The fact that India has poor physical infrastructure is common knowledge. The government realizes this and is trying to make amends to the oversight of past decades. The effort required however is mammoth and it is not possible for the government to build the infrastructure for India on its own. It needs partners who can help fund the construction of power plants, roads, ports and other critical facilities the lack of which pulls down Indian GDP growth by about 2%. The government has realized over the past 15 years that the way to go about this is to seek partnership from the private sector in building infrastructure for India. When we talk about private sector participation it is through creation of business models in the infrastructure space that involve creation of infrastructure and then recovery of upfront cost through user fees, tolls and sale of power generated. The sector is a fascinating place for private developers with an immense opportunity to earn. But, this opportunity is open to only those with deep pockets and the ability to manage risk well. Infrastructure projects are highly capital intensive. A power project of 2x500 MW (you need at least 3 such plants to power a city like Delhi) costs nearly USD 1 billion to build. The funding model for such projects is generally debt and owners’ equity in the ratio 75:25. The funding however does not come easy. This article discusses the difficulties that private sector developers face while arranging for these funds. The article also discusses what banks look for in a project while lending.
When developers need finance of the magnitude as above they need to come up with a business model that guarantees pay back of the upfront investment with a reasonable degree of certainty. No bank would lend to a project unless there is certainty of repayment. The loans are unsecured and carry high interest rates. Asset liability maturity mismatches make it difficult for banks to lend long term to infrastructure projects. These projects are long gestation and have lives of over 25 years. Developers look for loans with payback period that matches the project life cycle. If this is not so the projects would have negative cash flows for a large portion of their life-cycle. For banks to lend long term, they should have long term funds on their books which is rare. So what banks look for is a consortium of lenders that finances the project with arrangements of take-out finance. This essentially means that the bank will have an arrangement with another financial institution through which the original lending bank exits the loan through a takeover of loan by the second institution. This solves the asset liability maturity mismatch problem.
Banks in India are risk averse and lending is subject to strict due diligence. The level of comfort with infrastructure projects is particularly low because of the genuine reason of lack of predictability of the economic environment in the long term. This makes long term lending even more infeasible. Then, there are other sources of risk for lenders and these factors form the risk in financial closure for developers. These risks are tabulated below and are self-explanatory.
Risks to Financial Closure
• Faulty project preparation: Often, risks are not shared by parties who are most suitable to take the risk. Correct demarcation and allocation of risks is critical to commercialization of infrastructure.
• Likelihood of project to face land acquisition problems, environmental clearance issues and rehabilitation of displaced population.
• Long concession periods bring prospects of uncertainty
• Inadequacy of equity contribution proposed by developers is again a source of excessive risk for the lender
• Aggressive or unclear traffic projections in road projects can make the lender wary of the project
• Inadequate protection of lenders’ interests
• Availability of competing facilities which could cause less than predicted cash flows
• Project costs too high as compared to other similar projects
Bank lending to infrastructure projects can be promoted through facilitating take-out finance, special concessions to the sector on ECB limits and credit enhancement for infrastructure projects. Providing the sector a priority sector status will also help in flow of funds to the sector. If the banks are allowed to raise long term infrastructure bonds, it will become easier for them to lend long term. Allowing the pension sector to invest in long gestation infrastructure debt will also make the availability of long term finance easier.
Apart from domestic debt, there are other sources of finance for Infrastructure projects.
Sources of funds
• External commercial borrowings
• Bond market
• Securitization
• Buyer credit
• Multilateral funding
• Initial Public Offerings
• Foreign Direct Investment
• Subordinated/Mezzanine Quasi equity, without collaterals
• Convertible instruments(CD’s/CCPs, convertible debentures with warrants)
• Issuing equity to users/stake holders e.g. land owners
• Viability gap funding by the government
• Alternate assets in project being developed such as opportunities for real estate development
• Levy of taxes/tolls, user fees
Some of the above sources merit further explanation and comments and the same are discussed below:
External Commercial Borrowings (ECB):
Sources of ECB include: (i) international banks, (ii) international capital markets, (iii) multilateral financial institutions (such as IFC, ADB, CDC, etc.,), (iv) export credit agencies, (v) suppliers of equipment, (vi) foreign collaborators and (vii) foreign equity holders (other than erstwhile OCBs).
ECB for infrastructure is subject to government norms like a cap of USD 500 million per firm per year. The government recently modified ECB guidelines, allowing Infrastructure Finance Companies (IFCs) to avail of ECBs up to 50 percent of their owned funds under the automatic route. Borrowing of greater amounts will need to go through the approval route. This change will enable greater availability of funds to the infrastructure sector.
