Review of Infrastructure Development and Its Financing in India

Abstract

Infrastructure is one of the most crucial pillars of productivity in any economy. Pushing infrastructure development and particularly organizing funds for infrastructure projects have been the biggest challenge in developing nations. The present study was taken up to review the infrastructure development and its financing in India. The study intended to (1) study the infrastructure development in India in the 11th and 12th Five Year Plan, (2) examine the sources used for infrastructure financing in India, (3) assess the actions taken by government to facilitate infrastructure financing and (4) propose measures to augment infrastructure financing to overcome infrastructure deficit in the country. It was found that though Government of India and Reserve Bank of India have taken several initiatives to facilitate infrastructure financing, there still exists a vast gap between supply side and the demand side. Some of the recommendations given in the paper include the need to evolve innovative business models and mitigate administrative glitches to ensure larger private participation; exploit the untapped potential of diaspora; revisit the statutory liquidity ratio norms for banks; evolve the municipal bond market; boost regional integration and improved connectivity through creation of corridors between sub-continental regions, which would not only bridge the finance gap but also the knowledge gap, etc.

Keywords

Growth driver infrastructure development infrastructure financing internal sources external sources

Infrastructure: The Growth Driver

‘Infrastructure can deliver major benefits in promoting economic growth, poverty alleviation and environmental sustainability, but only when it provides services that respond to effective demand and does so efficiently’ (World Bank, 1994). Infrastructure is the basic foundation of a nation and the fate of a nation’s economy is directly integrated into its infrastructure development.

The IMF (2015) in its World Economic Outlook July 2015 projected global economic growth rate to be 3.3 per cent in 2015 and 3.6 per cent in 2016. The economic updates suggested that the growth rate in Emerging and Developing Market Economies (EMDEs) was four and a half per cent in 2014 which came down to 4.2 per cent in 2015, due to reduced real wages, crumpled demand, increasing unemployment, slowdown in China’s economy, structural bottlenecks and uncertainty in financial market. The World Economic Forum’s Positive Infrastructure Report (World Bank, 2015a) discovered that the world would have infrastructure deficit of US$20 billion per annum over the next two decades. The Organization for Economic Co-operation and Development (OECD, 2007) estimated that additional investment of US$71 trillion would be required in the infrastructure during 2010–2030. The McKinsey Global Institute (2013) projected a total infrastructure outlay requirement till 2030, to be between US$570 billion to US$670 billion. According to McKinsey Global Institute (2014), the projected portion of infrastructure funding in GDP must be increased approximately from 3.8 per cent to 5.6 per cent in 2020 worldwide.

The European Commission (2011) estimated that, by 2020, it would be essential for Europe to invest EUR 1.5–2 trillion in its infrastructure. The American Society of Civil Engineers (2013) quantified an investment gap of US$17 billion in the total infrastructure and assessed requirement for added capital outlay of about US$36 billion by 2020. While the advanced economies need to invest to sustain their old power, transport, telecom networks and water, the emergent nations have bigger difficulty of setting up the elementary infrastructure. Hence, in the emerging economies, the requirement for infrastructure investment is much more prominent. G20 recommended that emerging nations would have to invest additional US$10 billion per annum up to 2020 to meet the demands of increasing urbanization and cope up with global integration (Ehlersn, 2014; G20, 2013). According to McKinsey Global Institute (2013) and OECD (2014) from 2008 to 2017, expenditure on infrastructure would be US$90 billion in China, US$27 billion in India, US$20 billion in Russia and US$10 billion in Brazil.

Object of the Study

The current research was done to review the infrastructure development and its financing in India. The aim of the research was to (1) study the infrastructure development in India in the 11th and 12th Five Year Plan, (2) examine the sources used for infrastructure financing in India, (3) assess the actions taken by government to facilitate infrastructure financing and (4) propose measures to augment infrastructure financing in the country.

Methodology

A realistic study was steered to find measures adopted by Government of India and Reserve Bank of India to stimulate infrastructure growth and boost infrastructure financing in the country. The study was based on secondary sources. The data were collected from government reports, research articles, reports of research agencies and other online resources.

Overview of Literature

Infrastructure plays a crucial role in facilitating high economic growth. The effect of infrastructure outlay and its quality on economic development have been extensively studied and well recognized (Calderón & Servén, 2004). Röller and Waverman (2001) found the proof of strong positive causative linkage between telecommunications infrastructure and economic growth. Calderón and Servén (2003) conducted a study in the Latin American countries and found encouraging and noteworthy output contribution of transport, telecommunication and power. Donaldson (2010) used Indian data from 1870 to 1930 and found that railroad development resulted in reduction of the cost of trading, boosted the overall trade and augmented the real income. Mohammad (2010) found that the improvements in the basic infrastructure boosted growth in production. Agénor and Moreno-Dodson (2006) and Canning and Pedroni (2008) observed that despite substantial variations across countries, the infrastructure certainly contributes to economic growth in the long run. Though the correlation between economic growth and infrastructure is complicated (Fay, Toman, Benitez, & Csordas, 2010), it is an accepted fact that the expenses in creating new infrastructure have positive correlation with productivity and progression (OECD, 2007). Even though there are wide-ranging benefits of infrastructure outlay, there is a stark shortage in the capital outlay in the new infrastructure globally (Asian Development Bank, 2009; OECD, 2007). According to Bhattacharya, Romani, and Nicholas (2012), many emerging markets, especially the low-income countries need essential measures to escalate their expenditure in infrastructure development, in order to accommodate rising urbanization and promote inclusive growth. The requirement of enormous capital expenditure coupled with the fiscal imperatives in the developing countries necessitates the private organizations to take a greater part in financing infrastructure.

