs allowing securitization to happen needs to be implemented.

While there were early adopters like ICICI Bank and Citibank, almost all transactions in the market are

privately placed. Lack of appropriate legislation/legal clarity and unclear accounting treatment exacerbate

the situation.

Need for banks to raise more capital: In order to be able to fund a growing economy, public sector

banks need to raise further capital, especially if infrastructure lending by banks is to be kept intact for the

Twelfth Plan. According to an independent study carried out by IDFC in February 2011, diluting

Government stakes in all major PSBs to 51 percent by raising capital in 2013 could yield INR 1.45 lakh

crore more funds to lend to infrastructure from commercial banks. For example, the dilution of the

Government stakes to 51 percent in two major NBFCs viz. REC and PFC, 67 percent and 73.72 percent

held by the Government (Quarter Ending June 2011), works out to about INR 7,994 crore at current prices

which may result in additional increase in lending assets of IFCs by ~ INR 53,300 crore.

Possible capital raising by PFC and REC:

Government Holding as on 30th June 2011

Market Cap As on 30th June 2011 (INR Crore)

Equity dilution (%) Potential Capital Raised (INR Crore)

PFC 73.72% 18,300 22.72% 4,158

REC 66.80% 24,286 15.80% 3,837

Total 7,995

Source: IDFC

Insurance reforms

Since infrastructure financing is long term in nature, the depository profile of insurance companies is more

in tune with the funding requirement of the sector. Banks, as discussed, face asset liability mismatch

issues because their depository base is short term against long term nature of infrastructure loans assets.

Similarly, pension funds are key investors in long term infrastructure bonds. In India both had jointly

contributed around 5 per cent to the total investment in infrastructure in the Eleventh Plan.

Insurance/Pension funds have the ability to invest for longer terms, these institutions are restricted by

their respective regulatory bodies (IRDA and PFRDA) which limit their exposure to the infrastructure

sector even when they have sufficient funds available to invest.

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Some suggestions to increase investments in infrastructure from these insurance companies are

described below:

The IRDA (Investment) Regulations 2000, as amended from time to time, stipu late that “not less than 75

percent of debt instruments excluding Government and Other approved Securities shall have a rating of

AAA or equivalent rating for long term instruments and not less than P1+ or equivalent for short term

instruments”.

This limit may be changed to “not less than 50 percent in “AAA” rated and “AA+” rated debt instruments

may be incorporated, which would increase of better availability of insurance funds for debt instruments.

The tenor of investments in infrastructure related facilities may be revised to “not less than 5 years” from

the present “not less than 10 years” to enable insurance companies to invest in brown field infrastructure

companies/projects and also to enable the life insurance companies to fund the “take -out finance”

arrangements.

Insurance company investments into the special purpose vehicles (SPVs) of infrastructure projects,

debentures of private limited companies and non-dividend track record companies in infrastructure need

to be included with in the ambit of “approved investments” thereby providing flexibility o f funding options

for infrastructure projects.

For higher investment by the life insurance companies in infrastructure projects, the exposure can be

considered for revision to “20 per cent of the total project cost from current level of 15% of project equi ty”

as being done by IIFCL.

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Recommendations for ECBs

Recently, take-out financing arrangement has been permitted through ECB, under the approval route, for

refinancing of Rupee loans availed from domestic banks by eligible borrowers in the port, airport, roads

including bridges and power sectors for development of new projects. However there is a need to simplify

the process for take-out financing/refinancing Rupee loans through ECBs for infrastructure companies.

Current timelines to engage foreign lenders for takeout are limited making it difficult for foreign lenders to

come to an agreement at the initial stage itself and assume the execution risk at the time of take out.

This condition of entering into tri-partite agreement may be dispensed away with and an amount for such

take-out financing through ECB automatic route could be declared on an annual basis.

There is a need to relax the all-in-price ceiling for ECBs (i.e. 500 basis points over the 6 month Libor) for

infrastructure projects with average maturity exceeding 7 years. The interest rate ceilings set by RBI on

ECBs put constraints in availing foreign currency loans for domestic infrastructure projects.

Relaxation of the ECB ceiling of USD 500 million per annum per company for automatic route will help

make ECB stable source of financing and ensure increased ECB funding. This may be increased to USD

1 billion for Infrastructure financing.

International Investments: To facilitate flow of funds from the international market with flexible but

prudent regulatory framework, following measures could be considered:

Bringing IFCs in the infrastructure sector under the automatic route in line with other corporate.

Exempting withholding tax on interest and other payments to ECBs by infrastructure sector, including

IFCs.

Allowing, within a certain limit, Indian corporates in the infrastructure sector, including IFCs to issue

Rupee denominated bonds in the international market.

Impact of suggested measures on availability of non-budgetary funds (INR billion)

Particulars Funds Estimated Additional Funds Funds estimated (revised)

Commercial Banks 7,435 1,450 8,885

NBFCs 3,844 533 4,377

Insurance 1,507 4,522 6,030

ECBs 549 - 549

Total 13,337 6,505 19,843

Source: Planning Commission.

