Prospects in India’s Infrastructure Sector

By Kabir Narang

India’s 2016-2017 Union Budget provides a significant outlay for infrastructure expenditure. This spending is seen as a key component of the government’s plans to boost India’s growth levels to projections ranging between 7 and 9 percent. The allocation of US$ 32.41 to US$ 32.70 billion (Rs 2.19-2.21 lakh crore) and a newly liberalized foreign direct investment (FDI) policy further underline the government’s commitment in this regard.

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Government’s Outlook to Investing in the Indian Infrastructure Sector

Infrastructure is a key driver for the Indian economy. Increased spending in this sector has a multiplier effect on overall economic growth as it necessitates industrial growth and manufacturing. This in turn boosts aggregate demand by improving living conditions.

The infrastructure sector is wide-ranging and includes electricity, roads, airports, railways, water systems, public utilities, and telecommunications, the development of which raises the country’s economic productivity. Highways, ports, airports, roads, and rail are all necessary conduits for commerce, making their construction, improvement, and expansion all the more vital.

For these reasons, the Indian government has promoted investing in infrastructure, providing benefits such as the easing of tax restrictions and multiple financing alternatives. Such a focus on investment to boost GDP is a clear departure from previous consumption-led growth strategies. This is reflected in the total budgetary allocation – US$ 20.32 billion (Rs 137,333 crore) or almost 30 percent of the Union Budget. Arvind Subramanian, the Chief Economic Advisor, advocates such targeted public investment as an engine of growth in the short-run, which complements and crowds-in private investment.

The following financing initiatives are supported by the government:

• The National Infrastructure and Investment Fund (NIIF), whose objective is to maximize economic impact through investments in commercially viable projects, both greenfield and brownfield, while also kick-starting stalled projects.
• Public Private Partnerships (PPPs) are encouraged in the infrastructure sector, which is officially defined as a partnership between a public sector entity and a private sector firm, where majority share/equity belongs to the private entity.
• Merger and acquisition deals are also encouraged, with the elimination of those considered unsound sponsors.
• The Securities & Exchange Board of India enacted regulations in September 2014 allowing the creation of Real Estate Investment Trusts (REIT) and Infrastructure Investment Trusts (InvIT). Their purpose is to provide much needed liquidity for real estate and infrastructure players, giving investors an opportunity to invest in Indian stabilized assets through a listed platform.
• Equity capital (especially foreign) is the preferred form of funding rather than debt. Several Indian industries are already overleveraged, having borrowed more debt than they can sustain, leading their assets to be blacklisted as non-performing assets (NPAs). Yet, debt financing from foreign institutions is also discouraged as it increases currency risk.
• Funds will now be allocated from the federal government directly to local bodies. This eliminates the state governments as inefficient intermediaries and the unnecessary extension of credit lines.
• Sovereign wealth funds (SWFs) and pension funds are allowed to invest in infrastructure projects. They are given longer time horizons as they are not required to make immediate profits unlike private equity firms looking to quickly and profitably turnover target infrastructure projects.

Financing Models in the Infrastructure Sector

There are various financing models that can be used to commission infrastructure projects:

Build Operate Transfer and Toll or BOT (Toll): A private sector agent agrees to build an infrastructure project, operate it, and eventually transfer ownership rights to the government, which agrees to buying a certain amount of output to cover the initial investment.

BOT (Annuity): This model is exactly similar to BOT (Toll) except that the private party does not bear traffic or commercial risk. Payment is made at regular intervals.

The Hybrid Annuity Model: It is used for highway development projects; 40 percent of the construction cost is taken on by the government to aid the private developer. The remaining 60 percent is paid as annuity payments with interest to shareholders. The private party is protected from inflation and traffic risk.

Engineering Procurement Construction (EPC): This model is used to build roads and highways; the government provides all necessary clearance and funding. The private player solely undertakes the contracting of labor and construction.

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Legislation, Funding Opportunities, and Sector-Specific Advances

Plug and Play System: All permissions have to be first obtained by the concerned ministry before bidding for a project. This reduces the burden on private sector entities post-bid and problems of bureaucratic red-tapism.

Greater State Autonomy: Pertaining to the design of projects and programs, this follows from the recommendations of the 14^th Finance Commission. Ultra-local initiatives in urban infrastructure, electricity distribution, and sewage treatment are expected to have a direct noticeable impact.

Sagarmala Port Initiative: 90 percent of India’s trade by volume and 70 percent by value are moved through ports, thus playing a key role in facilitating external trade. The government focus is now on improving port infrastructure, increasing the capacity and draught at ports, as well as establishing inland waterways. Two new ports are to be developed at Dugarajapatnam in Andhra Pradesh and Sagar Island in West Bengal to enhance trade with India’s neighbors and the ASEAN countries.

South Asia Regional Connectivity: The Asian Development Bank (ADB) is keen to support India’s proposal to develop various infrastructure projects worth US$ 5 billion in South Asia to improve regional connectivity in the region. Two priority road corridors are being constructed at present – the first connects India with Bangladesh, Nepal, and Bhutan through North Bengal, and the second will establish India-Myanmar connectivity.

Power Sector: India is involved in developing power grids and transmission lines with surrounding countries such as Bangladesh. The 1,320 MW Maitree Thermal Power Project, a joint venture of NTPC (National Thermal Power Corporation) and Bangladesh Power Development Board, is awaiting development.

Real Estate Industry: Infrastructure developers who are part of a consortium will now be taxed as separate units in a move by the Central Board of Direct Taxes (CBDT). Normally, consortiums are formed to implement large-scale infrastructure or turnkey projects where multiple firms are engaged in engineering, procurement, and construction.

Smart Cities Mission: This is an urban renewal and retrofitting program by the Government of India that aims to develop the infrastructure of 100 cities, making them citizen friendly and sustainable. A total of US$ 15 billion (Rs 980 billion) has been approved by the Union Cabinet, with the remaining funding to emerge from PPPs and municipal bonds. Each participating city will establish a special purpose vehicle (SPV) to implement its Smart City plan. An SPV is a limited company incorporated at the city-level, in which the state and the urban local body are promoters, though private entities may hold up to a 50 percent equity stake. The largest sectors targeted for PPPs are in areas such as water supply, waste management, and transportation.

Observations

Under the Bharatiya Janata Party (BJP) led government, an increasing number of projects are being commissioned that target the expansion and improvement of consumer utilities, transportation, and communication needs, showcasing the priority given to the infrastructure sector. Forging relationships with private and foreign investors has additionally introduced long-term sustainability and global best practices in the infrastructure industry. Enabling this further are important government initiatives to ensure policy stability, ease of financing, transparency, and various legal and regulatory reforms. All of this projects a healthy outlook for investing in the sector.

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