Findings

Infrastructure Development in India

The Indian economy exhibited pliability and strength by registering 7.2 per cent GDP growth during 2015–2016. With the reforms process gathering momentum, it was expected that the yearly growth of real GDP would range between 7 and 7.5 per cent (Ministry of Finance, 2016). Christine Lagarde, IMF Chief, said that when the majority of the economies across the world were struggling with low GDP growth, India attained growth of 7.3 per cent in GDP in 2014 (World Bank, 2015b). She also said that projections showed that India’s GDP is anticipated to surpass that of Germany and Japan aggregated in 2019. Estimations also hinted that India will grow to US$200 billion economy in not more than 20 years and its proportion in world economy might increase to approximately 9 per cent from being less than 3 per cent at current (Christine, 2015). Nonetheless, the gap in India’s infrastructure is undisputable. According to the Global Competitiveness Report 2014–2015, India is placed at 87 among 148 countries for its infrastructure. In India, roughly 67 per cent of cargo and 85 per cent of people are transported through the roads. Humungous investments in infrastructure are the need of hour. The total capital outlay in infrastructure, which was approximately 5 per cent of the GDP in the 10th Five Year Plan and 7 per cent of the GDP in the 11th Five Year Plan, was anticipated to increase to approximately 8 per cent in the 12th Five Year Plan. The McKinsey Global Institute (2013) projected that if the outlay in infrastructure increased by 1/100th of GDP, it will result in added 3.4 million jobs in India.

The current study brings to light the infrastructure development in India during 11th Five Year Plan (2007–2012) and the first half of the 12th Five Year Plan (2012–2017) and also discusses the targets and the total capital outlay earmarked for the coming years to minimize the infrastructure deficit in the country.

Energy

India is the fourth biggest user of energy across the world. Energy sector has experienced growth, but there still exists a huge demand-supply gap. It must use the abundant energy resources available in the country and, if need be, supplement it with imports.

According to Infrastructure Statistics Report (2014), the total length of transmission lines which was 7,279 circuit kilometres in 2007–2008 has increased over the years to 8,726 circuit kilometres in 2011–2012. The electricity generation was 697 GWh (thousand) in 2005–2006, it has gradually increased to 1,057 GWh (thousand) in 2011–2012. The per capita consumption of electricity has increased from 430 KwH in 2005–2006 to 884 KwH in 2011–2012. But it was observed through advancement in this sector, there existed a consistent mismatch in the demand and supply of electricity. In 2007–2008, the total demand for energy was 739.343 thousand MU, the availability of energy was 666.007 thousand MU, while in 2012–2013 when the total demand was 999.114 thousand MU, and the energy availability was 911.209 thousand MU.

According to the 12th Five Year Plan (2012–2017), the aggregate installed capacity for the year ending 31 March 2012, including renewable energy sources, was 199,877 mega Watt. The proportion of renewable energy amounted to 12 per cent. The supply from renewable sources of energy is estimated to increase from 24,503 mega Watt (1 per cent) in 11th Five Year Plan to 54,503 mega Watt (1.43 per cent) in 12th Five Year Plan and to 99,617 mega Watt (2 per cent) in 13th Five Year Plan (2017–2022). This is comparable with countries like Indonesia (1.4 per cent), the USA (1.7 per cent), Thailand (1.0 per cent), Brazil at (3.1 per cent) and China (0.5 per cent), but nonetheless India needs to do more.

The Working Group for 12th Five Year Plan has projected a need for addition of 75,785 mega Watt in the existing generation capacity to cope up with the targeted economic growth during the 12th Five Year Plan period. During the 11th Five Year Plan period, utilization rate of approved outlay stood at 73.03 per cent (estimated expenditure of INR 4.2 trillion). Targeted expenditure during the 12th Five Year Plan period is estimated to be more than 2.5 times the previous plan period at INR 11.4 trillion.

Roads

India’s road system comprises of national freeways, state freeways, district roads and rural roads. According to the 12th Five Year Plan, the national highways of 76,818 km constitute 2 per cent of the country’s road network, but they transport 40 per cent of the road traffic. The state highways and major district roads together constitute 13 per cent of the country’s road network, transports another 40 per cent of the road traffic. Out of 76,818 km of national highways, approximately 23 per cent is four-lane (and above average), 54 per cent length is two-lane (average) and 23 per cent length is single lane (below average).

According to Basic Road Statistics (Ministry of Road Transport & Highways, 2012), the total surfaced road in the country as on 31 March 2012 was 55.46 per cent which comprised of National Highway of 76,818 km of which 100 per cent was surfaced road; State Highway of 164,360 km of which 99.14 per cent was surfaced road; Urban Roads of 464,294 km of which 73.04 per cent was surfaced road; Rural Roads: 1,938,220 km of which 47.97 per cent was surfaced road; Other Roads 1,747,864 km of which 75.97 per cent was surfaced.