To conclude, concrete policy and regulatory measures need to be undertaken. Some of the most

important include measures taken to increase the breadth and the depth of the corporate bond markets in

India, higher involvement of insurance and pension fund companies in infrastructure funding, and

providing an environment that is attractive to foreign investors.

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Financing Trillion Dollar Investment

Private Sector Investment

The Twelfth Plan has identified the crucial challenge of immediate reversal of growth deceleration with

revival of investment sentiments. The plan has emphasised for an action plan to address implementation

constraints in infrastructure which are holding up large projects.

Share of Private Sector Investment

Sector Share in USD 1 trillion infrastructure in investment in Twelfth Plan

Share of private investment

Electricity 27% 48%

Roads and bridges 17% 34%

Telecom 17% 92%

Railways 9% 20%

Irrigation 9% 0%

Renewable energy 6% 88%

Water supply and sanitation 5% 2%

Ports including Inland Water Ways

4% 87%

Oil and Gas pipelines 3% 48%

Metro Rail Transport 2% 42%

Airports 2% 80%

Storage 1% 72%

Source: Planning Commission 2012.

The share of private investment in the total investment in infrastructure rose from 22 percent in the Tenth

Plan (2002-2007) to 38 percent in the Eleventh Plan. The Eleventh Plan succeeded in raising investment

in infrastructure from 6.2 percent of GDP in FY08 to about 7 percent in FY12. The Twelfth Plan aimed to

raise it further to 9 percent by FY17. There is special emphasis on electricity generation with 27 percent of

the planned investment expected to be directed towards this sector.

The Eleventh Plan added 55 Giga Watts (GW) of generation capacity which, though short of the target,

was more than twice the capacity added in the Tenth Plan. The Twelfth Plan aims to add another 88 GW.

There is an additional investment of USD 57 billion for renewable energy (additional 30 GW of renewable

energy) of which private sector is expected to contribute as much as 88 percent. Compared to the last

plan period there is doubling of investment share targeted at the port sector (including inland waterway)

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with further increase in private participation.

The scale of private investment would require a significant reinforcement of an enabling policy and

regulatory environment. Even though the planned investment in infrastructure is on track but going by the

last plan performance on targeted investment, the pre-requisite is to provide a conducive business

environment which protects domestic and foreign investor interest. The Eleventh Plan achieved 93

percent of targeted investment because of performance of only few sectors like electricity, telecom and oil

and gas pipelines. But critical segments of infrastructure, i.e. roads, railways and ports, have under -

achieved their target mainly because of the lack of private investment.

Assessment of FY2013 Infrastructure Investment

Total investment across all infrastructure sectors in 2012-13 was INR 534,645 crore, the least since 2010-

11, mainly due to less than satisfactory performance in electricity, roads and bridges. This raises

concerns over the Government’s ambitious target to attract investment of INR 65 lakh crore (at current

prices) into the infrastructure sector during the Twelfth Five-Year Plan.

In 2012-13 GDP grew at a decadal low of 5 percent, impacting infrastructure spending and 2013-14 is not

expected to be any better as overall economic sentiment is poor. Prime Minister Dr. Manmohan Singh

had earlier stated he expected economic growth in 2013-14 at 5 percent, similar to that in 2012-13.

Infrastructure investment shortfalls (INR Billion)

Sector 2011-12 (A) 2012-13 (P) 2012-13 (E) Shortfall

Electricity 1,904 2,134 1,768 17%

Non-conventional power sector 281 282 257 9%

Roads & Bridges 1,301 1,401 1,077 23%

Urban Infrastructure (Water Supply & Sanitation) 257 340 312 8%

Ports 168 183 125 32%

Total 3,913 4,343 3,540 18%

Source: Planning Commission.

We have analysed below the factors leading to poor private sector appetite for investment in sectors like

power, roads, and ports followed by measures which have been initiated by the Government to revive the

infrastructure investments in these sectors.

What ails the infrastructure sector

The infrastructure sector has been lagging for the last few years. This has led to slowdown in economic

growth and infrastructure investments. While there are multiple issues that have plagued the sector, t hese

problems are interconnected with one issue leading to another. In other words, there has been a ‘domino

effect’ which has led to the present state of affairs. Main issues are:

Policy paralysis: The troubles for the sector started with the ‘policy paralysis’ that led to delays in

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statutory approvals and related clearances like land acquisition, environmental and forest.

Project viability takes a hit: With projects getting delayed due to lack of clearances (leading to cost and

time overruns), viability of projects was adversely impacted. This led to deterioration in the financial

strengths of infrastructure companies.

Demand slowdown: Apart from supply side issues mentioned above, slowdown in the economy led to

demand side issues with lower than anticipated traffic growth and low demand for power over past few

quarters. The slowdown also impacted Government spending, further hurting infrastructure companies.

Other issues: In addition to the above, there were other factors that impacted infrastructure projects. For

example, power projects had faced paucity of domestic coal as domestic coal production hit speed

bumps. To exacerbate the situation, imported coal prices increased (change in reference rate for

Indonesian coal) throwing viability of many power projects haywire. Road projects saw aggressive bidding

with developers promising to pay hefty premiums to win projects. However, many of these projects later

failed to achieve financial closure due to lenders shying away from funding these unviable projects.

