An Overview of Infrastructure Financing in India and Future Options

7/28/2019 An Overview of Infrastructure Financing in India and Future Options

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Think Infrastructure.Think IDFC.

Rajiv Lall, Ritu Anand and Nirmal Mohanty

Infrastructure Development Finance Company

An Overview of Infrastructure Financing inIndia and Future Options

November 17, 2007


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Introduction

Economic (9% growth per annum)

Indias medium-term ambition

Political (Inclusive growth)

Infrastructure has a significant role to realize both.

Government envisages a rise in infra spending from 5.6 % of GDP in 2006/07 to9.2% in 2011/12 to enable 9 % GDP growth in XI Plan.

Two sets of issues are impeding investment in infrastructure:

- Sector governance (brief discussion)- Financing system (focus of discussion)

Inability to meet the specific requirements of infrastructure

projects


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To support accelerated investment in infrastructure,sector governance must change.

Two characteristics of recent approach to infrastructure investment

Declining dependence on budgetary resources

Increasing reliance on private participation

Challenges for sector governance emerge from: reduced budgetary support

User charge financed strategy needs to assure investors of adequatepayment security (over a long period) and consumers of competitive tariff

Higher private participation

Level playing field, greater consistency and predictability of `rules ofgame and public consultations

But political economy is inhibiting such change in governance

Govt unwilling to give up its role as provider and regulator, although it iscreating facilitating frameworks; for example:

Newly created state-owned power utilities are acting as extension ofGovernment

`Open access is provided by Electricity Act, but States have beenreluctant to phase it in

Investment will be impeded if governance response is not appropriate


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GCF in infrastructure: bottom-up estimates by PC

(At 2006-07 prices)

Year 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

2006/07 prices Current prices

GDP at market prices($ billion) 1,006 1,097 1,196 1,303 1,420 1,548

Rate of growth of

GDP (%) 9 9 9 9 9 9

Bottom-upGCF in infra (as % of

GDP) 5.6 6.0 6.5 7.2 8.1 9.2

GCF in infra (US $

billion) 56 65 77 94 115 143 495 585Central (% of GDP) 2.6 2.7 2.9 3.1 3.4

State (% of GDP) 1.7 1.9 2.2 2.5 3.0

Private (% of GDP) 1.7 1.9 2.1 2.5 2.8

Eleventh Plan Period

Total (XI Plan)


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Financing pattern projected by the PC for XI Plan

It has been assumed that budgetary resources would be directed largely

towards rural infrastructure and north-east, leaving little room for funding

other infrastructure projects

(At current prices; $ billion)

Projectedinvestment

Budgetaryresources

Internal

resources/equity Debt

Center 231 57 52 122

States 180 122 17 40Private 174 0 52 122

Total projected

investment 585 179 122 284


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Who is financing and how, now (2006/07)?Also, PCs projection for 2011/12 at current prices.

2006/07 2011/12

% of GDP USD (bn) % of GDP USD (bn)

Central Government and its enterprises 2.1 21 @ 3.4 67

State Govts and their enterprises 2.3 23 $ 3.0 59Private sector 1.2 12 2.8 55

Total 5.6 56 9.2 181

Government borrowing 2.4 24 # 2.8 56

Internal Resources/ equity 1.2 12 1.9 39

Private sector 0.4 4 0.8 17

Public sector 0.8 8 1.1 22

Debt (required) 2.0 20 4.5 87

Domestic bank credit 0.8 8 2.0 40 (32%)

NBFCs 0.6 6 1.1 22 (37%)

Insurance companies 0.2 2 0.2 5 (16 %)

ECBs 0.4 4 0.5 9 (16 %)

Debt shortfall 0 0 0.5 11

According to PC, unfinanced gap is $11billion for 2011/12 and $ 45 billion for XI plan.


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What would this entail?

The recent trend of fiscal correction must continue

Higher populist spending can come only at the cost of infrastructure

investment in rural areas or economically depressed areas

Intermediation of domestic savings must be accelerated

Bulk of incremental savings must go to infrastructure

There are limits to bank exposure and by implication NBFCsexposure,to infrastructure

A fairly large part of private corporate savings must go toinfrastructure

There are indications of equity shortfall for private sector

If domestic savings cannot be adequately mobilized for infrastructuresector, additional access to foreign savings must be resorted to

But, can we?