According to the availability of roads per unit area, the road length per 1,000 sq. km grew from 1,288.74 km in 2007–2008 to 1,480.07 km in 2011–2012. Infrastructure Statistics (2014) showed that as on 31 March 2012, the road length per 1,000 sq. km was 1,480.07 km—in urban areas, it was 5,940.05 km and in rural areas, it was 621.58 km. The estimates also showed that the road length per 1,000 population was 4.03 km—in urban areas it was 1.27 km and in rural areas it was 2.3 km.

Under 12th Five Year Plan, the budgetary support for national highways is INR 1.44769 trillion and for rural roads is INR 1.26491 trillion. The sector is estimated to generate Internal and Extra Budgetary Resource (IEBR) of INR 0.64834 trillion and attract private outlay of INR 2.14186 trillion during the said period. With a government outlay of INR 11.4 trillion for the 12th Plan period, physical targets of road development (both freight and passenger traffic capacity) are targeted to be more than 1.5 times the achievement during the 11th Five Year Plan.

Ports

Ports facilitate coastal transport and international trade connectivity which is very crucial for economic growth. Ports consist of docks where ships anchor, while loading or unloading cargo. In India, ports are classified into two categories: major ports (controlled by Union Government) and non-major ports (controlled by State Governments/Union Territories). As on 31 March 2012, India had 12 main ports and 200 non-major ports. Usage of water transport enhanced between 2007 and 2012 total cargo moved grew from 72.6 billion tonnes in 2007–2008 to 91.4 billion tonnes in 2011–2012 while the aggregate passenger traffic grew from 1.66 billion in 2007–2008 to 2.14 billion in 2011–2012 (Infrastructure Statistics, 2014). During 11th Five Year Plan, an investment of INR 55.66 billion was made to augment the cargo handling capacity at various ports and a capacity addition of 185 million tonnes per annum (MTPA) was achieved. Government of India in the 12th Five Year Plan proposed to invest INR 737.93 billion on ports and the capacity of major ports is expected to be increased to 1,229 MTPA (NMDP, 2012).

Transport

Roadways: In India, approximately 57 per cent of the total cargo is transported through road, while in China, it is 22 per cent and in the USA 37 per cent. In contrast, the share of rail is only 36 per cent compared to 48 per cent for the USA and 47 per cent for China. India’s freight traffic majorly constitute bulk materials and that needs to be transferred over long distances which can be easily done through rail and waterways. Yet, the use of waterways is only 6 per cent unlike 14 per cent in the USA and 30 per cent in China. In India, the average speed of rail, road and ship is much lower than that of the developed economies (Infrastructure Statistics, 2014).

Railways: Indian Railways have a large network comprising of total tracks of 113,994 km—broad gauge 102,680; metre gauge 8,561 km and narrow gauge 2,753 km. 21,034 km is operated through electricity. Indian added 11,864 km of new railway tracks ever since independence, which is far inadequate to handle the present passenger load and the cargo volumes.

The average number of passenger trains operated daily was 10,385 in 2007–2008 which increased to 12,335 in 2011–2012. In 2007–2008, the average number of passengers carried daily was 17.88 million which increased to 22.5 million in 2011–2012 (Infrastructure Statistics, 2014; Ministry of Railways, 2012). Railways also upgraded the quality in terms of increase in electrification of rail track and change of narrow and metre gauge into broad gauge. The proportion of broad gauge increased from 81 per cent in 2007–2008 to 87 per cent in 2011–2012. But it is pitiful that the average speed of goods trains is 25 kilometres per hour which is almost 1/2 that of the USA. The expansion of the railway network is hugely inadequate. The 12th Five Year Plan estimated public sector investment of INR 5.19221 trillion and private sector investment of INR 1 trillion.

Shipping: India experienced a steady decline in shipping. India’s overseas trade which was approximately 32 per cent in 1999–2000 to come down to approximately 14 per cent in 2004–2005 and further reduced to approximately 8 per cent in 2010–2011. During the 11th Five Year Plan, the shipping industry saw an increase in fleet from 787 vessels increasing to 1,135 vessels and the total cargo being shipped increasing from 8.6 million gross tonnes to 11.03 million gross tonnes, making India rank sixteenth in the world (12th Five Year Plan).

During the 12th Five Year Plan, the target is to increase the capacity to 12.4 million gross tonnes. To accommodate the estimated traffic of 1,758.26 million tonnes by 2016–2017, the total capability of the port sector is envisioned to be 2,289.04 million tonnes. The 11th Five Year Plan had a projected capital outlay of INR 303.23 billion for shipping sector; however, only 58.3 per cent came through. The 12th Five Year Plan targeted investment of INR 289.50 billion in shipping sector. The private sector is expected to invest nearly INR 1.7 trillion in the ports (Infrastructure Statistics, 2014).

