In the wake of the IL&FS crisis or the NBFC crisis, the banks, lenders and all others have put in little more stringent measures. In this column, Vishnu P. Sudarsan & Megha Arora (Partners) and Tanvi Trivedi (Associate) from J Sagar Associates are analysing the impact of the crisis on Infrastructure Sector and outlining the way forward.
The key focus of the ruling Government to boost Indian Economy since the last few decades has been on the Infrastructure Sector. The Union Budget 2019-20 has reaffirmed this notion and the Government has promised to invest about 100 trillion in infrastructure across the next five years, firing up optimism in the sector. Where the Government is positive and determined to promote to the growth of the infrastructure sector, the sector itself has been hit by various catastrophes evidencing a bitter ground reality. As per the reports in the public domain, the value of stalled projects in India has risen to almost US$ 3 trillion since June 2018. As the infrastructure sector struggles with pressing issues such as (i) delayed land acquisition; (ii) poor financial health of public utilities and DISCOMs’; (iii) lack of adequate funding owing to capital intensive nature of infrastructure projects; (iv) poor pre construction planning, etc, unexpected events such as insolvency of Infrastructure Leasing and Financial Services Limited (“IL&FS”) Group, an infrastructure lender, add to the miseries of the already crippled infrastructure sector spreading panic amongst India’s money and equity markets, further deterring investments.
Vishnu P. Sudarsan
Whilst it is difficult to identify a single set of reasons for current state of affairs in the infrastructure sector, it is evident that there was need for better understanding of inherent gaps and risks of infrastructure projects such as the fact that they have a high gestation period and are considered high risk investments as they are typically capital-intensive and plagued by delays and cost escalations. Environmental issues and obstacles to land-acquisition further contribute to delaying and derailing infrastructure projects. Regulatory hurdles, judicial intervention and other variables abound when it comes to large-scale infrastructure projects, often-times resulting in the indefinite stalling of such projects.
Sector specific issues also creep in completed projects making them unviable investments, such as the regulatory issues including political uncertainty and reopening of power purchase agreements in the power sector being one such example. While on one hand the sector is dealing with aforementioned regulatory and sectoral issues, on the other hand there is a delay in payment of its dues by State DISCOMS rendering a viable investment becoming unviable.
The insolvency of IL&FS (totalling around 91,000 Crore) highlights the need for better infrastructure regulation. There is a need to evolve a less expensive, more durable solution to deal with future episodes of such nature. While the Government grapples with the IL&FS debacle and seeks to set in motion the next steps it is important to build on better infrastructure regulation to prevent such events in the future. The IL&FS event was followed by similar situations of two other major NBFCs’ coming to light —Dewan Housing Finance Ltd and Reliance Capital Ltd. These two, and a number of other firms, are struggling to meet their short-term debt obligations and repay bondholders like debt mutual funds (MFs), pension funds, and insurance firms. At a macro- economic level, to boost infrastructure development, a separate resolution mechanism is the need of the hour. For e.g. A Financial Resolution and Deposit Insurance (FRDI) Bill, 2017 to deal with resolution of financial firms was proposed. Through this Bill a resolution corporation was proposed to be set up and authorized to transfer assets to healthy firms, order mergers or amalgamations, liquidations etc. on the order of the NCLT. Though the FRDI Bill did not see the light of day, it would be a useful legislation to ensure a comprehensive resolution regime.
For infrastructure companies, investment can be stabilised by a combination of safeguards. Proper due-diligence and better appraisals by Banks, NBFCs’ equity funds, equipment suppliers and contractors and developers of infrastructure projects needs to be conducted to analyse the potential success of and return on investment in
relation to such projects. While it is true that return on investment on completed infrastructure projects is generally high, in many cases, investors make investments without analysing the success of these projects. Due diligence will bring to light these issues and help investors make wise decisions when funding infrastructure projects.
While NBFC’s battle with asset mismatch and other financing issues, draconian obligations in concession agreements such as stringent lock-in commitments and change in control restrictions add to the misery. Revival of the PPP model by re-drafting the concession agreements and implementing the Kelkar Committee recommendations to make it more balanced towards the private players will certainly alleviate the financial crunch faced by the infrastructure sector by providing more comfort and security to the lenders.
Finally, reliance on any single funding method is to be avoided at all costs. While, NBFCs certainly are a key source or project funding, there are several traditional and new methods to fund infrastructure projects. These include banks, Infrastructure Investment Trusts (InvITs) and Real Estate Investment Trusts (REITs). It is essential that these modes of funding also be explored, to ensure increased efficiency in funding infrastructure projects and resulting in a buoyant financial market.
Such safeguards would complement each other to create a healthier infrastructure sector in India, one which thrives on the strength of both domestic and foreign investment and prevents future financial untowardly events of the scale of the IL&FS event. Besides the above, an improvement in the governance standards including better governance and related party transactions will help infrastructure companies in scaling up and withstand any situation or financial crunch.
To fix the future we have to move to the past, Indian Infrastructure Sector would benefit from implementing 150 years old, Walter Bagehot’s advice on how to deal with a liquidity crisis. Bagehot said that: “Central banks should curb panic by lending “quickly, freely and readily” to any bank that can offer good securities” as collateral.”