Simplified regulations and risk reduction measures are required to revive India’s flagging infrastructure sector
Last June, India’s prime minister, Manmohan Singh, called a meeting to discuss the status of the country’s infrastructure sector. According to finance ministry officials, a series of road, rail and power projects with a total value of more than US$27 billion were delayed. A month later, two consecutive power outages crippled northern and eastern India, affecting 600 million people and bringing the nation to a virtual standstill. The blackout, hailed as one of the biggest power failures in the world, once again placed the dismal state of India’s infrastructure in the international spotlight.
In October, Singh’s coalition government was finally goaded into action. It announced a slew of big-ticket reforms – the most extensive in two decades – with the objective of revving up the economy, which was growing at its slowest pace for three years. Divesting stakes in state-run companies, opening up aviation and front-end retail to foreign investors and raising diesel prices were a few of the headline reforms aimed at stimulating investment and easing the fiscal deficit.
[ihc-hide-content ihc_mb_type=”show” ihc_mb_who=”3″ ihc_mb_template=”2″ ]
The key challenge, however, is to reinvigorate India’s languishing infrastructure sector, the poor state of which is estimated by some observers to shave around 2% from the country’s economic growth each year. The government aims to spend US$1 trillion on infrastructure between 2012 and 2017, of which it hopes to raise US$400 billion from the private sector. Opinions vary on whether the recent reforms will be sufficient to stimulate the necessary investment.
Atul Sharma, the managing partner of Link Legal-India Law Services, is optimistic. “The reforms announcement is already having a positive impact on investments,” he says.
Infrastructure accounts for roughly 40% of the turnover at Sharma’s firm, which was formed through the recent merger of Delhi-based Link Legal and India Law Services of Mumbai.
Sharma also points to the Asian Development Bank’s facility to kick-start the Indian bond market and channel domestic and international pension and insurance funds into infrastructure and utilities, which he says is a first for India.
The new funding avenue comes at a time when many Indian banks have exceeded their lending limits and become risk averse. “Mobilizing additional funds is essential if India is to meet its enormous infrastructure financing needs,” Vivek Rao, a senior finance specialist in the Asian Development Bank’s South Asia department, was quoted as saying on the bank’s website. “Plus, it’s important to prevent over-reliance on bank financing and to ensure that capital markets play a financing and risk mitigation role.”
Lessons from the past
Past experience bears out Rao’s view. Five years ago, when India’s economy was growing at 8%, many companies used debt rather than equity to fund their aggressive plans at home and overseas. Opportunism was at its height and companies of all hues branched out into capital-intensive sectors such as roads, power and telecoms, which typically have longer gestation periods than their core businesses. They sought funding from Indian and multinational investment banks, as well as from traditional banks and private equity investors. Some companies pledged their own shares to raise funds. A Bank of America report last year said that shares worth over US$33 billion were pledged with banks as collateral.
Today the loans have come to roost. Hindustan Construction Company (HCC), which built the Mumbai-Pune Expressway and the Bandra-Worli Sea Link, is one company where revenues fell short of cash flows due to outstanding payments, and debt-servicing dented the balance sheet. HCC was forced to restructure its debt. The restructuring terms included a moratorium on the principal for two years and an eight-year repayment period with interest rate concessions for the first few years.
Infrastructure Development Finance Company, meanwhile, became the first non-banking financial company to tap the international debt markets with a medium-term note programme to raise US$1.5 billion in tranches.
Other companies have been forced to engage in an infrastructure fire sale. According to a recent report by Bloomberg, GMR Infrastrucure, India’s largest private airport operator, plans to sell some of its toll-road assets in an initial public offering in Singapore, while DLF, India’s largest real estate company, has hived off its wind farm business.
In a further measure to ease the debt pile, the Reserve Bank of India has allowed Indian companies to take advantage of cheaper US dollar loans to repay rupee loans which were taken for capital expenditure.
Given the heavy involvement of banks in the financing and structuring – and all too often the refinancing – of infrastructure projects, Prashanth Sabeshan, a Bangalore-based partner at Majmudar & Partners, questions why none of the banks have been called to account when projects have run into trouble. “If projects are delayed, no bank officers are being hauled up and made answerable to the comptroller and auditor general of India,” he says.