Bond Market:
At the developers’ end the lack of a mature bond-market in India makes it difficult for developers to have access to sufficient long term lending. The creation and facilitation of bond markets in India has long been a focus of the government but the progress is slow since there is high demand for equity instruments as compared to debt instruments in India. Unlike the US where the bond markets are even larger than the equity markets, in India the bond markets largely comprise of government T-bills and corporate issues of bonds are few and far between.
Securitization:
Securitization generically refers to the pooling of cash flow producing assets (e.g. loans, mortgages, bonds) and subsequent issuance of securities in the capital markets backed by these collateral pools. Securitization can serve as an effective method for banks to hive off risk of long term receivables from infrastructure projects into the securities market. However, disowning risks through securitization instead of managing risks underlined the recent financial crisis. This has dissociated securitization from its positive attributes and given it a negative connotation. This does not bode well for the nascent securities market in India and the infrastructure sector which could have seen strength in bank lending based on risk distribution through securitization.
Foreign Direct Investments (FDI):
Even though provisions for FDI in infrastructure are liberal, the flow of FDI into the sector is tardy because of various reasons:
• Multiplicity of laws, rules and regulations
• Unstable tax structure in India
• Widespread corruption and political risks
• Complicated land acquisition and potential law suits
• Clearances from multiple agencies
• Complexities in labor laws
The above problems are well known but solutions to these are hard to come by because of the political nature of these issues. Till the time these issues exist health inflows of FDI into the sector cannot be a reality.
Issuing equity to stakeholders:
Another source of funds can be the issue of equity to stakeholders such as equipment suppliers (such as power equipment suppliers) or land owners whose land is acquired. Such measures bring down the need for upfront spending and debt and expand the equity base. Sharing of mining revenues is another example in which upfront debt requirements can be substantially reduced.
Viability gap funding (VGF):
The government recognizes the welfare role of infrastructure and the fact that not all infrastructure projects may make business sense. For projects that do not promise private developers positive returns on their investments there is a provision called Viability Gap Funding (VGF) through which the government funds part of the investment required in the infrastructure project to make it viable and thus attractive to private bidders for the project. When bids are sought from private developers they can quote a figure for the VGF required and it is then up to the government to evaluate the bidders w.r.t. the VGF demanded.
Alternate assets in Infrastructure projects:
Another way to make infrastructure projects attractive to developers is to allow them to develop real estate on the project premises in such a way that this development benefits from the project and provides the bidder another stream of revenue. The onus is on the bidder to assess the potential of such development and factor that into his bid to make it competitive. For instance, an airport developer is given the opportunity to develop hotels and shopping areas inside or in the vicinity of the developed airport. Such arrangements form indirect source of funding to infrastructure projects and are typical of them.
Conclusion:
Infrastructure projects are complex with a multitude of stakeholders. For a project to be successful, it is critical that interests of all stakeholders are safeguarded. The developers need to offer the lender a rational and stable revenue source of revenues. India is currently the largest Public-private partnership funded infrastructure market in the world. To sustain this market and to help it power infrastructure growth in India diversity in sources of liquidity is a must. No single institution will take up the risk of lending to long gestation risky projects. At the same time strong risk mitigation measures are required on part of the developers. They need to develop a very good understanding of the risks involved and price the risk at the start of the project. Unprofessional bidding on the part of developers leads to low bid prices which ultimately lead to the downfall of the developer as also the great harm to societal good. Promoters tend to downplay risks at project inception to get access to funds. Greater transparency in infrastructure projects can help the banking sector to lend more easily to infrastructure projects. Policy reform especially in land acquisition, tax structures and simplification of regulation can go a long way in encouraging participation of more players in infrastructure finance.
References:
www.finmin.nic.in
www.rbi.org.in
The author has worked in the Infrastructure Sector project execution for six years and is currently pursuing the Post Graduate Program in Management at the Indian School of Business, Hyderabad.
Sunday, December 19, 2010
Saturday, August 28, 2010
Life @ Indian School of Business
Its been 3 terms(4 months) at ISB. I am back in Delhi for the term break. As the fourth term is about to begin, I reflect on the life at ISB so far. The day begins early at 7.00 am if you have morning classes. 2 lectures of 2 hours each take you through the first half of your day. The faculty is world class, the likes of Prashant Kale in strategy make you feel like a director in the boardroom figuring out what a company should do with its strategy? How did Southwest reach its enviable position in airlines? Why did Kodak lose like it did. Did Schneider India take the right decisions? You have your say and yes people fall over themselves to participate in the class discussions for some CeePee points which will count towards their grade in the subject. Whether it is global economics, corporate finance, operations management or entrepreneurship, the core term subjects bring to you invaluable learning about the workings of the corporate business environment. I often wonder what we were doing without this knowledge!