Issues with dispute resolution framework: All these issues led to developers either walking away from

projects (termination of road projects citing delay in clearances) or knocking the Government doors for

relief (for tariff revision for power projects or premium restructuring for road projects). However, this

resulted in protracted arbitration which exposed the absence of adequate dispute resolution framework to

deal with complex issues facing the sector.

All these issues have resulted in a situation where new projects were not being initiated, under

construction projects started witnessing slow execution and operational projects started becoming

distressed. Consequently, infrastructure players bore the brunt with falling profits/ballooning losses

resulting in a situation of financial distress. Due to this deterioration in financial matrices, infrastructure

companies have shifted their focus to survival from growth. Fresh capital expenditure (capex) plans are

being deferred time and again, impacting every player in the infrastructure value chain.

Policy response to infrastructure issues

The Government seems to be adopting a three-pronged approach to solve the sector ills. First, the

Government is considering modifying regulatory framework. It is also framing dispute resolution

mechanisms to deal with the dynamic nature of infrastructure projects. Second, as far as existing projects

are concerned, it is trying to get projects moving by speeding up clearances and removing execution

bottlenecks. Lastly, the Government is looking at reinvigorating the capex cycle by awarding new projects.

We analyse these measures in detail below for each of the sectors i.e. roads/highways, power and ports .

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Modifying the policy/regulatory framework

Roads/Highways Sector

As mentioned, the major issues that have impacted road development in India in the last 2-3 years are the

aggressive bidding for projects by developers and the delay in receiving environment/forest clearances

and land acquisition.

Premium restructuring: Many road projects awarded over FY12 had attracted aggressive bids from

developers, who had promised to pay substantial premium to National Highway Authority of India (NHAI)

for winning these projects. With the economy slowing down and project timelines getting stretched due to

delays in clearances, many projects failed to achieve financial closure. Recently, the Cabinet Committee

on Economic Affairs (CCEA) has approved premium restructuring for all projects awarded on premium

basis. Projects will be evaluated on a case-by-case basis to ascertain their eligibility for premium

restructuring. An expert panel under Mr. R Rangarajan (Economic Advisor to the Prime Minister) with

representatives from Finance and Surface Transport Ministries, will be set up to finalise guidelines for the

same. This move is positive for the roads industry since it will resolve the impasse in which road projects

have been stuck for the past two years.

Amendments in the prequalification criteria: Over the last few years, some road projects have seen a

large number of players getting prequalified to bid for projects. Certain projects have seen close to 100

players being prequalified. As a result of the large number of players getting prequalified, many projects

have seen aggressive bidding while many of these projects have later been unable to achieve financial

closure. As a response, the following changes have been suggested in the prequalification criteria for

road projects: making technical/financial criteria more stringent, focus on financial closure as bid

qualification, barring players with non-performing assets (NPA) etc.

Amendments in the Model Concession Agreement (MCA): With the changing economic scenario,

Government felt the need to amend current MCA which provides regulatory framework for the roads

sector. Following changes have been suggested in the MCA: (a) Fulfilment of authority’s Condition

Precedents (CP) before appointed date; (b) Status of CPs during bidding process – provision of likely

timeframe required for fulfilment of CPs and penalty for non-fulfilment; (c) Increasing the penalty for delay

in land acquisition - The rate of penalty is to be enhanced to INR 100 (from INR 50) per 1,000 sq. mt. for

each day of delay; (d) Presence of State Support Agreement (SSA) - NHAI will ensure execution of the

SSA before the bidding process; (e) Compensation for delay in toll hike notification. (Source: Edelweiss

Research, Feedback Report)

In the Union Budget FY14, it was announced that a regulatory authority for the roads/highway sector

would be set up. This independent body would primarily look at the current challenges being faced by the

sector such as financial stress, construction risk and contract management issues.

There have been other key policy initiatives that have been taken in the recent past for the development

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of the sector:

Companies enjoy 100 percent tax exemption in road projects for five years and 30 percent relief

for the next five years. Companies are also granted a capital of up to 40 percent of the total

project cost to enhance viability.

Infrastructure finance companies such as India Infrastructure Finance Company Limited (IIFCL),

National Highway Authority of India (NHAI), Housing and Urban Development Corporation

(HUDCO), Power Finance Corporation (PFC) etc. have been allowed to issue tax free bonds to a

total of USD 9.2 billion in FY14.

Interest payments on borrowings for infrastructure are now subject to a lower withholding tax of 5

per cent vis-à-vis 20 per cent earlier.

Power Sector

One of the biggest issues being faced by power developers is the inadequate domestic coal supply and

volatility in the cost of imported coal. The uncertainty on the fuel cost front has thrown developers’

calculations haywire since many PPAs do not have adequate provision of fuel cost pass through.

This has put the profitability of many existing power plants at risk while also significantly raising concerns

about under development power projects. In addition, this has had a negative impact on new capex plans

in the power sector with the viability of power projects coming under a serious cloud.

Compensatory tariff: As far as existing power projects facing losses are concerned, the Government is

in the process of giving compensatory tariff e.g. Tata Power’s Mundra and Adani Power’s Mundra and

Tiroda plants. Additionally, the Government is working to step up domestic coal production by fast

tracking clearances.