Present-day roadblocks
With domestic infrastructure companies mired in debt, one might naturally turn to foreign investors to kick-start growth. Opportunities abound, but many prospective foreign players view the complex and bureaucratic regulatory environment that engulfs much of India’s infrastructure sector as a barrier to entry.
“No infrastructure project is ever completed on time due to the lack of policy reforms and the need for regulatory clearances,” laments Bahram Vakil, a partner at AZB & Partners.
“The main issue is regulatory uncertainty and unpredictability as to how the various Indian authorities will act or react,” adds Azmul Haque, a partner and co-head of the India practice at Singapore-based Shook Lin & Bok.
“Wherever there is government interference there’s uncertainty,” says Vinod Surana, the head of Chennai-based law firm Surana & Surana. “Foreign investors look for policy certainty, quick dispute resolution and minimal governmental interference. The paralysis in political and bureaucratic decision making is putting the breaks on the development of infrastructure projects.”
Sharma at Link Legal-India Law Services believes the problem runs far deeper than regulations alone. “It’s not a question of regulating or not regulating. It’s a whole gamut of issues where there is no will to grant approvals and nobody wants to touch any files,” he says.
“India is a great opportunity and everyone wants to be there, but how do you do it?” asks Erik Richer La Flèche, a partner at Stikeman Elliott in Toronto. “There’s a difference between what politicians say and what regulators do.”
Contradictions such as this, and the uncertainty they give rise to, discourage investors. “If there’s uncertainty about the laws, then it’s not a question about allocating cost, but who will take the risk,” says Shreya Lal Damodaran, a senior India consultant at Cleary Gottlieb Steen & Hamilton in London.
Damodaran also laments the lack of single-window clearances. In ports, for instance, the approvals have to come from three ministries – home, external affairs and defence. “When a project is approved there is a lot of back and forth, which is more stalling than pushing,” she says.
“Development in India is slow,” says Manoj Bhargava, a partner and head of the India practice at Jones Day in Singapore, “as being a democracy things move slowly and commitment to companies is less.”
Montek Singh Ahluwalia, the deputy chairman of India’s Planning Commission, acknowledges these problems and is aware of the need to speed things up. “The most important thing we have to do is to overcome implementation bottlenecks that are preventing big projects from taking off,” he recently told The Economic Times.
No fuel for growth
Another issue hampering infrastructure development is the paucity of fuel, particularly coal, which has sent big Indian companies scurrying to buy foreign coal assets to fire Indian power plants. India has the largest coal reserves in the world, but the quality of coal from state-owned Coal India has traditionally been poor. Reliance, GVK Group, Tata Power, GMR, Essar Energy and Jindal Steel are some of the companies that have invested in coal assets in Africa, Australia and Indonesia.
“Fuel availability continues to be a major issue leading to uncertainty in power generation projects,” says Hemant Sahai, the managing partner of HSA Advocates, a Delhi-based law firm with a strong infrastructure practice. “Imported fuel is the only option in the foreseeable future until new domestic mines are developed.”
Latent potential
In spite of the challenges, there is near unanimity in the belief that current woes will be ironed out eventually.
Seema Jhingan, a partner at LexCounsel in Delhi, is one such optimist: “India is set to see a massive infrastructure capital expenditure cycle over the next decade as the existing infrastructure fails to support India’s massive population,” she says.
“People are thinking of deploying funds, but it will take time before they jump in,” adds Damodaran.
L Vishwanathan, a partner and head of the infrastructure practice at Amarchand Mangaldas in Mumbai, points to the tremendous opportunities that exist, but concedes that “foreign investors have to take a long-term view”.
The short-term reality is: infrastructure investment has shrunk and many existing projects are yet to go on-stream. According to the Reserve Bank of India’s annual report for the year ended 30 June 2012, investment in infrastructure plunged to US$18.5 billion from US$41 billion in the previous year, dragged down by power and telecoms. Today, while investments in the scam-tainted telecom sector have virtually dried up, funding of roads, ports and airports has also decelerated and the rising losses of public-sector utilities continue to have an adverse effect on the power sector.