Civil Aviation: Civil aviation is also an essential engine of growth and development. The total of operative airports increased from 109 in 2007 to 120 in 2012. Average number of flights handled daily grew from 2,931 to 3,385 and average number of passengers handled daily improved from 2.4 lakhs to 3.3 lakhs during 2007–2008 to 2011–2012, indicative of surge in airport congestion (12th Five Year Plan). Air transport has displayed a prominent growth in availability, in terms of number of carriers and accessible seating kilometres. During 2006–2011, the passenger handling capacity augmented from 72 million to over 220 million and cargo handling capacity improved from 0.5 million tonnes to 3.3 million tonnes. According to the Report on Traffic Handled at Airports 2011–2012 (Airports Authority of India, 2012), the total travellers handled 52.947 billion; cargo transported 2,279,990 tonnes (Infrastructure Statistics, 2014).

As per the investment plans of the airline operators, the passenger capacity is expected to increase to 370 million by 2017. Present growth in cargo will necessitate investment in specialized cargo terminal and equipment. Independent estimates suggest an additional requirement of about 180 operational airports over the next 10 years. Indian airports would require an investment of about INR 675 billion during the 12th Five Year Plan to meet the traffic growth forecasts, of which the private sector is likely to contribute around INR 500 billion (12th Five Year Plan).

Urbanization

Increase in urbanization is posing huge stress on existing infrastructure. Census 2011 revealed that about 31 per cent people lived in urban regions and contributed 63 per cent of the GDP. It is anticipated that by 2030 urban regions will be housing 4/10th of total populace and will contribute 3/4th of India’s GDP (Ministry of Urban Development, 2014). The announcement of ‘Smart Cities’ by the Modi Government emphasized the necessity for an all-inclusive growth of physical, social, official and economic infrastructure for enhancing the life quality. The mission envisaged developing of 100 smart cities during 2015–2019. The Government also announced ‘Atal Mission for Rejuvenation of Urban Transformation’ (AMRUT) for the modernization of 500 cities and ‘Sardar Patel Urban Housing Mission’ (Khan, 2015).

The Modi government has allocated US$150 billion to the ‘Smart City’ initiative. In consultation with consortium of national and international consultants, the government would be identifying 100 cities and each selected city would receive a grant INR 1 billion (US$15.7 million) per year for over a five-year period. Government in January 2016 declared the names of the initial 20 cities which would be developed into Smart Cities. In terms of population, these 20 cities house 35.4 million people and these cities would have a total investment of INR 508.02 billion during the five-year period.

Infrastructure Financing in India

Internal Sources

India has a reasonably high savings rate. The savings as a portion of GDP are 22.3 per cent for household, 7.2 per cent for corporate and 1.3 per cent for public sector. Almost 50 per cent of household savings are in the form of deposits in banks, leaving an insignificant portion in contractual investments. So the major problem is not the availability of savings, rather the channelizing the savings into infrastructure investment (GOI, 2013). The channels through which the funds reach the infrastructure sector are (i) Government, (ii) Commercial Banks, (iii) Non-Banking Financial Companies, (iv) Insurance Companies & Pension Funds, (v) External Commercial Borrowings and (vi) Equity and FDI from abroad. It is anticipated that during the 12th Five Year Plan, the shares of Bank credit would be 51.4 per cent, Non-Banking Financial Companies (NBFCs) 27.3 per cent, External Commercial Borrowings (ECBs) 14.6 per cent and Pension or Insurance Funds 6.6 per cent in debt financing (12th Five Year Plan, Vol. 1).

Government: Traditionally, infrastructure financing is the responsibility of the government. According to the Planning Commission, India’s infrastructure investment during 10th Five Year Plan (2002–2007) was US$250 billion, in 11th Five Year Plan (2007–2012), it was US$450 billion and in the 12th Five Year Plan (2012–2017), it is estimated to be US$1 trillion which at current prices would amount to INR 65.79463 trillion (KPMG, 2014). During the 12th Five Year Plan of the total capital outlay on infrastructure, 52 per cent is anticipated to be paid by the public sector contrary to 63 per cent in 11th Five Year Plan. This noteworthy change in the approach solicits higher participation of private organizations. This would help government to focus on limited resources in social space of the economy (Planning Commission, 2012).

Administration’s transformation and innovative initiatives in the recent years have helped the infrastructure sector to grow, though on-ground challenges remain. Difficulty in ensured financial returns and weakness of macroeconomic atmosphere have diminished the appetite for risk of developers towards upcoming ventures. Though the revival of the sector is possible, it is projected to be sluggish as the majority of players are saddled with leveraged balance sheets and delayed projects. Moreover, if the structural constraints like ambiguity in land procurement, undue delays in sanctions and insufficient sources of funds are not addressed promptly, the executions on the ground may fail to add impetus (ICRA, 2015).

The initiatives taken by administration to organize funds for infrastructure sector include the following: (a) Infrastructure Debt Fund, (b) Tax-free Infrastructure Bond (c) Amendment of the IRDA Investment Regulations, 2013, (d) Enactment of the new Land Acquisition Act, (e) Real Estate (Regulation and Development) Bill, (f) Increased role of financial organizations like IFCL, PFC, (g) Simplification of FDI norms for Railways, Construction, and Defence and (h) Relaxation of ECB policy (ICRA, 2015).

