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What’s Still Needed In Indian Infrastructure Financing?
Infrastructure providers are incentivised to establish greater creditworthiness for their investments, relying primarily on market finance with government enhancements as additional support
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This intersection of post-pandemic growth in economic activity and a resolute commitment to achieving net zero emissions presents a golden opportunity for India to reimagine its infrastructure development and financing strategies, with a focus on sustainability, and future readiness. While promoting green finance is crucial for sustainability, prioritising projects that enhance the transportation of goods and services that can bolster manufacturers' competitiveness and provide an overall boost to the economy is equally important.
To begin with, India's ambitious Net Zero 2070 plan sets forth enhanced targets for renewable energy deployment and carbon emission reduction. Achieving these goals would require a staggering $10.1 trillion to decarbonise the power, industrial, and transport sectors, according to an independent study by the Council for Environment, Energy and Water - Centre for Energy Finance. India needs to establish its own taxonomy of economic activities that align with net-zero goals, to enable regulators to propose norms for climate-labelling of financial products that facilitate sustainable investments.
Overall, the Indian government has already taken several steps to enhance the nation's attractiveness to international infrastructure investors. These measures include improved regulatory frameworks, efficient offtake arrangements through central government-backed counterparties, and a range of financial products such as toll operate transfer, InvITs, sovereign-linked commercially managed equity funds, production-linked incentive schemes, and tax benefits for large international institutional investors. India's focus on reducing logistics costs relative to GDP and its leadership in the transition towards clean energy and mobility are also making steady progress.
However, given the substantial resources required to bridge the infrastructure deficit (at least five per cent of GDP per annum), direct funding by the government is a challenge. Therefore, it is essential to shift the focus from discussions on the size of a fiscal stimulus to leveraging public resources and bringing in private players. This approach allows for more efficient and equitable infrastructure financing by spreading the cost of investments over time and sharing it with future beneficiaries.
Nevertheless, leveraging finance is only one aspect of the equation. The other crucial factor is how the funds are spent. Traditionally, the emphasis has been on physical infrastructure, such as road networks, water and electricity pipelines, ports, airports, and public housing. However, it is equally important to ensure that infrastructure spending translates into reliable and continuous infrastructure services. Simply expanding water pipelines, for instance, does not guarantee regular water supply. India needs accountable and efficient utilities, companies, and corporatised agencies that can effectively utilise infrastructure investments to deliver uninterrupted services.
Merely building physical infrastructure is not sufficient; equal attention must be given to the reliability and quality of infrastructure services, for assured infra-utilisation revenue accrual. Infrastructure financing should prioritise projects that not only expand infrastructure networks, but also ensure the uninterrupted delivery of services. Infrastructure services must align with sustainability and resilience goals. Climate change adaptation measures, energy efficiency improvements, and green infrastructure solutions should be integrated into projects funded through infrastructure financing.
Infrastructure financing comes in various forms, typically based on the industry they serve. Economic infrastructure financing focus on projects that contribute to a country's overall economic growth, such as new ports that facilitate foreign trade. These projects often lend themselves to public-private partnerships (PPPs) as they generate shared value between the government and private entities. Social infrastructure financing aims to improve access to basic services like electricity, water, and sanitation, irrespective of their net present value. Commercial infrastructure financing benefits specific user groups, like toll roads and metro rail projects that directly charge users for their services.
Infrastructure projects often require several years to build and generate revenue only after completion. To bridge this gap, long-term infrastructure finance bonds with extended durations are used. However, currently there is a lack of depth in India's infrastructure and corporate bond market, affecting the ability to raise necessary resources. A well-functioning bond market enables infrastructure providers to access long-term finance at competitive rates. It promotes transparency, price discovery, and efficient allocation of capital. Additionally, a robust bond market can create secondary market liquidity, allowing investors to buy and sell bonds, thereby enhancing market efficiency.
While banks play a significant role as financiers, their short-term liabilities make it challenging to hold long-term assets on their balance sheets for extended periods. In India, corporates have traditionally relied heavily on the banking sector for financing, in contrast to advanced economies where they tap into the bond market. This skewed imbalance in financing sources has significant implications, particularly for infrastructure financing. When corporates rely heavily on bank loans, a “crowding out” effect may occur, wherein limited credit availability for other sectors, including infrastructure, becomes a concern.
To tap into financial markets and ensure investment, strengthening public Development Finance Institutions (DFIs) is a viable alternative. Development banks and export credit agencies can enhance the efficiency of their finite resources by utilising financial instruments like guarantees or mezzanine capital. Additionally, infrastructure investment funds can tap into international capital markets, unlocking vast resources.
Development Finance Institutions can be further leveraged, but their track record is mixed. Instead, the government can utilise its fiscal power to offer different mechanisms for accessing capital markets and institutional investors such as pension funds and life insurance agencies. Introducing a second generation of DFIs that offer credit enhancement and bond insurance is imperative. These institutions would provide credit enhancement, first-loss protection, and partial guarantees, enabling infrastructure providers to access long-term finance from both domestic and international markets. The approach offers multiple advantages. First, it allows the government to share investment risks with markets, relying on market assessments of project creditworthiness. Second, infrastructure providers are incentivised to establish greater creditworthiness for their investments, relying primarily on market finance with government enhancements as additional support.
If the benefits of infrastructure are evident, why are successful project implementations scarce? To address this, boosting public-private partnerships (PPPs) through a dedicated nodal agency, leveraging technology, strengthening the corporate bond market, finalising contractual arrangements, establishing robust regulatory oversight, and capacity building are essential. Furthermore, capitalising on the interest of global pension funds in alternative assets, including infrastructure, presents an opportune moment for Indian infrastructure financing. Asset monetisation, coupled with private sector operating efficiencies, can raise capital and optimise infrastructure development.
For infrastructure financing to pick up sustainable momentum, attention must be given to fiscal burdens, the asset-liability mismatch of commercial banks, subdued investments in PPP projects, the investment obligations of insurance and pension funds, the need for an efficient corporate bond market, insufficiency of user charges, and legal and procedural challenges related to land acquisition and environmental clearances. It’s not just the infra hardware, it’s also allied areas and the softer aspects that would help.
Srinath Sridharan - Author, Policy Researcher & Corporate advisor
Twitter : @ssmumbai
Dakshita Das is a former civil servant and policy expert, who now heads a government committee on Gender Budgeting and is the government nominee on the Disciplinary Committee of the Institute of Chartered Accountants of India