The decline in infrastructure investment is having knock-on effects, as prospective investors in other sectors cite the poor state of India’s infrastructure as a reason for staying away.
Infrastructure paralysis
With projects bogged down by regulatory, bureaucratic and financial baggage, delays are mounting
Consider Posco of Korea’s ambitious US$12 billion proposed steel plant in Orissa in eastern India. Posco signed an agreement with the Orissa government in 2005 to set up the plant, which was scheduled to begin production by the end of 2011, after it received the environment ministry’s go-ahead. Eight years later, the steel major is still grappling with land acquisition issues, as local villagers refuse to give up their land, claiming the plant would deprive them of their forest-based livelihood.
The delay in the project – billed as the largest foreign direct investment in the country – has resulted in the Korean company threatening to pull the plug on the deal.
However, Posco’s Indian ventures haven’t all been so troubled: the company opened a steel mill last May in the western state of Maharashtra. This US$259 million plant is strategically located to cater to a fleet of Indian and global auto companies, including Volkswagen, Skoda, General Motors, Tata Motors, Mahindra, Audi, Mercedes-Benz, Premier Auto and Bajaj Auto. The plant is barely 100 kilometres from Dighi Port on the west coast, where Posco has built a warehouse.
Another delayed project is the US$90 billion, 1,483-kilometre Delhi-Mumbai industrial corridor, which is being built with financial and technical aid from Japan. The corridor will link India’s political and financial capitals and create a series of new industrial “smart cities” with the aim of expanding India’s manufacturing and services base and boosting the economies of the six states through which the corridor will pass. The deal was signed in 2006, but a trust fund for the project was set up only last year.
The uncertainty of gas allocation in the region has been partly blamed for the delay. The gas is needed to power half a dozen 12,000-megawatt power plants that will be constructed as part of the project.
In the roads sector, government sources say that more than 21 highway projects totalling US$2.8 billion in four states have been cancelled or delayed. Four years after the construction of the 291-kilometre Panipat-Jalandhar highway in northern India was given the go ahead, only 70% of the road has been built. The 21-month delay resulted largely from the non-availability of construction materials – in this case the stone aggregate – caused by a ban on mining in Karnataka state, ordered by the Supreme Court in July 2011 in response to illegal mining and environmental degradation. The delay has resulted in the estimated cost of the project doubling to US$413 million.
For better news, look skywards, where passenger traffic in the aviation industry crossed the 162 million mark last year. The Airports Authority of India is upgrading and modernizing 35 non-metro airports, while five international airport projects are to be built through public-private partnerships. Despite niggling concerns such as airport tax, land encroachment and land acquisition, aviation, and its associated infrastructure, could well provide the silver lining in a very cloudy sky.
It is a sad irony, therefore, that while infrastructure was a mainstay of India’s growth over the last decade – catapulting the country to the second fastest growing economy in the world after China – its current sluggishness may be dragging down other sectors of the economy.
Oiling the wheels
So, what needs to be done to get things moving again?
“The risk has to be reduced,” says Akshay Jaitly, a partner at Trilegal.
Jaitly points to several ways in which this could be achieved. First, he emphasizes the important contribution that good legal drafting can make to the management of risks. Any ambiguities in the project documentation, particularly the sections that set out the allocation of risks between the government and the private bidder, make it difficult for bidders to carry out a meaningful risk assessment.
“In many places [the bidding documents] are not clear,” says Jaitly. “We spend a lot of our time advising clients as to what certain terms in those bidding documents mean, so that they can take a view on what kind of risk they present.”
Jaitly also suggests that certain pre-approvals could be granted before projects reach the bidding stage.
For example, site-specific environmental approvals for particular projects to be constructed on particular sites could be granted in advance of the bidding process. This would considerably reduce the cost and risk incurred by the winning bidder. Similarly, for projects in sensitive sectors such as port development, potential bidders could be invited to apply for “in-principle” security clearances before they enter the bidding process. This way, they could enjoy a higher degree of certainty that if their bid is successful, they will obtain the clearance they need to proceed with the project.