India Infrastructure Finance Company Limited (IIFCL): The state has facilitated PPP (Public–Private Partnership) model by setting up IIFCL. It provides not only refinance to eligible financial institutions against their infrastructure-lending portfolio but also long-term senior and subordinated debt through participation in lending consortium. It also effectively addressed banks’ asset–liability mismatches problems. It provides partial credit guarantee to enhance the ratings of the project bond issue that helps to attract insurance companies and pension funds. It is anticipated that this would deepen the infrastructure bond market in India.

Infrastructure Debt Funds (IDFs): IDFs are special vehicles for investment, which are established as trusts or NBFCs. They were launched during 2011–2012, to speed up the inflow of long-term funds in infrastructure schemes. IDFs are supposed to fund only PPP projects and be party to Tripartite Agreement with the concessionaire and the sanctioning authority. IDFs can refinance the bank loans to release new loan to infra-projects. IDFs approached insurance companies, pension funds and state funds, as investors. Reserve Bank of India permitted foreign funds in IDFs, as a result, making way for long-standing institutional investors and FIIs registered with SEBI. IDFs can raise funds by issuing dollar or rupee-denominated bonds and this would add momentum to secondary market for bonds. The regulatory transformations allow IDFs to park funds in non-PPP projects as well. The fund could witness inflows to the tune of INR 5–10 trillion during the 12th Five Year Plan period (Care Ratings, 2013).

Alternative Investment Funds: Additionally, foreign investors are allowed to invest in Alternative Investment Funds and the governments of China, Japan and South Korea have committed to provide technological expertise and funds to the projects (Jones Lang LaSalle, 2015).

Real Estate Investment Trust (REIT): India’s first REIT is expected to be launched in the first half of 2016. From a real estate perspective, the sanctioning of REITs has a huge potential for transforming the industry. An REIT owns or finances income-producing real estate. Designed on the concept of mutual funds, REITs allows regular flow of income, divergence and value maximization to the investors. REITs allow a person to invest in portfolios of large-scale properties through the purchase of stock (REIT, 2016).

Infrastructure Investment Trusts (InvITs): InvITs allows pooling of money from individuals for directly investing in infrastructure. InvITs have been told to mobilize household savings via capital market route. It is envisioned that this ‘will decrease the stress on banks and make accessible fresh funds’ (Union Budget 2014–15, Budget Speech of Finance Minister, 2014). The InvITs would channelize long-term funds in infrastructure sector and release developers’ capital for utilization in new projects. Foreign investments will also be enabled in InvITs. Investors will advantage from better liquidity, while promoters will have access to capital markets and better scalability (ICRA, 2015).

Banks: Thus far, banks have played a fundamental role in funding infrastructure projects. Banks catered to more than 50 per cent debt funds needed in infrastructure sector (Khan, 2015). The portion of infrastructure in total credit by banks rose from 6 per cent in 2007 to 11 per cent in 2011 and to nearly 15 per cent in 2012. The bank credit to infrastructure projects was INR 950 million in 2001, grew to INR 100,740 million in 2015, causing a compound annual growth rate (CAGR) of approximately 40 per cent over the last 14 years. RBI Financial Stability Report (2015) stated that infrastructure, constituting 50 per cent of total advances, had almost 30 per cent as stressed advances. Reports disclosed that infra-projects constitute nearly 1/5th of the INR 28.6 billion restructured loans.

Reserve Bank of India has taken numerous reforms to remove the complexity of infrastructure funding. The modification in prudential norms allowed credit exposure to single borrower to increase from 15 per cent to 20 per cent and for group from 40 per cent to 50 per cent of Bank’s capital (Tier I & Tier II capital) (RBI, 2013a). The other measures taken by RBI include the following:

Stressed Assets Management: RBI’s (2014) ‘Framework for Revitalizing Distressed Assets in the Economy’, outlined a plan of action to incentivize prompt detection of troubled projects, apt reorganization of viable accounts and rapid revival or sale of unfeasible accounts. The salient features include (a) creation of Central Repository of Information on Large Credits (CRILC), Joint Lenders’ Forum (JLF), Corrective Action Plan (b) incentivize creditors to reach jointly and promptly to a corrective action plan, (c) allowing banking organizations to dispose of assets reported as SMA-2 to Asset Reconstruction Companies and (d) structure for Strategic Debt Restructuring in talk with SEBI (ICRA, 2015).

5/25 Scheme: RBI announced ‘Long-Term Structured Project Loans Scheme’ also known as ‘5/25 Scheme’. Under this, banks were permitted to repair stretched amortization period for infrastructure loans, with periodic refinancing every five years. This was expected to safeguard long-term sustainability of infrastructure projects by easing the stress on cash flow in the early years and in taking care of the maturity incongruities in funding such projects (Khan, 2015).

Securitization: Securitization includes putting together many contractual liabilities or other non-debt resources which create future cash inflows by selling those future inflows to an investor as securities. Through securitization banks liberate their capital, rebalance risks and coped with their asset–liability management. According to Harun R. Khan (2015), despite the apparent benefits, India’s securitization market is at nascent stage, as the disastrous ramification of the Global Financial Crisis and the alleged role of securitization in the financial catastrophe have profoundly injured the confidence of the investors.