Standard bidding documents: On the issue of future power plants, the Government has revised the

bidding framework by coming up with a new Standard Bidding Document (SBD) for the power sector. It

has recently cleared the proposal of tweaking the SBD for Case-II thermal power plants and that for Case-

I plants is expected shortly. The new SBD for Case-II projects addresses the risk associated with fuel

price volatility and fuel availability as fuel cost has been made a pass through. At the same time, clarity

has been brought in the termination and other generic provisions in the contract. Bidding is to be based

on single parameter – capacity charges – as compared to a levellised (including capacity plus variable

charges) tariff earlier, bringing in more objectivity in the bidding framework. The capacity charge would be

linked to depreciation and loan repayment as well as to the inflation index. This decision is expected to

speed up the process of awarding the proposed Ultra Mega Power Projects (UMPPs) at Bedabahal,

Odisha and Cheyyur, Tamil Nadu. It is expected to kick-start investment of ~INR 400 billion in the power

sector.

Financial restructuring of State Distribution Companies: While the Electricity Act 2003 envisaged

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separation of interlinked activities of SEBs and making them individually self -sustaining entities, the

situation, especially of distribution entities, has not improved meaningfully over the years. State

Governments, entirely responsible for the distribution sector, have failed to keep pace and the situation

has gone from bad to worse. Realising the importance of the distribution sector in the power value chain ,

the Government in September 2012 decided to intervene by rolling out a scheme to restructure State

discoms keeping in mind Shunglu Committee’s recommendations. The scheme entails measures to be

taken by State Discoms and State Governments for achieving financial turnaround by restructuring the

debt with support via a transitional finance mechanism by the Government. Key feature of the scheme is

converting 50 percent of outstanding short-term liabilities into bonds to be taken over by respective State

Governments and the balance 50 percent to be rescheduled by lenders with adequate moratorium of at

least three years backed by State Government guarantees.

Tariff hikes: Recent tariff hikes and offer of State Government support would revive confidence of

developers. Some states have been granted steep tariff hikes in recent years in order to reduce the

widening gap between their average cost of supply (ACS) and average revenue required (ARR) on power

supply. Discoms have also been asked to strictly follow planned reduction in aggregate technical and

commercial (AT&C) losses in the system. While AT&C losses have improved marginally, much more

needs to be done to lower them further. (Source: Edelweiss Research, Feedback Report)

To promote investment and for the development of power sector, the Government announced various

measures in the Union Budget for FY14, key ones of which are:

Government to reintroduce ‘generation based incentives’ for wind power projects to boost

capacity addition in the sector for which USD 147.3 million is to be allocated to the Ministry of

New and Renewable Energy.

To reduce dependency on imported coal, a Public Private Partnership policy framework is to be

devised with Coal India Limited to increase coal production.

Low-interest–bearing funds to be provided from National Clean Energy Fund (NCEF) to Indian

Renewable Energy Development Agency Ltd (IREDA) for on-lending to viable renewable energy

projects.

The total plan outlay for the power sector for FY14 is estimated at USD 1.6 billion, a significant 27

percent higher than the revised estimate of USD 1.5 billion for FY13.

During FY13, Government liberalized FDI policy for power exchanges by allowing FDI investment

up to 49 percent.

Port Sector

Regulatory framework for major ports has been amended to anchor developer interest.

Existing norms for port tariffs are governed by a complex formula based on return on capital and

implemented by the Government-appointed, but largely autonomous, Tariff Authority for Major Ports

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(TAMP). These rules were widely seen as restrictive, hampering growth and therefore putting off

investors.

Global port operators with substantial investments in India such as PSA International, APM Terminals and

DP World have repeatedly expressed their grievances at what they see as a crippling tariff structure.

Port tariff reforms are under way in India and guidelines for determining tariffs are expected to lean

increasingly towards market-based mechanisms. The Ministry of Shipping has already announced that

projects approved under the PPP mode from April 2014 will not be bound by previous regulations. The

Twelfth Plan envisages INR 1.07 crores of new investment for the development of non-major ports out of

which INR 1.05 crores is expected to come through the PPP route.

Facilitating project clearances

Measures discussed above largely relate to regulatory/policy and are more relevant for future projects. In

addition, to ensure that existing infrastructure projects that have been stalled get requisite clearances fast,

the Government has established with an institutional mechanism in the Cabinet Secretariat called the

Project Monitoring Group (PMG) which will be headed by an Additional Secretary. This cell will work to

revive ~330 stalled infrastructure projects which have a total investment size of ~ INR 16,000 billion.

The working group would evolve a protocol for resolving problem areas, while the sub-groups will try to

settle specific issues. Various ministries (like roads, railways, environment and forest, coal, shipping,

telecom, commerce, mines, civil aviation etc.) have been asked to assign a nodal officer of the rank of

Joint Secretary or above to co-ordinate with the cell. The sub-groups on coal and environment are slated

to meet every week - given the plethora of affected projects. PMG has been vested with powers to deal

with different ministries and departments at central, state and local body levels to get the projects fast-

tracked. The cell will coordinate with the Cabinet Committee on Investment (CCI) to ensure speedy

clearance for projects. (Source: Edelweiss Research, Feedback Report)

The success of these initiatives could be a make or break for the infrastructure sector.

