GAME ON for INFRASTRUCTURE

Infrastructure sector is at the cross roads after two decades of mixed experience in private public partnership (PPP) model approach. While the economy is convulsed with covid-19, global supply chain issues, climatic challenges and inflation, the government's unwavering focus for stimulating investments in infra favours the sectoral prospects.  India's plans to monetise Rs 6 trillion across sub-verticals of infra and Rs1.1 trillion of national infrastructure pipeline augurs well for the near to medium term growth.

Given that the infrastructure is a growth engine to propel economic growth, the choice of PPP model will be a critical pillar for future investments.

Over the years the government transitioned to innovative models and re-drafted the concession agreements to elicit private participation. The shift also aimed at re-balancing the risks which was asymmetric distributed towards private player. In the below sections, we shall analyse in depth about various sectors along with an outlook.

Shift to Balanced Risk Framework

In the backdrop of severe delays in road projects, the government coined a new framework called hybrid annuity model (HAM)in middle of last decade.This model and cash contract model were the chief mode of awards to relieve the high balance sheet pressures for developers.

Originally, HAM was introduced to stimulate private participation in roads, it gradually made inroads to other sectors like water and sanitation projects and with some bespoke adopted in electric bus concessions as well. Notwithstanding, the lender's concern over less skin in game for developers because of the low equity contribution, the government's push and correction of concession terms (like linking the revenues to marginal cost of lending against original bank rates) led to large scale adoption of this model. The Covid-19 led stress on the liquidity of the developers were also addressed by release of frequent grants during the construction phase. 

NHAI ushered in the road projects implementation, however, water projects had been handled by National Mission for Clean Ganga. This sector gains traction due to the increased attention towards environment related projects. Additionally, the emergence of Environment, Social and Governance parameters are an important consideration for stakeholders' decisions.

The concession or operation framework in electric bus operations (Rajasthan, Uttrakhand and others) and street lighting projects like in Maharashtra & UP are gradually picking up. The underlying risk of counterparty is to an extent mitigated through upfront funding of the escrow account with ensuing three or six months of revenues. Although this addresses risk to an extent, the functioning of this method for a longer period would provide the necessary confidence for investors.

Reshaping Competitive Landscape

In certain segments of infra like roads and renewables, the intensity of competition is immense given the attraction of the PPP model and the alterations made in the contracts. As against average five bidders for HAM projects, the average number of bidders are above nine with some as high as 15, thereby compressing the differential between bids in certain cases. The bidder list is significantly higher for EPC projects. This may be a healthy sign from a concession grantor perceptive, however, the aggressive bidding attitude of players in the past not only derailed the build own and operate model but also led to a prolonged recovery period for roadswith many developers running into bankruptcy.

In renewable space, the disruptions to supply chain in solar modules and elevated logistical costs has veered the cost economics and currently the sector faces slower absorption of new bids. The introduction of production linked incentive scheme to boost the local manufacturing of modules is unlikely to yield immediate results but would pay off over the medium to long term. Currently, India imports about 90% of its requirement.

Selective Relief Measures

The evolution of bid based model for renewable space although led to rapid reduction in costs, the perils of counterparty risks continues to weigh in on the investments. Several attempts to strengthen the utilities operational and financial position has not yielded the desired results.

Atmanirbar discoliquidity package announced to wade through the stress partially aided in clearing the piled-up receivables. However, the annual loss for all discoms was about Rs. 350 billion (FY19) and poised to report higher losses in FY21 and FY22. Additional debt to fund the gap and this liquidity package may offer temporary respite but it is unlikely to provide a permanent fix to the quandary. The infrastructure development measures like installation of smart meters, larger budgetary support of Rs. 0.97 trillion with a focus on curtailing the AT&C losses and eliminating the gap between the cost of supply and revenues is important step in the right direction. The implementation of this scheme would be a litmus test given the fundamental mend the discoms have to adopt.

