Infrastructure: The see-saw story

At a press conference held by engineering conglomerate Larsen and Toubro (L&T) in January, a rather bizarre fact came to light. While discussing the various challenges that India's largest engineering company faced in recent times, the management cited three unique problems in three different parts of the country to drive its point home.

In Mumbai, public interest litigation held up work on the ambitious coastal road project. Infrastructure projects in the National Capital Region came to a halt for 30-45 days owing to high levels of air pollution in winter. And the new government in Andhra Pradesh scrapped the previous government’s plan of building the state’s new capital in Amravati, leaving many infrastructure projects in the lurch.

These are mere samples of the various challenges that infrastructure creation in India faces. Be it for environmental concerns, legal wrangles, land acquisition issues or the collateral damage of political brinkmanship, getting an infra project off the ground and taking it to fruition need stakeholders—infra developers, investors, EPC (engineering, procurement, construction) players—to navigate a complex minefield. If one is successful, the upside is split between all: The government earns brownie points with happy citizens; EPC contractors get paid well; and asset developers and owners can expect to make a decent return on investment. If the project fails, the responsibility solely rests with the private sector.

That’s one of the main reasons why the public-private partnership (PPP)model, which was expected to be the right route for infrastructure creation in the country, is all but virtually dead. Arindam Guha, partner at consulting firm Deloitte, says that, over the past five to six years, most infra projects offered for execution via PPP weren’t fleshed out well at the feasibility-study stage. “Delays, cost overrun, and negative business sentiment have led the private sector to stay away from the infrastructure sector,” Guha observes. “Also, the regulatory framework, including that for renegotiation of contracts and dispute resolution leaves much to be desired.”

With the private sector shying away, much of the burden vis-à-vis spending on infrastructure has fallen on the public sector, and the central and state governments. The estimated investment in infrastructure in FY18 and FY19 was around `20lakh crore, 65% of which was borne by the public sector. In the long run, that isn’t a tenable situation since the government has a fiscal deficit to worry about—the target has been set for 3.5% of GDP in FY21—and it also needs to spend on social welfare where the private sector can’t be expected to play a major role.

No prizes for guessing that’s bad news, especially when the economy isn't exactly in the pink of health. Now with the Coronavirus pandemic taking its toll on the world economy, attracting global capital into India’s infrastructure sector is going to be tough.

According to CRISIL’s Infrastructure Yearbook 2019, the cumulative infrastructure investment in India between FY11 and FY19 stood at `77lakh crore. The Revised Estimate of government spending in FY19 shows the public sector’s share of infra spends rose by 28% year-on-year. In the Budget Estimate for FY20, this is expected to narrow to around 6%“owing to the restricted fiscal space”.

R. Shankar Raman, L&T’s director and chief financial officer, described the situation as challenging while speaking at the company’s press conference in January. “Economic growth has slowed down considerably and that is not good news for companies like ours that depend on investment momentum,” Shankar Raman said.“The biggest challenge right now is that there aren’t enough new jobs and consumption, and discretionary spending has come down. People are also moving out of asset classes like real estate because of this.”

At a time like this, it is crucial the private sector and global investors are brought back into the game. The government appears seized of this imperative and has taken some steps. It announced the creation of the National Infrastructure Pipeline (NIP)in December 2019. The NIP comprises a set of infrastructure projects identified by the government which will need an investment of ₹102 lakh crore to be implemented by FY25. The government envisages a structure wherein it will bear 39% of the funds required for these projects, state governments will contribute an equal share, and the rest will be pooled in from the private sector.“The NIP is the first attempt that has been made to identify infra projects and tag them according to which stage of their life cycle they fall under. It will help the government prioritise projects and attract private sector funding wherever required,” says Guha of Deloitte.

Different subsections of the infrastructure sector have seen varying degrees of success over the last few years. While there has been considerable progress in activities such as railway electrification and airport modernisation, capacity augmentation in the power sector has been challenged due to subdued demand and environmental concerns over thermal power. Renewable energy, a sector in which India had made rapid strides over the last couple of years, is also under pressure due to increased counter-party risks (from state power distribution companies in frail financial health); renegotiation of power purchase agreements by newly elected state governments; unviable tariff caps during auctions, and land acquisition issues.

