At the end of last year, India’s government declared its ambition to spend $400 billion over the next five years to develop roads, railways, airports and new energy supplies – a crucial part of the strategy to sustain the country’s formidable economic growth.
Foreign investors and domestic players have been quick to respond to new project supply with an explosion of new funds over the past two years. And the unbridled success story of the country’s equity market in 2007 suggested that construction companies and investment vehicles had secured a lucrative new vehicle for attracting foreign and domestic capital.
But in early February, infrastructure-related IPOs (initial public offerings) ground to a halt as the local benchmark Sensex index fell sharply, in line with global market distress.
The flotation of Emaar MGF, an India-Dubai real estate joint venture, was scrapped that month, while international market darling Reliance Power lost 17% of its market share on its first day of trading on February 11. Jaiprakash Power’s $1 billion IPO and Gammon Infrastructure’s $100 million public offering are also on hold.
S Nanda Kumar, global infrastructure and project finance analyst at Fitch in Chennai, argues that the public investment scramble for marketable infrastructure resources has cooled, and companies will have to attract more conservative chunks of investment from now on. “Given the runaway boom in India’s equity market, infrastructure was getting crazy valuations,” he says. “Premiums charged were not on quality of the underlying assets but over-exuberance – this bullish sentiment has now changed.”
Agreement
“Current market conditions suggest that Indian infrastructure-focused corporates will face greater difficulty obtaining equity funding this year,” says Sachin Johri, managing director of project equity at Indian firm Infrastructure Development Finance Corporation (IDFC).
This is less of a problem for the companies that have already received sufficient investment, but for the projects in progress, a critical near-term challenge is how to manage refinancing risks.
To fund most new projects in India, the first port of call is commercial banks. Bank loans typically don’t come with sufficiently long tenors, which means long duration projects suffer from refinancing risks while domestic capital markets offer limited flexibility to hedge these bets.
“A lot of bank lending comes with interest rate reset clauses every three years, but if inflation is above 5% and rates continue to rise, there will definitely be a significant stress on marginal projects that have lower debt coverage ratios,” says Nanda Kumar.
The stakes are high, warns Anubha Shrivastava, south and south-east Asia portfolio director at UK government-owned fund Capital for Development (CDC). “There will be a loss for investors due to higher interest rates.”
At the heart of the issue is a lack of experience in India of investing and managing long-term infrastructure assets. This means bankers and investors are often too short-term focused and often overlook refinancing risks and changes in business cycles, says Nanda Kumar.
Toll Road trial
This is a particular challenge for new long-duration toll road assets that have only recently made the transition from annuity-based concessions, after reforms introduced by India’s National Highway Authority last year. It is compounded by the lack of a deep domestic capital market that could provide alternative financing options as well as flexible deal structures to offset short-, medium- and long-term risks.
Shrivastava fears that, with the avalanche of domestic liquidity and as new foreign funds begin to unleash their capital, efforts to improve financial risk management will be undermined. “There is too much liquidity in the market, and those who will get hurt will not just be intelligent private equity guys but domestic players and banks,” she says.
Nevertheless, political risk could be India’s greatest challenge this year. “There is the possibility of an election in six–12 months’ time, and people expect that the resulting political noise could then distract from the focus on securing new projects,” Johri says.—S.V.