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(as % of GDP)

FRBM targets

2005/06 2006/07

(RE)

2007/08

(BE)

(2008/09) 2009/10 20010/1

1

2011/1

2

Consolidated (Centre

plus States)

Revenue Deficit 2.7 2.1 1.2 0 0 0 0

Fiscal deficit 6.6 6.4 5.6 6 6 6 6

Capital exp + Netlending 3.9 4.3 4.4 6 6 6 6

Of which: on infra 2.0 2.3 2.3 2.7 2.8 2.9

Continued fiscal correction is critical.

The rest of capital expenditure is on defense (0.9% of GDP), housing, education,health and family welfare etc.

If fiscal correction ceases or reverses, capital expenditure on infrastructure

would suffer, unless non-infra capital expenditure is squeezed.

Financing through larger borrowing would crowd out private investment.


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But, maintaining the same pace of fiscal improvementas in recent past will be difficult

Actual fiscal consolidation has been overstated because of higher off-budget spending

Oil and food bonds, fertilizer subsidy and losses of state utilities amount to

about 2 percent of GDP.

There are additional risks to future fiscal consolidation

Recommendations of the Sixth Pay Commission

About half of fiscal deterioration between 1996/97 to 2001/02 can be

attributed to the Fifth Pay Commission (revenue deficit from 3.5 % to 7

% of GDP and consolidated fiscal deficit from 6.3 % to 9.9 %)

Special economic zone

Proliferation of SEZs would lead to significant revenue loss due to tax

holidays

395 have already been formally approved Economy may slow down

Most of the recent improvement in fiscal performance is due to revenue

growth

Populist spending may rise due to upcoming election


10/2010

Availability of domestic savings is not an issue.

Actual Projected

87/88 99/00 05/06 06/07 07/08 11/12

Gross Domestic Savings 20 25 32 34 35 39

of which

Household sector 16 21 22 23 23 24

Financial savings 8 11 12 12 12 13

Physical savings 8 11 11 11 11 11

Private Corporate sector 2 5 8 9 9 11

Public sector 3 -1 2 2 3 4

GDS has been accelerating and the trend is likely to continue, but the critical assumptionin this projection is that the entire incremental savings will be financial.


11/2011

Even with such assumption, intermediation of GDS will be achallenge.

Intermediation efforts

(Percent of GDP)

2006/07 20011/12

Total infrastructure spending 5.6 9.2

Gross domestic savings 30.0 39.0

o/w financial savings 23.0 28.0

Memo items

o/w ratio to be directed toinfrastructure (%) 24.3 32.8


12/2012

Especially, when bulk of long-term household savings areappropriated by the Government

Household Financial Savings (% of GDP)


13/2013

And when bulk of incremental savings must go toinfrastructure

2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

Infrastructure spending 5.6 6.0 6.5 7.2 8.1 9.2

Private infrastructure spending 1.2 1.7 1.9 2.1 2.5 2.8

Gross domestic (financial) savings 23 24 25 26 27 28

Incremental infra spending 0.4 0.5 0.7 0.9 1.0

Incremental private spending 0.5 0.2 0.2 0.4 0.3

Incremental financial savings 1.0 1.0 1.0 1.0 1.0

% share of infrastructure inincremental financial savings 40 50 70 90 100

% share of pr ivate infrastructurespending in incremental financialsavings 50 20 20 40 30

(% of GDP)


14/2014

Commercial banks credit to infrastructure has been growingrapidly

0

200

400

600

800

1,000

1,200

1,400

1,600

2001 2002 2003 2004 2005 2006 2007

Infrastructure Power Telecommunications Roads and ports

Rs billion


15/2015

But, can commercial banks meet the challenge in themedium term?