Roads/Highways Sector

The PMG has secured environment clearance for eleven infrastructure projects worth ~INR 150 billion.

The details for roads projects are as below:

Projects that have received environmental clearances

Project Segment Location Cost (INR billion)

Cuttack Angul road project Road Odisha 11.2

BSCPL Aurung Tollway Road Chhattisgarh 12.3

Source: Government documents, News articles, Edelweiss Report

Apart from the projects listed above, the Cabinet Committee of Infrastructure (CCI)/Project Monitoring

Group (PMG) has also discussed clearances for other projects on a case-by-case basis. The projects

discussed and the actions taken are summarised below:

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Other projects looked at by CCI/PMG:

Project Cost (INR Billion)

Issue Decision taken

Sasan project (Reliance power)

200 Stage II clearance for Chhatrashal block

The developer needs to submit compliance of stage I conditions to Ministry of Environment and Forest (MOEF); thereafter stage II clearance will be granted

L&T Hyderabad Metro Rail 164 Permission for quarrying

The company is in the process of obtaining clearances; matter to be taken up with the state government.

Nigrie project (Jaiprakash Power Ventures)

100 Diversion of forest land for railway siding

Company is yet to identify land for compensatory afforestation and further approvals would be granted only after the developer does so.

GMR Kishangarh Ahmedabad expressway

77 Premium restructuring

Premium restructuring to be considered.

JAS Infrastructure and Power 74 MOEF clearance Geological report for the captive coal block is yet to be prepared. Thereafter, mining plan will be approved and developer can approach MOEF for clearance

Athena Chhattisgarh Power 62 Fuel supply Fuel Supply Agreement (FSA) to be signed

Tori-I power plant (Essar Power)

97 MOEF clearance Proposal pending with Jharkhand state government; to be send to MOEF for forest clearance

IOCL project- New marketing terminal at Eastern sector refinery, Paradeep

2 Approval of DPR for railway siding

Required approval given

Delhi Airport Aerocity Security clearance Security clearance given

Jindal India Thermal Power, Angul, Odisha

Fuel supply Linkage recommended to ministry of coal for Phase II of the project

Source: Government documents, News articles, Edelweiss Report

Power Sector

The CCI has cleared 18 power projects with a generation capacity of 15.6 GW and involving an

investment of INR 838 billion (banks have lent INR 133 billion to these projects already). The CCI has

asked Coal India to sign fuel supply agreements (FSAs) for all these projects.

Power projects for which FSAs have been approved

Project Generation capacity (MW) Investment (INR Billion)

Maruti Clean Coal and Power Limited 300 15

TRN Energy 600 28

Korba West Power 600 29

DB Power 1,200 58

Jhabua Power 600 30

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Tirodha Phase I, Maharashtra, Adani Power 800 40

GMR Kamalanga Energy 1,050 60

Lanco Babandh Power 660 35

Talwandi Power 2,000 100

Haldia Energy 600 34

Prayagraj power 1,980 95

Mejia TPP (Unit-VIII) DBC power project 500 25

Raghunathpur TPP DBC Power Project 600 30

DB Power Ltd. II 600 32

RKM Powergen 1,440 90

Corporate Power 540 47

Lanco Amarkantak 1,320 77

Abhijeet MADC Nagpur Energy 246 14

Total 15,636 838

Source: Government documents, News articles, Edelweiss Report

Apart from these projects, as per a CCI directive, Coal India has offered supplies to 8,240 MW power

projects that do not feature in the list of entities with which Coal India had to sign FSAs as per the

presidential directive, but are commissioned and need immediate coal linkage to start power generation.

The total investments in these projects were ~INR 437 billion.

Additional power projects which will get fuel supplies

Project Developer Generation Capacity (MW)

Lalitpur Power Project, Uttar Pradesh Bajaj Hindustan 1,980

Kawai Project, Rajasthan Adani Power 1,320

Chhattisgarh Project GMR 1,370

Singrauli Project, Madhya Pradesh Essar Power 1,200

Malibrahmani Project, Angul, Odisha Monnet Power 1,050

Tirodha Phase II, Maharashtra Adani Power 1,320

Source: Government documents, News articles, Edelweiss Report

Following CCI intervention, a couple of power projects have seen progress. NTPC’s North Karanpura

project has taken off after the CCI resolved the dispute with Coal India over the site of coal reserves and

restored the coal linkage. Following this, NTPC has already applied for the renewal of the time-barred

environmental clearance. Similarly, Lanco’s Babandh project has obtained the first-stage environment

clearance from the Centre. It is expected to secure the second stage approval (forest clearance) soon.