Take-out Financing: This facilitates refinancing of the long-term projects with the medium-term funds. It allows banks to refinance project loans through full or partial take-out financing and fix an extended settlement period. Despite merits, the method has hardly produced results, reason being that the model fails to foresee reasonable risks and returns sharing. The opinion is that since the commencement of the project, banks shoulder liquidity and credit risk, but once the project is financially viable, withdrawing investment would result in upset future earnings on verified advances. Moreover, if the original creditors are mandated to do away with their safety interest, their outstanding risk will be subordinated to the interest of the take-out banker (Khan, 2015).

Infrastructure Non-Banking Finance Companies (NBFCs): RBI announced Infrastructure Finance Companies (IFCs), as exceptional class of NBFCs. Such companies must have at least 75 per cent of their total assets to include infrastructure assets. Besides that they would advantage from a lesser risk weight on their borrowings from bank (from 100 per cent to as low as 20 per cent for AAA-rated borrowers), greater allowable borrowings from bank (up to 20 per cent of bank’s net worth in contrary to 15 per cent for NBFC), right to use to ECBs (equal to 50 per cent of own funds through automatic route) and easing the single party/group exposure regulations for debt as well as equity. It was envisaged that this would facilitate a creditworthy IFC to raise added funds, for longer maturity period and at lesser cost, and lend more to infrastructure companies (RBI, 2013b). The prominent IFCs operating in India are Power Finance Corporation (PFC), Rural Electrification Corporation (REC), Infrastructure Development Finance Company (IDFC), IIFCL and L&T Infrastructure, etc. During 2008–2010, the credit sanctioned by these IFCs grew at the CAGR of 28 per cent. The REC and PFC, together constitute 80 per cent of the advancing by IFCs, had CAGR of 27 per cent during the same period (Sengupta, Sacchidananda, & Manish, 2015). PFC’s total sanctions were of INR 3,709 billion, total disbursement stood at INR 2,089 billion and the NPA recorded a low of 0.93 per cent of the loan assets up to 31 March 2012 (PFC, 2012). The unsettled loans of PFC and REC were INR 23,160 million as on March 2012 (REC, 2012). The sectoral allocation of financial resources was confined to sectors like roads, power and ports and rural electrification, etc. by the watchdogs. As the resource for capital resource is restricted in contrast to the commercial banks, they require further drive of capital mobilization.

Insurance Companies: Insurance companies are most apt for infrastructure financing, but in India their contribution is insignificant. This is due to thin insurance penetration and low insurance density. The insurance outreach has surged from approximately 3 per cent in 2001 to 5 per cent in 2010 but fell to nearly 4 per cent in 2011, due to the opening of the insurance sector to private players. The insurance density increased from US$11.5 in 2001 to US$64.4 in 2010 and but it slid to US$59.0 in 2011 (IRDA, 2012). The insurance penetration in the USA is 9 per cent of GDP, in France it is 11 per cent of GDP and in South Africa it is 16 per cent of GDP. Similarly, insurance density in UK is US$4,535, in the USA it is US$3,347, in Brazil it is US$398 and in South Africa it is US$1,037. Second, constitutional pre-emption by state and regulators restricts investment in infrastructure. Third, public insurance firms prefer to invest in government securities. Fourth, other than LIC, other players have not displayed craving for longer maturity paper.

According to IRDA (2012), the total investments of life businesses increased from INR 60,420 million in 2007 to INR 158,130 million in 2012 and non-life insurance companies grew from INR 5,040 million in 2007 to INR 9,930 million in 2012. In 2012, nearly 7 per cent of total investments of life insurance companies and 15 per cent of total capital outlay of non-life businesses were in infrastructure sector. As per the Fifth Amendment of IRDA Investment Regulation (2013), it is binding for life businesses to invest 15 per cent of their fund in infrastructure and social sectors. On the other hand, the rules also laid down minimum rating of AA for investing in debt paper which inevitably excluded funding in debt of private sponsors.

Pension/Provident Funds: In India, out of a projected workforce of 32.1 billion only 12 per cent are covered by pension schemes. The Indian Pension Fund managed by EPFO amounted to US$790 million in 2012. Total Pension Fund assets with EPFO were nearly 5 per cent of GDP compared to 50–100 per cent in developed nations, with insignificant exposure to equities, unlike 40 per cent in developed countries. Both EPF and PPF are sources of long-term funds; however, most of it deposited in government securities due to stringent regulatory norms. Lately, EPFO is thinking of investing in AAA-rated corporate bonds of private enterprises as well.

Financial Markets: A well-integrated financial system, where the banking sector and bond market supplement one other, diminishes financial instability and boosts the efficacy of capital distribution. Moreover, with bank already reporting record high investments in infra-projects, there is an imperative need to rearrange the financing activities towards the bond markets in larger interest of the country’s financial system. Recently, numerous initiatives were taken to handle both the demand side and the supply side limitations in the growth of the corporate bond market.

Bonds Issued by Banks: Reserve Bank of India has allowed banks to issue long-term bonds to raise funds for long-term lending and specified that such bonds will be out of the ambit of the regulatory binding of CRR (cash reserve ratio) and SLR (statutory liquidity ratio). RBI has also permitted cross-holdings by banks equal to 1/5th of the principal issue, in order to encourage the issue of such bonds (Khan, 2015).

