Infra development calls for a mature financial system
by Mallika Jain

Infrastructure financing presents a number of challenges. The large scale of investment and long gestation period involved in infrastructure projects require investors to be prepared for a long horizon for debt repayment and return on equity. But commercial banks in India are limited in their ability to invest in very long-term illiquid assets as they source their funds from deposits of shorter tenure, say, three years. Further, market and commercial risks assume greater significance for lenders as infrastructure projects entail nonrecourse or limited recourse financing. This, in turn, requires specialised appraisal skills.

Various factors which are considered before sanctioning finance for a project include promoters profile (developer's background, experience, track record, project execution strengths, financial strength, ability to raise equity for the project etc.), preparedness for project implementation (in terms of approvals, consents, clearances from various government agencies), execution of key construction contracts etc.), status of tie-up for project inputs (e.g. land, fuel, water etc.), sale arrangement etc.

Because of its public interest nature infrastructure investment has other risks like political and regulatory risks. As a result, complex risk mitigation and allocation arrangements gain importance in infrastructure financing. Clearly, this indicates the special nature of infrastructure financing, involving lengthy and time-consuming process of negotiation before achieving financial closure.

Because of the lengthy and often tedious process of infrastructure financing, financial closure is an important milestone in the execution of any project. In fact, timely implementation of a project depends largely on the capability of the project promoter in lining up the required funds on time and at a reasonable cost.

According to information available with ProjectsToday, during first quarter of year 2010, 11 large projects announced achievement of financial closure. Of these projects, four are in the power sector, six in roadways and transportation sector, and one in the refinery sector. For a country aiming to invest $1 trillion in the 12th Five- Year Plan in infrastructure, this is incommensurate. The government seems unperturbed by the prevailing situation. Whatever steps it has taken in this direction have been half-hearted.

For example, the ministry of power had set up the Inter Institutional Group with SBI as its convener for expediting the financial closure of private sector power projects. The IIG has not met even once for the last about three years.

As Yashpal Singh, Associate Vice President (Project Advisory & Structured Finance), SBI Capital Markets puts it: "It had, at best, a very limited success." Further, recent measures by RBI of hiking the key policy rates may not augur well for the infrastructure sector. Hike in CRR is estimated to suck out excess liquidity of around Rs 12,500 crore. Yashpal Singh feels, "Considering huge excess liquidity in the banking system, even after the current CRR hike, there will be sufficient liquidity in the banking system so that flow of funds for big infrastructure projects is minimally affected. But, funding for licence fee for 3G, capex for 3G rollout etc.

would require anywhere between Rs 1,00,000 to Rs 1,25,000 crore in the next few quarters and this will impact the liquidity." Fortunately, RBI, realising the gravity of the situation, has announced special measures to provide liquidity in the system which may face a cash crunch because of huge outgo on third generation (3G) telecom spectrum licences and payment of advance tax by companies.

Till July 2, banks have been permitted to avail of support of up to 0.5 per cent of their net demand and time liabilities, which will provide an additional liquidity support of over Rs 20,000 crore.

The big question is whether this measure is sufficient to tide over the situation. Sooner or later the central bank will have to revert to liquidity tightening measures to contain the spiraling inflation.

Tightening liquidity scenario will also have its impact on rate of interest. Most of the infrastructure projects are being funded on project finance basis and the door-to-door tenure is generally about 15 years. Depending on the promoters' profile, project structure and security structure, the floating annual interest rate band for infrastructure projects may range from 11 to 11.75 per cent, linked to bank PLRs. Though bankers and financial institutions do not expect any immediate impact on the lending rate due to the hike in key policy rates of RBI, upward revision is a likely possibility in the next few quarters. A hike in interest rates and scarcity of funds may drive away investors and it is time the government develops a mature financial system.