The logjam in infrastructure financing
Indian Express, 24 October 2014
The first wave of infrastructure investment in India, from 2000 to 2010, had a faulty strategy for financing. Even if all problems of approvals, corruption, land acquisition, etc. are solved, the logjam in financing holds back the second wave of investment that we seek to now ignite. We have run out of expedient short-term solutions; the deeper problems now need to be addressed.
Through the 1990s, the fruits of liberalisation were hampered by poor infrastructure. The first wave of investment in infrastructure got going by the late 1990s, with reforms of telecom, the NHAI, a few ports, etc. At this time, the difficult questions of infrastructure financing were addressed using expedient short-term solutions.
Banks as lenders to infrastructure. Infrastructure debt has long maturity and, in the early years, high risk. The right investors for this are found in the bond market, particularly the global bond market. But RBI blocks foreign investment and blocks the bond market. A short term fix was found: to place a lot of infrastructure debt on the balance sheets of banks.
This mistake haunts the field of infrastructure financing. Banks are unable to give long-term debt (which hurts projects, who require long-term financing) and unable to absorb risk. This gave us stressed infrastructure companies and stressed banks. The balance sheet difficulties of infrastructure companies and banks are now holding back infrastructure investment, even if all the practical problems are solved.
Foreign currency debt for infrastructure. With the weak bond market, and increasingly reticent banks, it was expedient to push dollar denominated debt for infrastructure companies from foreign investors. The expedient answer was the wrong one. Infrastructure companies have cashflows in rupees, and borrowing in dollars induces currency mismatch. This caused serious problems when the rupee depreciated.
The `norm' for leverage. One complex question in corporate finance is the safe level of debt. Based on the risks of a company, private financiers should choose how much debt they feel it can safely take. Infrastructure companies were very risky and were finding it difficult to raise debt. We were expedient and decided to load them up with a lot of debt any way. The careful analysis of projects was done away with, and we came up with a bureaucratic `norm' of 70:30 debt:equity. This is a high degree of borrowing, and has helped push many infrastructure projects into trouble.
Handling of distress. When a company fails to make payments on its debt, this should trigger a bankruptcy process, where shareholders are wiped out, and control shifts to the debtors. If this is done, there are no sick infrastructure projects. As an example, suppose there was reckless bidding and a telecom company had debt and equity adding up to 100. Once revenues start flowing, we discover that the net present value of the project is only 50.
At present, in India, this is an intractable mess: the company becomes an NPA, and begs for renegotiation. But it is actually a simple situation. The bankruptcy process should get triggered; the asset should get sold for Rs.50, and this should be used to pay off the debtors and shareholders in order. The bankruptcy process solves the intractable problem of sick companies in default.
Once the private sector knows that there will be bankruptcy process if things go wrong, the problem of wrong bidding in auctions, followed by renegotiation, will go away. However, we in India have taken the expedient path of not building a bankruptcy process. This gives us a persistent stream of sick projects, wrong bidding, and the governance challenges of renegotiation.
Trillion dollars of construction/development companies? When we think of the field of infrastructure in India, we think of construction companies like L&T or HCC. Their balance sheets are tiny when compared with the trillion dollars of infrastructure that has to be built. The end game must be clearly understood to be free standing and financially healthy infrastructure operating companies. These should be companies that own infrastructure assets, maintain them, and obtain toll revenues. These are low risk utilities. Once the asset is working, and tolls are flowing in, it is easy to value the equity and debt.
Financing structure for a trillion dollars of operating companies. All our work upstream in developing new infrastructure assets, which involves political risk, construction risk, etc., should be seen as a pipeline which ends up as boring operating companies. These operating companies should obtain gigantic equity and debt investment from global investors, as they should be seen as the safest way to invest in India. Over a decade, we should end up with perhaps $50 billion of market value of infrastructure construction and development companies, and $1 trillion of market value of infrastructure operating companies (i.e. utilities). It is feasible to have more than half of the market value of these utilities from global investors.
This requires that global investors can easily invest in the shares and bonds of these companies, and hedge their currency risk. But RBI hinders foreign investment in equities, blocks foreign investment in bonds, and prevents currency hedging, so this framework has not developed.
We badly wanted infrastructure investment. We took a series of expedient steps through which the first wave of investment got going. At every step of the way, short-term thinking prevailed. The long run has now caught up with us. The bottlenecks of infrastructure financing will frustrate the second wave of infrastructure investment even if all physical problems are solved.
We must fix the six expedient moves described above. Infrastructure debt should be the work of the Bond-Currency-Derivatives Nexus and not banks or bureaucrats. We must get away from borrowing in dollars, and from any fixed 70:30 debt:equity ratio. We must enact an Indian Bankruptcy Code, through which assets will work for the economy, even if the original shareholders or bondholders lose money. We must pursue the end-game of listed infrastructure operating companies which are boring utilities generating stable cashflows. We must remove barriers to foreign investment into bonds, private equity and public equity, through which over $500 billion of investment comes into infrastructure operating companies over a decade.
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