Corporate Bonds: Government securities rule the Indian debt market as they are highly liquid in nature. The corporate debt majorly constitutes private placements by wholesale investors such as the AMC, banks, EPFO, LIC, etc. Recently, the process of issue for corporate bonds was made easy and norms were made uniform. Re-issuances of corporate bonds were allowed to augment liquidity in the secondary market. Increasing investment limits for Foreign Portfolio Investors (FPIs) and considerable drop in the withholding tax from 20 per cent to 5 per cent has been done to improve the investor base. Foreign Institutional Investors (FII) were allowed to issue rupee-linked bonds to expand the offshore rupee bond market. In stock market, measures were taken to increase transparency and Delivery-versus-Payment (DvP) settlement of OTC transactions was introduced to remove settlement risk. Repo and Credit Default Swaps were allowed in corporate bonds. The issue of bond has risen by nearly 236 per cent from INR 174.781 trillion in 2008–2009 to INR 413.879 trillion in 2014–2015, the number of issues grew by almost 153 per cent during the same period. The daily trading volumes in the stock market increased to INR 4 trillion in 2014 from INR 0.63 trillion in 2009 (Khan, 2015).

Credit Enhancement: During 2013–2014, RBI allowed banks to offer partial credit enhancements to corporate bonds issued by private entities and Special Purpose Vehicles (SPVs) for financing infrastructure projects. Banks need to seek board approval for issues such as assessment of risk, setting overall exposure limits, etc. Issues relating to type of bonds, capital relief to the banks taking exposure and the partially credit enhanced portion for issue of bond, guidelines for the default recognition were to be finalized thereafter.

Municipal Bond: Municipal bonds played a very restricted role in funding urban infrastructure projects. Only 1/100th of the total Urban Local Bodies contribution is financed by municipal bonds in contrast to 1/10th in the USA. The magnitude of the municipal bond market is very narrow. This indicates that although bond financing is viable source for ULBs, there are restraints upsetting both the demand and the supply side.

External Sources

There is a need to explore the international debt market to channelize funds into the domestic market through the following routes:

International Financial Organizations: (a) World Bank: The World Bank funded projects worth US$2.5 trillion per annum during 2011–2015. It provided support to the IIFCL through financing PPP mode. (b) Asian Development Bank (ADB): India received cumulative financial and technical aid of nearly US$2.7 trillion from ADB. (c) BRICS Bank: The New Development Bank (NDB) also called BRICS Bank is likely to finance growth projects in the BRICS nations and also other emerging nations. The NDB will have capital of US$10 trillion comprising US$5 trillion as callable. (d) The Asian Infrastructure Investment Bank (AIIB) with initial capital of US$5–10 trillion and bank from 57 countries as its members are expected to offer enormous financing to the infrastructure projects in Asian sub-continent (Khan, 2015).

External Commercial Borrowings: Government of India (GOI) and Reserve Bank of India (RBI) have modified the regulatory framework considering the necessity of foreign funds, particularly in the infrastructure projects. RBI along Government has been trying hard to rationalize the ECB regime to enable more rupee-linked offshore long-term borrowings in excess of 10 years. ECBs can be arranged through (i) Automatic Route and (ii) Approval Route. ECB for infrastructure investment in up to US$50 billion per borrower annually for Rupee/Foreign Currency expenditure is through automatic route. ECB can also be done global banks, worldwide capital markets, multinational financial companies, credit agencies, foreign vendors, foreign partners and foreign equity holders (RBI, 2013c).

The total ECB/FCCB (foreign currency convertible bond) borrowings are estimated at INR 54.9574 trillion and the foreign funds for infrastructure projects are projected at INR 5,495.7 billion. According to the Working Group on Savings 12th Five Year Plan, the total foreign funds of INR 33.1834 trillion and funds to be INR 6,106.5 billion have been arranged through this route.

Foreign Direct Investment: Government permitted 100 per cent FDI under automatic route to facilitate financing in power, mining, civil aviation sector; construction projects; natural gas and petroleum sector; telecommunications; industrial parks and special economic zones. FDI is also permissible through approval route in civil aviation beyond 49 per cent, beyond 74 per cent up to 100 per cent in existing airports and companies financing in infrastructure/services other than telecommunication. Cumulative FDI inflows into the infrastructure sector were worth US$2.5 trillion during the 12th Five Year Plan and averaged US$5 billion annually. The records reveal that telecom sector was the biggest recipient with a share of 40 per cent followed by power 25 per cent, petroleum and natural gas 19 per cent, transport, 11 per cent and non-conventional energy 5 per cent (Economic Survey, 2013). While FDI inflows to the country have been robust, a shortfall in estimated FDI for infrastructure cannot be ruled out in case of prominent external shocks.

Foreign Institutional Investor (FII): The Finance Ministry had declared the increase in FII investments in listed non-convertible debentures and bonds distributed by infrastructure companies by US$2 trillion. Before this, the limit was US$1.5 trillion in corporate debt, with an extra limit of US$5 billion in bonds with a left over maturity of more than five years. The extra limit was further raised to US$25 billion in March 2012. In June 2012, the Finance Ministry further reduced the lock-in period and the residual maturity to one year and also permitted FIIs to trade amongst them through lock-in period.

