Bumpy road ahead

IN THE 12th FIVE- YEAR PLAN (2012-17), India has set a target of $1 trillion (Rs 54.27 lakh crore) to be invested in the infrastructure sector, 17% of which is dedicated to roads. But funding is becoming a challenge, with issues of land acquisition, environment clearance, and slowing traffic growth. Banks are usually the lenders to the roads sector, primarily at the construction stage, and take on the risks till completion. But with an estimated Rs 1.2 lakh crore invested in the sector, they are sceptical of committing more. “Ideally, the risk [at the construction phase] is addressed by short-term finance, which the banks provide. Then there needs to be a funding structure that frees up the banks and works for a longer tenure suited to the cash flow of the project,” says K. Venkatesh, chief executive and managing director, L&T Infrastructure Development Projects.

Here’s where a bond backed by India Infrastructure Finance Company (IIFCL), under its credit enhancement scheme, comes in. IIFCL will provide partial credit guarantee to the bond offering of GMR Jadcherla Expressways (on National Highway 7 in Andhra Pradesh), which will raise the instrument’s rating to AA. This will help the company to raise cheaper funds and tap into insurance and pension funds, which are mandated to invest only in entities rated AA and above.

However, the bond, being sold as an alternative to bank financing, faces many challenges. Among them is its ability to attract the class of investors it wants.

The bond primarily aims to tap into pension and insurance funds that have stayed away from the roads sector. The credit guarantee will improve the rating, but funds will still be worried. “If the bond gets downgraded, the insurance companies are stuck because there is no [well-developed] secondary market [for bonds],” says Rohit Inamdar, senior vice president and head, corporate ratings, ICRA, who rated the Jadcherla project.

The project is an operational one, (which means that construction risk is mitigated) and the bond proceeds plan to retire its existing debt from commercial banks. But the challenge, according to Abhaya Agarwal, partner and leader, PPP, government, and transaction advisory services, Ernst & Young, is that “the bond’s ability to procure future project finance during construction stage remain untested”. He feels existing lenders in projects doing well may be reluctant to accept repayment for performing debt (typically, a loan on which payments of interest and principal are less than 90 days past due).

Also, the guarantee requirement for the credit enhancement scheme could go up once extended to under-construction projects. “IIFCL will provide maximum 50% guarantee. Now the challenge is, if a BB rated entity with 50% guarantee can move up to AA rating (to tap insurance and pension funds). That is something rating agencies will have to look into,” says Inamdar.