Road and highway construction activity, which had tapered off in between, saw some momentum in FY20. Road construction had suffered in the time of the build-operate-transfer (BOT) model, where private developers bore the brunt of development-related risks (such as land acquisition)without available recourse in the form of revised toll tariffs to compensate for time and cost overruns. However, newer business models such as toll-operate-transfer (TOT)—in which the government develops the roads through an agency like the National Highways Authority of India and then hands it over to a private party for operations, maintenance, and toll collection—have found takers.

However, some industry experts are sceptical about how much of the investment target set under theNIP can actually be achieved, given the capital constraints faced by the government. Vinayak Chatterjee, co-founder and chairman of infrastructure services company Feedback Infra, says that the announced objective of the NIP implied an investment run rate of ₹20 lakh crore per year, vis-à-vis the current run rate of around ₹12lakh crore per year. “The execution of this pipeline may take longer than envisaged since execution of projects worth ₹20 lakh crore per year needs a project pipeline of ₹80 lakh crore, which is absent,” Chatterjee says. “I would be happy if we can do ₹75-80 lakh crore from this pipeline in total.”

Only 40% of the projects identified as part of the NIP are under implementation, while the rest is in a concept or development stage.

The other significant step taken by the government to mobilise resources for funding India’s infrastructure needs—pegged at $4.5 trillion by2030—is the creation of the National Infrastructure InvestmentFund (NIIF). The NIIF is India’s first attempt at creating a quasi-sovereign wealth fund with a $3-billion commitment from the government. NIIF is also backed by Temasek, Abu Dhabi Investment Authority, HDFC, ICICI Bank, Kotak Mahindra Life Insurance, and Axis Bank. It has also raised funds from well-known global pension funds such as the Canada Pension Plan Investment Board, Australian Super, and Ontario Teachers’ Pension Plan.

In effect, the NIIF has taken the government's equity contribution and leveraged it to raise more equity from domestic and international investors to create an $8 billion-$10 billion corpus across three funds—a master fund focussed on creating platform firms (like a ports and logistics platform in partnership with DP World), a fund of funds, and a strategic fund(through which it acquired IDFCInfrastructure Finance).

Sujoy Bose, managing director and chief executive officer of NIIF, says that the fund’s creation was in response to the needs of investors who wanted a credible counter-party in India to share risk with as they look to expand their exposure to India’s infrastructure sector. “The main purpose [behind the creation of NIIF] was to crowd-in domestic and foreign capital into the Indian infrastructure sector through a trusted investment management platform,” says Bose.“While the Indian government was the original sponsor, we operate at an arm’s length distance from it and follow a disciplined investment approach with a long-term mindset.”

THE NIIF, Bose says, is closely looking into the NIP and figuring out thematic areas where it can invest. The four buckets that it has identified include greenfield projects such as renewable energy; secondary deals where the government can monetise assets (like bidding for airports and TOT road projects); healthcare; modernisation of traditional sectors like agriculture and sunrise sectors like smart metering for power and data centres.

Yet, the capital that the NIIF is deploying is a fraction of what the sector needs. Chatterjee says India needs to leverage domestic equity and raise cheap global debt to create a new-age development finance institution with a balance sheet of at least ₹20 lakh crore.

Since it is clear that the creation of large infrastructure projects are best left to the government as it is best suited to handle development-related risks, leveraging long-term private and foreign capital is a great idea as it can help take these projects off the government's hands when they are ready and free the latter’s resources for the creation of new infrastructure. With home-grown business houses like the Jaypee Group, Essar Group, and Anil Ambani-led Reliance Group burning their fingers in the process of making large, debt-backed infrastructure bets, the new breed of asset owners in India are the foreign pension funds, sovereign wealth funds of other countries, and private equity funds that have a long-term horizon.

But the Covid-19 crisis has cast a shadow on fundraising. Bose says it will surely take a hit in the near term, as people avoid travel. He himself cancelled two international trips during which he was supposed to meet potential investors. But if the spread of the virus can be contained in a reasonable time, the long-term prospects are still bright. “There is robust demand for infrastructure in India,” says Elias George, partner and head, infrastructure, government and healthcare, KPMG in India. “It is just a question of getting the supply-side architecture right.”

(This story was originally published in the April 2020 issue of the magazine.)