Land acquisition is another area in which the risks to investors could be reduced. Jaitly suggests that the government could complete the process of acquiring and aggregating the land for a project before inviting bids for its construction.
Shardul Thacker, a partner at Mulla & Mulla & Craigie Blunt & Caroe in Mumbai, agrees: “Pre-bid, everything should be in place and land acquisition wrapped up,” he says.
Thacker has noticed that investors are already modifying their behaviour to mitigate the risks they face. “Foreigners are now actively seeking Indians as equal partners in infrastructure joint ventures to de-risk their investments,” he says.
Aside from reducing the risks in infrastructure projects, Sahai at HSA Advocates suggests a series of other measures to get the sector moving.
For a start, he urges a relaxation in the change in ownership provisions in concession agreements to enable investors to exit infrastructure projects after a shorter period of time, thereby freeing up their capital for new investments. He suggests that investors should be free to exit after three to five years, depending on the complexity of the project.
Sahai also urges the government and the Reserve Bank of India to promote better hedging instruments to minimize the foreign exchange fluctuation risks facing foreign investors. “The proportion of foreign debt needs to increase in the infrastructure sector,” he says, “and the biggest obstacle to this is the lack of any guarantee against foreign exchange fluctuation risk.”
To counter the difficulties associated with the paucity of fuel, Sahai suggests that fuel price risks should be borne by the buyers of power, rather than the developers of power projects, as is currently the case. “The regulatory mechanism must permit the passing through of this fuel risk to consumers in the form of tariffs,” he says.
Finally, Sahai suggests that more sectors, including railways, should be opened up to public-private partnerships. He also urges the government to announce “a prudent mix of annuity and toll concession projects … with lower risks in annuity models being attractive to certain investors”.
Global competition
If stimulus measures such as these are not implemented soon, there is a danger that investors will take their money elsewhere. “We believe that the India story is great but there are also other good investment destinations,” warns Jaitly.
La Flèche at Stikeman Elliott agrees. He says that companies are no longer prepared to wait endlessly for their projects to take off and would rather fly away to destinations “which offer a better business environment”. He cites South America, Australia, Africa and other parts of Asia as likely alternatives.
“The India story is very complicated and everything takes very long. People want a framework and a certainty in the way to get things done,” La Flèche says.
According to business information provider Dealogic, India lost its number one position to Australia in the 2012 global project finance sweepstakes. While the volume of project finance deals in Australia grew 121% from the previous year, with 55 deals worth a total of US$81.9 billion, India’s volume was halved, with 172 deals totalling US$45 billion. By comparison, China’s volume was up 24%, with deals worth US$11.9 billion, while Brazil climbed 45% with US$17.7 billion.
Democratic hopes
As India fights to regain its former glory in the infrastructure sector, much will depend on the general election scheduled for next year, and the electioneering and political posturing that takes place beforehand.
Already, in early February, the government exempted road, canal and pipeline projects from rules requiring them to obtain specific consent for the clearance of forested land. The change, which means that the infrastructure and environment ministries will no longer work at cross purposes, was introduced to address concerns that approval bottlenecks were causing unnecessary delays to projects.
More relief may come in the shape of the long-awaited land acquisition bill, which could enter the statute books this year. By alleviating many of the traditional land acquisition problems, the bill, if passed, promises a greater degree of certainty for infrastructure investors. However, a provision that would make it mandatory for developers to obtain the consent of 80% of landowners if the land is to be acquired for private projects and 70% for public-private partnerships has been strongly criticized by investors, who argue that it could push up land acquisition costs.
But when times are tough, Nikhil Gandhi, the chairman of SKIL Infrastructure, knows what to do: “There are no two ways about it,” he says. “Tough times are the best times to invest in infrastructure. I pour more cement and concrete into my projects as the costs are reasonable and people are easy to hire.”
Gandhi, if anyone, should know. He set up India’s first private port in Pipavav in the state of Gujarat; built a 20-kilometre four-lane road linking the port with a major highway, and sought government help to build a railway track between the port and the nearby region of Saurashtra.
[/ihc-hide-content]