(at end of period)

Rs. Billion CAGR (%)

2000/01 2006/07 2011/12 2001/02 to

2006/07

2006/07 to

2011/12

Total credit outstanding 5114 19289 58865 25 25 (assumed)

Of which:

Outstanding credit to industrial sector 2188 6973 18086 21 21 (assumed)

Outstanding credit to infrastructure sector 113 1430 6305 53 34 (required)

Memo items:

Outstanding credit to infrastructure as a % of: (required)

Credit to industrial sector 5.2 20.5 34.8

Total credit 2.2 7.4 10.7

To attain the XI plan infra target set by the PC:

Note that not all commercial banks finance infrastructure; for those that do, the ratios are even higher


16/2016

Significant share of private sector retained earnings wouldhave to be directed into infrastructure

2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

Private sector equity requirement 0.4 0.5 0.6 0.6 0.7 0.8

Private corporate savings 9 9 10 10 11 11

o/w savings of privateindustrial sector 3.5 4.0

% share of equity requirement tototal corporate savings

4.4 5.6 6.0 6.3 6.6 7.7% share of equity requirements to

corporate savings in industrial

sector 11.0 21.0

(% of GDP)


17/2017

Faster development of corporate bond market isunavoidable

There are limits to banks exposure to infrastructure

NBFCs exposure to infrastructure is limited by banks growth potential

A banks exposure to a single NBFC should not exceed 5 % of banksnet worth and banks exposure to all NBFCs should be less than 40 %of banks net worth

NBFCs can and do have access to mutual funds, but such access istypically limited

MFs generally prefer short-term bonds and are extremely couponsensitive

Insurance companies typically prefer public sector NBFCs

All these imply that corporate bond market will have to be the mainstay ofinfrastructure development

Will be a source of long-term funds, allowing insurance companies,pension funds to play a bigger role

Developing a vibrant corporate bond market will take a few years

What do we do in the mean time?


18/2018

As concerns for external viability subside, ECBs havebegun to pick up

ECB flow s in India

-5

0

5

10

15

20

25

1990/91 1992/93 1994/95 1996/97 1998/99 2000/01 2002/03 2004/05 2006/07

Gross Repayment Net

$ Billion

%External debt/ GDP

26

36 35 3330

26 23 23 23 21 22 21 20 17 16 15 16

0

10

20

30

40

50

1990-91 1992-93 1994-95 1996-97 1998-99 2000-01 2002.-03 2004-05 2006-07

Long-term debt to GDP Short-term debt to GDP


19/2019

ECB was the biggest contributor to net capital flows in2006/07

Source: RBI's "Macroeconomic and Monetary Developments, First Quarter, 2007/8, J uly 2007

(US $billion) 2005/06 2006/07 Change

Current Account (net) -9.2 -9.6 -0.4

Capital Account (net) : 24.2 46.2 22.0

of which:

Foreign Direct Investment 4.7 8.4 3.7

Portfolio Investment 12.5 7.1 -5.4External Commercial Borrowing 2.7 16.1 13.4

Short-term Trade Credit 1.7 3.3 1.6

External Assistance 1.7 1.8 0.1

NRI Deposits 2.8 3.9 1.1

Addition to Reserves 15.1 36.6 21.5

INDIA'S Summary Balance of Payments


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ECB restrictions are impeding infrastructureinvestment

To reduce complications in macro management, Government has attempted to slowdown ECB flows by

Setting a very low limit ($ 20 mn) for domestic expenditure; prior RBI approval

Infrastructure generally has a low import intensity

All-in-cost ceiling has been reduced by 50-100 basis points

Makes it difficult to raise senior, subordinate debt, mezzanine financing,as the maximum permissible return is not considered enough to matchrisk

ECB is not allowed for integrated township

Need for prioritization has been recognized, but not implemented

Because of a lurking fear of arbitrage opportunities

Should ECBs into infra surge, there would be concerns about exchange risk

One option is to facilitate risk participation in infrastructure projects by foreigninvestors, which would create contingent liability for the latter

This could be accommodated within the overall limit for ECBs

May not solve the funding problem, but will help distribute risk more widely

Documents

An Overview of Infrastructure Financing in India and Future Options