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Port Sector

In the Union Budget FY14, it was announced that two new major ports will be established at Sagar, West

Bengal and in Andhra Pradesh to add 100 million tonnes of capacity and a new outer harbour will be

developed in the VOC port of Thoothukkudi, Tamil Nadu through PPP at an estimated cost of INR 7,500

crores. The PMG has secured environment clearance for couple of ports as below:

Projects that have received environmental clearances

Project Segment Location Cost (INR billion)

Development of Haldia dock-II (North) Port West Bengal 8.2

Development of Haldia dock-II (South) Port West Bengal 8.9

Source: Government documents, News articles, Edelweiss Report

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New investment cycle on anvil

Apart from taking steps to amend the regulatory framework and speed up clearances, the Government is

also trying to bring projects to the bidding table. It hopes to award these projects and thereby give a fresh

lease of life to the moribund capex cycle in the country.

Some of the projects on which the Government is focusing are listed below:

Road projects like the Eastern Peripheral Expressway, Delhi-Meerut Expressway, Mumbai-Vadodara

Expressway.

Power projects like the UMPPs at Cheyyur and Bedabahal and power transmission projects.

Port project in Durgarajapatnam, Andhra Pradesh.

Railway projects like the Mumbai elevated rail corridor, locomotive projects, Dedicated Freight Corridor

project.

Airport projects like the Navi Mumbai Airport, O&M contracts on PPP basis. (Source: Edelweiss

Research, Feedback Report)

The Government’s focus on reviving project award is a step in the right direction. Many of the projects

targeted are large ticket projects and may need a lot of Government intervention with regards to getting

clearances/land acquisition in place or for setting up of regulatory framework (like in case of expressways)

before the bidding starts. To this extent, we believe it may be a while before project award actually

happens. Still, the Government’s effort to bring these projects to the bidding table is a definite positive.

In a bid to ramp up investor sentiment, in June 2013, the Government of India set an investment target of

INR 1.15 lakh crore in PPP projects across infrastructure sectors in rail, port and power in the next six

months. The proposals include Mumbai elevated rail corridor (INR 30,000 crore), two international airports

in Bhubneshwar and Imphal (INR 20,000 crore) and power and Transmission projects (INR 40,000 crore).

A steering group is being formed to monitor the award and implementation of projects on priority basis.

Besides airports and Mumbai's elevated rail corridor projects, the group will also monitor two Locomotive

projects (INR 5,000 crore), accelerating E-DFC (Eastern-Dedicated Freight Corridor) (INR 10,000 crore)

and port projects (INR 10,000 crore)

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Equity Financing

A Perspective

As India opened up infrastructure for private sector participation in it ’s Eleventh Plan, a large pool of

Indian infrastructure companies participated. The increasing investment from private players, attracted

Private Equity funds to start up India infrastructure focussed funds to reap the benefit of the India growth

story.

FDI in infrastructure over past few years (INR billion)

Sector FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014

Foreign Direct Investment

300 313 299 245 367 329 95

Source: Economic Survey

However, as discussed earlier the issues around project implementation has subdued/eroded equity

internal rate of return (IRR) for Private Equity. This has resulted in reduced investment activities in past

few years. The equity investment, including FDI, during the first three years of the Eleventh Plan was

approximately 14 percent of the total investments made towards Infrastructure whereas the overall debt

contribution was 41 percent (implying a debt equity ratio of 2.93:1).

Equity (including FDI) availability estimates for Twelfth Plan (INR billion)

Sector FY2013 FY2014 FY2015 FY2016 FY2017 Total

Equity (Foreign Direct Investment /Equity)

616 736 880 1,054 1,265 4,554

Source: Planning Commission

Equity funding will be a key constraint going forward, possibly even bigger than debt funding. A large part

of equity investments rely on foreign investments with domestic investment institutions not too keen at

primary level for taking equity in Infrastructure projects. Regulatory changes which will make projects

commercially attractive are needed to draw adequate equity capital to infrastructure sectors. The private

equity market in India has to be analysed in juxtaposition with the global infrastructure investor market as

it is largely driven by the global market trends.

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Global Infrastructure Investors market

A recent survey by Deloitte LLP, UK of infrastructure investors across continents reveals that the

infrastructure asset class has successfully weathered the economic storm, with many investors citing that

their investments have been resilient during the financial crisis. Approximately 70 percent of investors

stated that their investments are currently achieving or exceeding target internal rates of return (IRR).

Following their experience of the downturn, investors are bullish about the sector’s prospects, with the

majority stating a clear focus on investment in core infrastructure assets located in the safe haven

geography of Western Europe.

A number of overarching market characteristics and trends across the infrastructure investors’ landscape

emerged from this survey as defining the sector today:

Funds are performing well against IRR targets. This bodes well for the sector and indicates that

confidence has returned to the infrastructure market following the financial crisis.

Increasing focus on asset management to deliver returns. Increased focus on asset management,

and in particular, pro-actively managing leverage. Encouragingly, a majority are expecting their investee

companies to increase capex investment over the next few years, as this is often viewed as an easier

strategy to drive IRR performance than Merger and Acquisition (M&A) activity.

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Lack of supply. Market is characterised by "deal-hungry" infrastructure investors who have significant

capital at their disposal but who are continually hitting a "road block" in terms of finding the right asset to

invest in. This lack of supply of assets is driven by the fact that many of the large disposal programmes

announced by major European Utilities and Governments have not commenced, as they focus on more

immediate priorities.