But yes it comes at a price. You get a max 6 hours of sleep a day, and the spend rest of the time outside classes trying to pin down lose ends whether in studying for your courses, picking up on a club event, organising one yourself or "networking"
Well networking is a buzzword on campus. Everyone tries to network with everyone. The other day I saw a guy try to network with the trees at ISB. Well kidding, but just about! It is such a craze at campus that no one wants to miss out an opportunity to build a contact. Its a indset that has come to stay. I personally feel that it is slightly overdone in the Indian context. As it is we are living in an almost American MBA at India. The networking challenge is one spawned by the American MBA dream as well. In the US you are unlikely to make it to a worhtwhile career unles s you are adequately "connected'. But fortunately, that is not the case in India so far. I would cite two reasons: 1. The Indian market still has jobs and work to be done, and the market tends to fins you if you have the skills for the job. 2. The Indian entrepreneur is smart enough to hire the better skilled candidate than the better networked candidate.
That saidit does no harm networking if you remember who all did you network with! Most of the times you don't!. You don't even remember the names of your classmates yet and keep asking we met before .. you are Rajat right! The person says No, I am Atma. There you go!
They say it is downhill after the third term. Lets see. The third term did seem to be over the top with workload. The ELPs are picking up, so are the pro bonos. Some of us will be headed out for Study Treks abroad and others will plan Goa trips in the next term break. All in all , life is moving fast at ISB and in no time we would be through this journey they call a "Roller Coaster".
Tuesday, January 19, 2010
Power Sector in India-Challenges and Opportunities
India is a power deficient country with peak power demand shortages of
upto 15% which requires load shedding and leads to lost productivity
worth billions of rupees. With the liberalization of the economy,
during the nineties, came about an increased focus on ramping up power
production capacity. This focus culminated in the Electricity Act 2003
which abolished requirement of a license to produce power.
This led to the entry of numerous private sector players in the power
sector such as Reliance Power, Tata Power and Lanco Infratech etc.
Each of these players were vying for a share of the pie and either
conjuring up MOUs for potential projects with state governments or
bidding in the tariff based bidding for thermal power projects for
projects identified by the government.
In case of the tariff based bidding, the government forms a shell
company which takes care of land acquisition and primary clearances.
The bidders bid for the lowest rate at which they will sell power.
This rate or tariff is a levelised for the design life of the project
which is mostly 25 years. While coming to this rate the power sector
companies consider important factors like availability, proximity and
cost of fuel in addition to the cost of infrastructure and equipment.
The bidders make an effort to seek competitive advantages over other
in by reducing their costs by identifying economical equipment vendors
as well as forming an operation plan which helps them bring down the
tariff to the lowest possible figure. It can be pointed out here that
the projects nearer to the source of coal bring out lower tariffs as
the cost of coal transportation is reduced. Most ultra mega power
projects(UMPPs) are located near coal mines, such as Sasan or at port
locations ,such as Mundra, where imported coal is directly available.
A little about project execution – once a project is awarded to a
bidder, the bidder takes up the execution starting with the award of
equipment contracts to suppliers. Almost all private sector power
players are sourcing equipment from China. This equipment is 60% the
cost of that supplied by domestic players such as BHEL. The reason for
this gap and the quality of this equipment can be the subject of
another essay, however China’s huge manufacturing capabilites with
cheap manpower enables them to line manufacture power equipment. Site
clearance and leveling is the first activity that is taken up followed
by start of construction for major facilities. A typical time frame
from zero date to unit commissioning for a typical 500 MW unit is 36
months. The process involves collaboration of structural designers,
equipment suppliers and construction personnel. An efficient and
experienced team of professionals is a must for any organization
attempting to execute such a project. Some private players, due to
lack of quality personnel, are going for EPC contracts to Chinese
players. However lack of sufficient checks and balances at the
organization’s end can lead to poor equipment and construction quality
as well as system integration.