In roads, the NHAI allowed for disbursal of construction grants at an increased frequency - monthly grant payments as compared to milestone linked payments, thereby alleviating the strain the developers could face due to protracted covid situation. The road sector has made significant strides because of the long history of operational PPP model. That being said, timely redressal of issues plaguing other sectors is critical to further build investor thrust. The case in point here is airport sector, where successive waves of Covid has dented the prospects. Not only the limitations in opening up the airports to international traffic but also the general hesitancy to travel due to the Covid has accentuated the sector's liquidity issues. There is a high probability of permanent removal of some travel post the pandemic due to usage of technology in businesses. The inherent strength of the business model although permits the collection of the lost revenues in the future, the temporary mismatch combined with an ongoing capex exacerbate the financial weakness.  Internationally, both US and some Europe countries offered relief package for airports. Notwithstanding, the passenger demand recovery, steps to lessen the impact of protracted covid situation is imperative.

Urban mass transit like metro rail also has suffered significantly due to the covid induced lockdown. Even prior to the covid, these assets faced an elongated stabilisation period and were looking for solutions to align the concession life with debt tenor. Absence of any policy measures on this front, led to continued dependence on the sponsor for meeting the debt obligations.

On the contrary, toll projects are resilient and it has been proven from multiple disruptions like de-monetisation and successive waves of covid. Tolls bounced back within a period of about three months after covid induced lockdown. Hence, there was requirement of minimal policy actions, although concession extension was provided.

Novel Funding Trends

The developers with success in completing and stabilising the project before 2020 are embarking on a capital market issuance to take advantage of the low interest rates. India Ratings rated the first bond transaction of HAM road asset issued by GR Infrastructure. Alternatively, some players are keen to refinance the loans through a new term loan given the limited size of the facility. At the same time, some of the new players are challenged to achieve financial closure due to either sponsor's credit weakness or funding the project below NHAI indicated costs. The strong sponsors' owned projects financial closure does not come under strain and lenders continue to factor in the sponsor profile as one of the important considerations.

Financing for renewables hinges on the sponsor strength, counterparty credibility to a large extent and the debt serviceability. Generally, weak counterparty linked projects command a higher interest rates with tight debt structure including reserve requirements. Counterparties like Andhra Pradesh, Telangana, Tamil Nadu, Rajasthan and Maharashtra haveexhibited erratic payable period in the past.

Alternatively, novel structures like InvITs and pooled funding have gained momentum given the diversity both in terms of counterparty and location. This model also offers tax advantages to the developers. Therefore, mid to large players may increasingly opt for InvITs structures and small to mid-size players may opt for pooled projects funding.

Emerging Consolidation Theme

With many pension funds and long-term private equity players entering India, various sub-segments of the infrastructure have become cynosure for acquisition. Renewable projects on stabilisation have galvanised private equity/pension funds. Increasingly the market would see a bouquet of projects become acquisition target. Recent portfolio sale by Softbank to Adani is a just one such example. In the past, some projects of Shapoorji were acquired by KKR owned Virescent.

On the other hand, HAM based assets like roads and water sector see acquisition interest even during under construction stage. Equity participation guarantees a ready made asset for operation byprivate equity players.

Resolution of stressed assets also has opened up acquisition possibilities, this is common in stressed thermal sector. Although the resolution process is slower than originally anticipated, the process has led to emergence of new breed of developers like private equities taking up stressed assets. Consequent to take over, the debt is downsized resulting in better financial profile. At the same time, there are many assets with no takers given the multitude of issues surrounding the project.

Way Forward

Infrastructure assets are numerous and each assets' have idiosyncrasies, hence separate and an unique solution is required to address the challenges. Notwithstanding the sub-segment, the counterparty assessment is the fulcrum. Policy actions to embolden the state-owned counterparties would decide the future interest of investors. As the PPP model evolve like electric bus concessions and other sectors embrace variant of this model, the counterparty's significance will further enlarge.

In the event of decoupling projects from state owned counterparties and adopting user payment model like toll projects, port assets and airport assets, balanced risk approach would decide the success. Notwithstanding the concession model, infrastructure sector has already set into a golden era.

– Siva Subramanian

Director & Head, Infrastructure and Project Finance of India Ratings & Research

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