Regulatory risk remains the key concern. High on the topical agenda, regulation is seen by the

investors as the key risk, both from an investment and asset management perspective. What was once

seen as a key attraction for investing in infrastructure assets is increasingly being treated with trepidation.

Focus on 'tried and tested'. - the majority of investors have maintained their focus on core infrastructure

assets which demonstrate essential characteristics, such as high barriers to entry and monopolistic

features, often combined with the business being regulated and/or offering long-term contractual

protection of revenues. In addition, although there is clear appetite to invest in jurisdictions outside of

Europe (particularly due to the Eurozone crisis), in terms of actual deals completed, Western Europe

continues to be the preferred jurisdiction for most investment managers.

Globally, following their experience during the downturn, almost all of the investors interviewed stated that

they have a resolute focus on investing in core infrastructure assets over the next two years, which

continues the trend seen earlier.

Regulated utility and transport assets continue to be highly attractive investments. At the same time there

are clear concerns with regards to the regulatory environment, number of funds pointing to the impending

tariff reductions.

As with the findings in the survey, Western Europe continues to attract the strongest investment focus by

the vast majority of investors. However, increasingly, there is more appetite to deploy capital outside of

Europe, with the exception of India and China. Former darlings of the global economy, these jurisdictions

appear to have become increasingly less attractive to investors as their high economic growth of recent

years has slowed.

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From an investment perspective please indicate the level of focus Companies will have on the

following markets over the next two years (5 being very high and 1 being very low)

Source: Deloitte Report 2013

Infrastructure private equity in India

As mentioned, private equity firms have shied away from Indian roads, ports and power projects in the

last few years as the credit profiles of many companies have deteriorated amid delays in project

approvals or access to fuel for power plants. Moreover, the infrastructure sector has suffered due to

inadequate political momentum and experienced investments almost completely dry up with ongoing

regulatory uncertainty compounding this problem. Nevertheless, in the absence of mature bond market

and bank reluctance to lending, more equity is needed to fund infrastructure development in India.

Key challenges for private equity in infrastructure currently are as below.

Policy/Regulatory issue. Regulatory uncertainties pertaining to these sectors e.g. changes in model

concession agreement, pre-qualification criteria for bidding etc. in road sector, compensatory tariff/fuel

pass through, restructuring of state utilities etc. in power sector and tariff reforms in port sector, have

taken it’s toll by driving away the private equity investors.

Concern about returns. A previous wave of private equity investment in Indian infrastructure was often

in early stage projects, many of which were bogged down by delays, eroding prospects for returns. This is

particularly true of investments made during the boom years of 2004 through 2007, which are now

reaching maturity. Their performance is causing concern among Limited Partners (LPs).

High leverage. Due to high gearing of most of the infrastructure companies, assets are under distress in

view of repayment burdens which further worsens the project profitability.

Expectations mismatch over asset valuations. Despite the trend towards more realistic valuations

given that majority of infrastructure assets are in distress, developers/promoters tend to reference

0

1

2

3

4

5

Central/Eastern Europe India/China North America Western Europe

2007 2010 2013

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valuations to a good market situation.

Macroeconomic environment. India's performance on macroeconomic factors including GDP growth,

inflation and other economic factors were disappointing throughout 2013 resulting in increased concerns

to the private investors. While the policy framework remains uncertain and continues to deter investment,

Government reforms embarked on towards the end of 2013 is expected to dispel these concerns.

Although these issues create certain cause for concern, we have reason to believe that the fundamentals

of the Indian private equity market are sound. The Limited Partners (LPs) and General Partners (GPs) still

believe in the long-term potential of private equity in India and in India's growth story. While the economy

may have slowed down, GDP continues on it’s upward trajectory, bringing continual increases in new

investment opportunities in the infrastructure which would be required to maintain the growth momentum.

Sector-wise FDI equity investment in FY2014 (April-October 2013) (INR Billion)

Rank Sector 2011-12 2012-13 2013-14 (Apr-Oct)

1 Service Sector 246 263 79

2 Construction: Townships, Housing, Built-up Infrastructure

152 72 42

3 Telecommunication 90 16 1

4 IT 38 26 29

5 Pharma 146 60 59

6 Chemicals 184 15 25

7 Automobile 43 83 44

8 Power 76 29 18

9 Metallurgical Industries 83 78 14

10 Hotel/Tourism 47 177 9

Total 1,105 819 320

Source: DIPP

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Going forward scenario

Going by recent trend, private equity investment in Indian infrastructure is poised to pick up following a

lengthy dry patch as debt-stressed operators of toll roads and other projects come under pressure from

banks to offload assets to strengthen balance sheets.

Large private equity houses i.e. Kohlberg Kravis Roberts (KKR), the Blackstone Group and Macquarie

Group are looking at buying completed projects, a relatively safe bet, tempted by valuation expectations

that have reportedly fallen significantly over the past two years.

The Central/State Governments have taken initiatives to clear up the regulatory as well as clearance

hurdles stalling infrastructure investment. These measures are aimed at reviving the new investment

cycle in the infrastructure by addressing investor concerns such as bid document changes, premium

restructuring in the road sector, compensatory tariff, bidding criteria changes in power sector, etc. This is

expected to result in multiple opportunities in these sectors for the equity investors as well as addressing

some of their key concerns thereby attracting the new investment.

