Building India's tomorrow
Indian infrastructure must be oriented to the possibility of creating a robust ecosystem involving all stakeholders.
We are at the midpoint of 2018. The chance to attend an infrastructure conference at this juncture would provide the perfect opportunity to reflect on and re-examine the issues confronting the Indian economy today. A bevvy of distinguished delegates ideated on the next significant steps to finance Indian infrastructure at the annual meeting of the Asian Infrastructure Investment Bank in Mumbai. There are some critical takeaways from the meeting, allowing us to revisit some interesting themes.
The success of the National Highways Authority of India's (NHAI) toll-operate-transfer model and the ability of the government to create infrastructure assets effectively once again brought to the fore the advantages and need for "asset recycling" done well.
Attracting long-dated patient capital such as pension funds and insurance companies into greenfield infrastructure projects will be challenging, given that such funds are not adequately equipped to undertake construction risk. Therefore, a significant method to finance new infrastructure will be through government participation in the construction phase – and mobilisation of the capital pool through asset monetisation after that. This asset monetisation will provide the government with the capital with which to create new infrastructure. Covered bonds as a financing instrument made for an interesting discussion. Despite the relatively smaller bond market in India, the creation of a covered bond market framework here is one that merits attention. In common parlance, one can think of covered bonds as those that have recourse both to an issuer and a pool of assets. Covered bonds in Europe, especially Germany have been a game-changer for over a hundred years. It would be prudent to see what potential they have in India.
It was also interesting to note the emphasis placed by experts on the potential for better contract design to help create more financing. While we have made significant strides in contract design for infrastructure projects, the Non-Performing Assets (NPAs) at banks demonstrate that more work needs to be done to align equity sponsors' interests with those of the lenders.
Better contracts that reward equity holders for well-executed projects and hold them accountable (by penalising and locking in their cash-flows) if project execution suffers, can help create better project structures, instead of lenders who are left stranded with heavily-leveraged projects. A better contract design ensures that as the cash flows from a project decline and the project is unable to meet specific pre-determined financial ratios, the equity sponsor is unable to withdraw any cash from the project.
If the project returns can meet the financial ratio conditions again, then the equity sponsor will not have the money "locked-up". Such a contract design, as correctly pointed out by a distinguished panellist, also helps ensure, to some degree, that bidding for projects isn't aggressive above and beyond financially viable levels. A contract design that ensures that equity sponsors have more "skin in the game" leads to a better financing market for infrastructure.
One issue that certain public infrastructure assets such as metros (rapid transit system) have faced is financial viability due to low revenues from the asset relative to the investments required. In projects such as metro train networks or industrial corridors, it is essential to realise that to ascertain the monetary value creation from the asset, merely looking at the cash flows from the asset itself is insufficient.
A metro train network or an industrial corridor project has significant value creation in the surrounding areas through increased connectivity, resulting in substantial increase in property prices. Designing mechanisms that can capture some of the upsides in the property value to finance the infrastructure asset can be crucial. Design of such an arrangement will take time but is well worth the effort. The Hong Kong Mass Transit Railway provides an excellent template that can teach us a lot.
The biggest takeaway from the conference was the need for various stakeholders in the infrastructure ecosystem to engage and work together. The multilateral institutions, the export credit agencies, and the government can work together to create mechanisms to boost infrastructure financing. Export credit agencies, along with the multilateral institutions, can play a significant role in both providing capital and, more importantly, in lowering the cost of capital for infrastructure projects. Given the fact that infrastructure projects tend to have an essential component of long-dated debt, the ability of multiple institutions to cooperate and fill in the financing gaps is critical.
Discussions around infrastructure and finance always point towards the large size of the infrastructure gaps and the vast pool of global capital.
The ideas above might provide valuable insights into solving the infrastructure finance paradox.
(The author heads Development Tracks, an infrastructure advisory firm. The views expressed are strictly personal)