Major challenges in power capacity addition are: - inability of
agencies responsible for tendering viable projects within time frames
specified; inability of agencies taking up projects to complete them
in schedule; insufficient trained manpower to competently handle major
projects; problems in financial closure and availability of funds and
lack of international best practices in project execution in Indian
companies. Another major challenge to the
sector is the issue of land acquisition
which is holding up a number of projects in the country. We could get a
taste of that in Singur which was well publicised. Many such Singur's
are there all over the country with the land acquision process being
subeverted for vested interests. This is a major area of worry and one that
needs sweeping reforms.
Infrastructure is an area that needs huge capital expenditure. It is
no longer possible for the government to meet the infrastructure
demand of the growing economy from its own funds. The involvement of
the private sector in partnering the government to achieve
infrastructure targets is a must. However, the private sector has a
core profit motive. The challenge is to align the profit motive with
quality infrastructure creation. Added difficulties like political
biases and presence of vested interests in government not to mention
potential for corruption are major hindrances to the smooth
functioning of this sector. There are no simple solutions and we are
seeing rapidly evolving dynamics.
The targeted 11th plan spend of USD 500 billion has the lion’s share
for the power sector at USD 160 billion. This is obviously a great
opportunity for business! You can have a share of that USD 160 billion
in case you choose to participate in the proceedings. The sector needs
good managers and leaders to resolve the dilemma of coexistence of
profit and welfare motives. It needs managers who build systems which
can make this symbiosis possible and leaders who are strong enough to
see the projects through. In this lies an opportunity for anyone
interested in this sunrise sector which has opportunity beyond
description. For anyone who is up for the challenges in this sector
there exists no upper bound! Good luck!
Sanjeev Sharma
ISB CO 2011
Monday, December 7, 2009
If we don’t do it who else will
We are a country of a billion people. Out of these billion only 40 % are literate and have access to basic education. A still smaller number go on to pursue higher education. But there is a common attitude which makes us all no different from each other – indifference.
Why are we so indifferent towards everything? From basic cleanliness in the cities to following the laws of the land, it is the educated lot who make a major contribution to the pathetic state of affairs that we constantly discuss in elite forums and deride our country about. We complain about the lack of laws whereas we ourselves do not let go of an opportunity to find loopholes in law and its enforcement and take advantage of it.
Public sector vs Private Sector
Having worked both in the public and private sector I have seen the functioning and differences therein of these sectors. Here are the few basic differences that make the two so different:
1. Reactive approach Vs Proactive approach: Instead of waiting for things to happen you find out what lies ahead and go about unravelling the curled spirals of project management.
2. No holds barred approach: There isn’t an excuse. No reason is big enough. If something has to be done there ought to be a way. Clear thinking and correct evaluation of a scenario holds the key. Once the problem is defined half the work is done you know!
3. Employee empowerment-You are trusted until you break trust. Complete power and total responsibility defines your role in the private sector!
4. Removal of unnecessary hassles- There’ll be numerous hassles that public sector ideology ties around your feet. You break free and kick the air. You do what is necessary and you won’t have to do what is wastes time or energy. You have the freedom to focus!
5. Value of time and money: Time is money and both are invaluable. Lose any and you lose your way. the ultimate essence of good management and a good manager! You respect these and respect comes to you automatically.
The Financial Crisis: How it all started
April 27th, 2009 by Sanjeev SharmaThe world is reeling under the most monstrous financial crisis that has visited since the 1930s. Here’s my take on this and how I understand it:
The US is a developed nation with people whose needs are largely met and who have little incentive to go out and buy(stuff that really drives economies such as consumer durables, capital goods etc). As a result the growth of industry in the US as in any developed economy was stunted. At the same time there is a lot of money to invest both in the US and outside. Dismal bank rates and poor performing stock markets were bad investments to say the least. Avenues of investment with good return were limited.
MBAs in the US thought they could get out of this no returns on anything scenario by riding on the realty market where prices of homes were constantly on the rise. To feed the investors hungry for good returns they carved out a complex set of instruments bunndling the mortgages of home home buyers vested with lending institutions. These mortgages promised to be great investments when the house prices were moving up. Now to increase the supply of these mortgages more and more borrowers were required. The banks helped generate these borrowers by incresing lending. The quality of lending suffered as loans were readily made available to even those who did not deserve them i.e the sub-prime. This fed the raging fire i.e provided a huge market for investment for surplus cash with institutions.
The real chaos began when the subprime borrowers started to default on their payments and loan foreclosures started. The home prices started to fall with these foreclosures. Suddenly the complex instruments that seemed so lucrative when the borrowers were repaying their loans started to pop. Their values began to come down. Huge institutions with millions in these ‘assets’ started to panic and gradually these ‘assets’ became ‘toxic’. This led to the collapse of giants such as Fannie Maye and Freddie Mac.