Fund Raising. Fund raising continued to be challenging, with infrastructure private equity firms closing on

USD 540 million of new commitments in Q2 2013. Though this is more than double the value of new

commitments raised during the previous quarter (USD 251 million), at an absolute level this remained

rather low, especially when compared with the monthly investment rate of USD 500 million to USD 600

million in the last few months. However, this is not expected to have a material impact on private equity

investments in the near to mid-term, as a large part of investments in India is made by global funds from

their global capital pools.

CDC, the UK’s development finance institution, has announced a major new investment into Indian

infrastructure, bringing new capital to key sectors including roads, ports, social infrastructure and power.

CDC has committed USD 200 million to the India Infrastructure Fund 2 (IIF2) run by IDFC Alternatives

Limited. The commitment from CDC, which is it’s largest ever to an Indian investment fund, has helped

IIF2 reach a first close of USD 644 million, with the IDFC team targeting a total fund size of USD 1 billion

from a range of institutional investors. The fund will provide long-term, equity investment for both

construction and operating infrastructure projects across the country.

Everstone’s USD 250 million first close of Indospace Logistics Park Fund (managed by a joint venture

between Everstone Capital and Realterm Global) to build industrial warehousing was the largest fund

raised during Q2 2013. 75 percent of the eight new successful funds raised in Q2 2013 were raised by

GPs with prior experience.

Measures to enhance the equity availability. Additionally, certain measures on the policy/regulatory

need to be implemented to enhance the availability of equity funds e.g.

Increase the funding pool. Increased domestic funding for infrastructure needs to be facilitated by suitable

policy amendments (with prudential limits) which would enable greater participation in private equity from

domestic entities such as pension and provident funds, banks, insurance companies etc.

Listing of funds. Security and Exchange Board of India (SEBI) to facilitate listing of infrastructure funds.

Ability to list such funds would provide greater liquidity to the investors of such funds thereby making such

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vehicles more attractive to a larger set of investors.

Tax treatment for unlisted equity. Tax treatment on unlisted equity shares especially for approved

infrastructure sectors may be brought on par with listed shares. Most often each project is executed

through a SPV, which would typically be an unlisted entity. This move can also bring down the effective

cost for such projects.

Recently, enactment of Finance Act 2013, Consolidated Foreign Direct Investment (FDI) Policy effective

from April 2013, rationalization of investment routes and monitoring of foreign portfolio investments etc.,

would go a long way in facilitating flow of foreign funds in India.

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Way Forward

The imperative of rapid scaling up of the infrastructure capacity – in the Government and private sector

(developers, contractors, consultants, financial intermediaries and investors) – entails developing and

implementing projects of the required scale and within the tight time frames envisaged. The recent

initiatives on the part of the Government have begun to turnaround the story as far as the private

participation is concerned through project execution and planning new investments.

However, achieving private sector investment target in the infrastructure sector during the Plan period

would largely depend on the Government’s ability to address the regulatory uncertainty and clearance

related issues going forward. This would reinstate confidence of the financial institutions in the

infrastructure projects improving their liquidity challenges.

Also, in order to incentivise the large scale use of private sector participation in infrastructure, it would be

useful to link the Government funding to the effort of developing projects as PPP. It would be necessary to

put in place a value for money framework acceptable to the Government and which would be used to

systematically benchmark bids from the private sector for each project.

Further, the ability to meet infrastructure investment target of USD 1 trillion (INR 65,000 billion) will

critically depend on successful reliance on an alternative source of financing to bank loans (i.e. bond

market) and implementation of fiscal consolidation as a means of freeing up bank lending and reducing

upward pressure on interest rates.

There are credible reasons to believe that the fundamentals of the Indian private equity market are sound.

Our GDP continues on it’s upward trajectory, bringing continual increases in new investment opportunities

in the infrastructure which would be required to maintain the growth momentum. Plenty of opportunities

and long term potential in the infrastructure would keep attracting private equity to invest in it.

Lastly, to implement an ambitious roadmap for the Twelfth Plan, improved standards of governance and

concerted political will would be required to take these targets and goals from inspirational statements to

actual development.

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Disclaimer

This publication, prepared jointly by Deloitte Touche Tohmatsu India Private Limited (DTTIPL) and Private Equity and Venture Capital Association of India (PEVCAI) is based upon research and/or analysis of the secondary market data gathered from various public sources, which we believe can be relied upon for the purpose of this publication. By using reference to the various documents publicly available, neither DTTIPL nor PEVCAI has intended to infringe upon the existing intellectual property rights, if any, of the owners of such documents.

Specifications in this publication are nonbinding and are intended solely for informational purposes. Whilst efforts have been made to ensure usage of correct data, DTTIPL and PEVCAI assume no responsibility for errors or omissions in this publication. DTTIPL and PEVCAI do not guarantee the accuracy or completeness of information, data references, or other elements contained in this publication.

The objective of the paper is to facilitate discussion on the subject of investment opportunities in the infrastructure space in India especially for private equity funds and players.

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