Infrastructure debt funds — ready to roar

These funds may be tiny compared to banks, but are a viable funding proposition

For long, Indian public sector banks have taken the lead to provide the necessary funding for infrastructure projects in the country. In fact, much of the deteriorating state of affairs at State-owned banks in recent times is the result of their so called ‘compulsion’ to lend to core sectors such as infrastructure.

While funding very long-term infrastructure projects presents a host of challenges for Indian banks — only exacerbated by weak balance sheets — Infrastructure Debt Funds (IDFs), conceived to provide an additional funding route for such projects, have been able to tap into private funds and fund more projects over the past three years.

But with an asset base of a little over ₹10,000 crore (all IDFs put together) these funds are still tiny when seen in the larger context of banks’ lending exposure to the infrastructure sector. It’s time to ensure more bang for the buck.

Lower risk

Of the two routes through which IDFs are set up — the non-banking financial company (NBFC) and mutual fund (MF) routes — the former has been gaining ground. The various risk-mitigating features under the NBFC route have helped IDF-NBFCs draw investors and deploy funds in more projects.

The IDF-NBFCs’ scope of financing is limited to projects that have successfully completed one year of commercial production. Hence, they do not carry construction risk, land acquisition risk, risk of obtaining basic approvals, or risk of non-infusion of equity by the promoter.

Under the IDF-MF route, all projects, even the ones that are under-construction, can be financed, thus pegging the risk higher.

According to the RBI’s initial guidelines, IDF-NBFCs were allowed to invest only in public-private partnership (PPP) infrastructure projects, subject to a tripartite agreement between the project authority, the company and IDF-NBFC, and a compulsory buyout with termination payment, in case of a financial default.

In May 2015, the RBI came out with revised guidelines that widened the scope of financing by IDF-NBFCs to include investments in PPP infrastructure projects without a project authority, and non-PPP projects.

The risk is still relatively lower as it covers projects with minimum one year of commercial operations. Also, in sectors such as power, say, wind and solar, where assets can be mortgaged to lenders, a tripartite agreement offering guarantee is not required.

Resolving ALM issues

Banks in the past have been reluctant or unable to lend to very long-term projects, given their inability to raise funds for such long tenures.

IDFs, on the other hand, offer just the solution to asset liability management (ALM) issues. IDF-NBFCs can raise long-term funds and are hence able to provide long-term fixed rate financing to borrowers/projects.

Given the relatively lower risk in the projects funded by IDF-NBFCs, rating agencies have assigned AAA rating to these bonds. This has helped channelise pension/insurance funds to infrastructure projects, as was envisioned earlier.

Low-cost funding

Providing low-cost funding to infra projects has also been paramount to enhance the viability of projects. IDF-NBFCs, given their lean operating structure, score over banks on the operating cost front right away. IDF-NBFCs also carry an inherent tax advantage that allows them to offer cheaper finance than banks for infrastructure projects. Income generated from deploying funds is tax-free for IDFs. In the last one year, IDF-NBFCs have been able to offer loans between 9 and 11 per cent, 0.5 to 1 per cent below that of banks.

IDF-NBFCs have also been able to provide fixed-rate, long-term loans up to 18 years, eliminating interest rate risk for projects.

Scope for more

Most of the objectives — addressing ALM issues, offering low-cost funding and routing long-term pension and insurance funds to infrastructure projects — for which IDFs were envisioned in the first place appear to be bearing fruit.

But infrastructure debt funds are still tiny. The banking sector’s overall lending to the infra space is about ₹9 lakh crore. For the NBFC format (only operational projects), the market size may be a fifth of this. All IDF-NBFCs put together currently have an asset base of over ₹9,000 crore.

To be fair, the regulator and the Centre have been actively ironing out issues and challenges over the last one to two years. The RBI increasing the scope of financing under IDF-NBFCs in 2015 has ensured faster build-up of assets. Two years back, the asset base of all IDF-NBFCs was just around ₹600 crore. The Department of Economic Affairs and the NHAI have been proactive in their efforts, say market players, leading to faster approvals.

SEBI recently eased exposure norms for debt funds for investments in housing finance companies to channelise more funds towards the Centre’s goal of providing affordable housing.

A similar dispensation for bonds issued by IDF-NBFCs can help them raise more funds for deployment in infrastructure projects.

One cannot ignore the merits under the MF route, either. The market for an IDF-MF is larger as it can finance all projects. Each scheme lends to different projects and investors in these schemes ideally take a direct risk and exposure to such projects. This route also needs to gain acceptance fast by bringing in a more mature class of investors.

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