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Building the right bridges: an Indian perspective

 

31 March 2009

Written by Sanjeev Dhuna and Srinivas Parthasarathy (Partners at Allen & Overy LLP) and Nishant Parikh and Karan Singh (Partners at Trilegal). This is one in a series of articles looking at financial regulation and reform.  

According to a recent McKinsey report, India’s shortfall of key infrastructure financing is estimated at USD190 billion with several projects failing to achieve financial closure because of lack of liquidity, high interest rates and challenges in financing sponsor equity.

Some new infrastructure projects proposed by the government have also found few or no bidders – despite the fact that they offer attractive returns to financiers. The problem is more acute for projects structured to be highly dependent on returns from real estate development surrounding the project.

But lack of liquidity is only part of the problem that India needs to address. A more fundamental issue is the lack of legal and policy frameworks in these markets that provide certainty for investors looking to put up funding to secure these projects.

Unlike China, where state-owned enterprises have invested heavily in infrastructure in the past decade, the Indian government expects that 30 per cent, or about USD150 billion, of its infrastructure funding under the current plan period, needs to come from the private sector.

India’s relatively underdeveloped infrastructure, compared with China, arguably makes for a more attractive investment opportunity; however, to convert this opportunity, the Indian government must introduce quick and effective regulatory reforms.

To be fair, the Indian government has taken several concrete steps to support and encourage PPP projects in India. It has established a Project Development Fund to finance preparatory expenses of PPP projects and a Viability Gap Funding Scheme to grant assistance of up to 20 per cent of the project capital costs for competitively bid infrastructure projects that can be justified in social returns but carry an “unacceptable commercial rate of return”.

In 2006, the India Infrastructure Finance Company Limited (IIFCL) was set up to provide long-term debt financing for PPP projects. The Indian government has also developed standard project documents for a number of sectors to provide predictability and mitigate risk to private capital. India is also actively exploring extending the PPP model to social sectors such as health and education.

While this is a good start, for India to achieve the required momentum, the executive, legislature and judiciary need to work together. A good framework should be followed up with effective implementation of projects to address cumbersome processes and delays in decision making.

On the executive front, easier processes, greater predictability in decisions, quick decision making and an improvement in governance at both central and municipal levels are critical areas for development.

As for the legal framework, India’s insolvency laws need updating and India should consider extending current laws dealing with the enforcement of security to foreign lenders. The development of a more liquid and deeper corporate bond and derivatives market is another way to encourage investment in infrastructure by foreign institutional investors.

Finally, the courts in India need to take a ‘development’ approach to their decision-making. The culture of public interest litigation (PILs) is well entrenched in India. However, in recent years, PILs from self-serving groups have overwhelmed the dockets of courts which are already struggling to clear their back-log.

The attitude of the judiciary to alternative dispute resolution mechanisms (especially arbitration) also deserves attention. An effective arbitration regime can enhance investor confidence and provide predictability in enforcement of their legal rights.

Emerging markets are also directing their monetary and fiscal policies towards infrastructure to drive demand. In this regard, India has recently taken a few measures, including: liberalising its policy on External Commercial Borrowings; allowing IIFCL to raise approximately USD8 billion through tax free bonds for funding infrastructure projects; and lowering the central bank’s benchmark lending rate by 400 basis points since October last year.

However, India’s stimulus package of 0.8 per cent of GDP pales in comparison with China’s stimulus package of USD585 billion or 13.3 per cent of GDP.

The communiqué issued by G20 foreign ministers earlier in March called for certain measures to address funding problems more generally, including:

  • pursuing all options for mobilising International Financial Institutions’ resources and liquidity to finance infrastructure
  • doubling IMF resources
  • tripling the Asian Development Bank’s capital to just over USD150 billion
  • reviewing adequacy of the capital resources of all multilateral
  • development banks to provide appropriate increases in funding
  • giving developing countries more voting power in the governance of the IMF and the World Bank.

On 2 April, the G20 should consider increasing funding for export credit agencies (ECAs). ECAs provide debt finance for the importation of plant and machinery for infrastructure projects from the ECA’s home state. Increasing their resources will – on one hand – provide much needed liquidity to key infrastructure projects; on the other hand, the demand for such components will stimulate manufacturing in the developed world, leading to a win-win solution for both the developing and the developed world.

All of the proposed G20 measures, if implemented, will provide much needed liquidity. But, in an increasingly competitive investor market, how efficiently India is able to use any such liquidity will depend on the extent and speed of its reform measures.

The steps taken by the Indian government in the past few years for infrastructure development have been in the right direction. But as India faces elections and the possibility of a new government, it is critical that any political party that comes to power continues with and builds on the progress made by the current government.

Further information

View the webcast: Philip Wood on what really caused the financial crisis and what needs to happen now.

 

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