Banks stopped lending and as a result all sources of finance and funding dried out. Interset rates were constantly brought down but to no help. This sent the economy into a tizzy. The mental frame of people in the US became even more negative and everybody started to save at the same time-consumer spending slowed down. This really put the brakes on the US economy.
To come out of this mess it should take a while. Especially for the people to make a habit of spending again. We in India are affected because US is one of our biggest customers and banking institutions are affected by the low liquidity in the world markets. The unwillingness of banks to lend even in India is causing the Indian economy to slow down. Economic progress is directly related to the free circluation of funds and the returns generated on these funds by innovative entrepreneurs. The slowdown in flow of funds is leading to the slowdown in the indian economy and not lack of demand as such. That explains why the decline in Indian growth is not as drastic as the US.
Booms and busts are the way the economic cycles run. Only thing is this is a deep well that we are into and it may take a while before we can come out of the water to breathe fersh air again!
Comments are welcome!
Sachin’s 42nd test hundred.
March 21st, 2009 by Sanjeev SharmaMarch 21, 2009
Today India won her first test match of the ongoing test series in New Zealand. The win is the first since 1976. It is a cornerstone win in Indian cricket. For long the Indian team has lived with the fear and fact that they could not win abroad. Off late this is changing. We have a dynamic thinking captain in Dhoni and a beautiful mix of youthful energy and experience. The win is entirely deserved and can be attributed completely to the strengths that this team has consistently displayed. The win is all the more heartening and lovely because Sachin played a huge part in achieving it.
For nearly two decades now Sachin has been an integral part of almost everyone’s life in India. We have come to expect a lot from him. Like any human he is not faultless and has had his share of bad times. The Indian public however doesn’t forgive its heroes during their bad times. If we look at the way the careers of our earlier heroes have ended esp Azharuddin, Ganguly and Kapil Dev, it does give a lot of pain. After these instances of roiled fullstops to the carriers of these stalwarts one fears how Sachin’s career would end. It is really pertinent that we give him a joyful and proud farewell whenever the time comes. After Sachin’s score of 150 in New Zealand one does feel elation but I feel a sense of relief as well. For with this innings, not only has he has earned India a win that is precious beyond words, but also proven beyond doubt that he is still has mettle and is the people’s hero. However I really wish that the end of his career is as beautiful as has been the golden era of cricket that he has bestowed upon this nation.
Now this is not as easy as it sounds. Sachin loves the game and is doing very well at the moment. He may have some plans for his retirement but his love for the game and the fact that he still good at the game will make the decision very tough for him. But what he must realize that a timely decision on his retirement would go great lengths in etching his memories in the nation’s soul forever. Often a bitter end to the careers like in the case of Ganguly or Azharuddin lingers in the public memory and the greater days of glory seem a little less shinier. I would not want the same to happen to one of India’s greatest and the most loved heroes. We as the public must remember that we can never repay him for the moments of exhilaration and joy that he has given us. The least we can do is be gracious when he is near the end of his reign. But most importantly Sachin should call it a day when he feels that the nation still needs him and longs to see him bat and not when his reflexes have faded further and the public focus is on his non-performance. I am sure if Sachin is able to time his retirement in this manner he would have maximized the love he gets from the nation and his own personal satisfaction with his career.
Oh boy-why am I writing this?
January 18th, 2009 by Sanjeev SharmaI used to be my english teacher’s favourite pupil. Partly because I was a cute little kid and also because I wrote not that badly. That encouraged me to make even more effort in polishing my skills. But just as I was thinking of building my writing skills I collided headlong into the competitive frenzy of intermediate pre-grad classes seeking admission into engineering colleges. Everything other than pure classical physics and calculus took a backseat. Even through college there was hardly any time left after barely touching all the credits. As an engineer in the professional world, writing as a habit was something that I left far behind. But after five years into engineering structures around India I feel I miss something. There have been things I always wanted to do but never got to. And now that the wave of life has moved along the timeline and settled into a more consistent amplitude from an interference of high and low frequency beats, I am focussing on things that were always dear to me. Playing tennis is one, learning how to play the guitar is another and writing is what has brought to me this blogsite. I hope writing on this blog will -one, help me explore myself and how i interact with this world; two, let me share my experiences with everyone who is interested and three, give me a creative satisfaction that I believe only writing can. So ..
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