Offshore Rupee Bonds: In 2013, IFC issued Rupee-Linked Offshore Bond. The largest investment had come from the US investors followed by the European & Asian investors. Later, IFC was allowed to issue a 10-year, 10 billion Indian Rupee Bonds (equivalent to US$16.3 billion) in 2014. These bonds also known as ‘Masala Bonds’ were the first rupee bonds to be registered on the London Stock Exchange. IFC also issued onshore Rupee bonds to finance infrastructure projects. In India, despite numerous regulatory initiatives to activate the bond market to provide the infrastructure financing as an alternative to bank credit, the growth of corporate bond market remains in progress (Khan, 2015).

Discussion

The fact that infrastructure and finance are the lifeblood of any economy needs no reiteration. Inadequate infrastructure is the biggest constraint in growth and development of Indian economy. To attain the predicted growth rates, India needs to develop robust infra-system. India is facing huge funding gap, which needs to be reduced. Issues such as problem in clearances, difficulty in land acquisition, delay in decision-making, pricing model of infrastructure projects; inadequate dispute resolution mechanism, etc. need to be addressed, to make infrastructure a lucrative investment. There is also a need to create a facilitating atmosphere and set up suitable protections to encourage bigger participation by the private organizations in infrastructure projects. An elementary prerequisite for advancement of investment in infrastructure sector is a favourable policy environment, helpful in appealing private and overseas investment, while shielding community welfares and benefits.

In infrastructure financing, the problem is not that of inadequate savings, but rather deficiency of adequate financial intermediation, proficient in channelizing and mobilizing domestic savings into infrastructure sector. In the last few years, the policymakers have taken numerous measures, such as introduction of PPP model in infrastructure sector, facilitating bank financing to infrastructure sector, stimulating bond markets as alternate source of funding and creating novel and advanced channels of funding, to boost infrastructure financing. However, the regulatory and investment guidelines need further restructuring so that there can be larger scope to promote resilient financial system with diverse investors, innovative financial instruments, alongside liquidity and depth to support long-term funding.

India at present has the highest lending rate among the BRICS nation. The ability to meet infrastructure investment target of US$1 trillion critically depends on (a) the state’s capability to make the bond market popular as an alternative source to bank credit and (b) their capacity to bring about financial consolidation and decreasing upward pressure on rates of interest.

According to Ministry of Overseas Indian Affairs (2015), there are approximately 28 million Indians living abroad. Hence, there is a huge untapped potential of diaspora finance for infrastructure development in the country. Since the diaspora savings are mostly locked up in low-yielding bank accounts in the host countries, offering an annual interest rate of 4 or 5 per cent, the Government and reputed private companies can resource the wealth from migrants by selling diaspora bonds offering attractive interest rates. These bonds will also arouse emotional appeal to the NRI to make their valuable contribution in the development of their motherland. Diaspora finance would potentially help in lowering the cost of financing for development projects back home.

Banks have for long played a vital role in infrastructure financing. The credit exposure of banks is stretched to optimal level. Their balance sheet size, growth in non-performing assets and absence of motivations to advance to infrastructure sectors hugely restrict further credit expansion. It is advisable that banks should raise additional capital, by injecting Tier II capital and divestment of government stake, to avoid sector concentration. The mergers and consolidation in banking sector can diminish exposure constraints. The banks should finance the construction and the initial operation period of the infrastructure project, with insurance and pension funds providing the refinancing of bank loans over a long period, this would address the issue of asset–liability mismatch faced by banks. The Indian practice of applying CRR or SLR to ‘NDTL’ is not in corroboration with the global trends. Currently, the developed countries do not impose SLR requirements for prudential purpose. In the developing countries, the liquidity requirement applicable on time deposits is usually lower than on demand deposits. Some developing countries have SLR rate of less than 17 per cent for liabilities having a maturity period of less than one year and zero for liabilities having a maturity of over one year. Keeping in mind the dual aim of maintaining liquidity for premature withdrawals and compliance of the monetary policy, it is desirable that the application of CRR should be confined to cash and cash-like instruments, which include demand deposits and deposits with no minimum lock-in period. The requirement for SLR should be phased out, in view of Basel II norms, which are characterized by stern asset classification, capital adequacy and provisioning standards and guidelines. The Basel II norms appropriately ensure that the financial intermediary has sufficient liquidity to service its fixed-time liabilities. Another preposition which the banks can try using is: use inter-bank operations to manage day-to-day liquidity, treat savings account balances as long-term funds.

According to Niti Ayog (2015), during the 12th Five Year Plan period, there has been drastic fall in the private investments in the infrastructure sector in the country. It is necessary to (1) re-design the 3P models to rationalize the distribution of risk and reward among the different stakeholders, (2) put in place adequate and effective dispute resolution mechanism, (3) open up railways, ports, renewable energy sectors for 3P, (4) design a broad National PPP policy explaining the aims, scope and executing principles of the PPP programme envisioned by the state, (5) develop e-due diligence system, to ensure faster clearances, (6) greater transparency in screening process, (7) speedy update of changes made in policy and accessibility to vital data and publications, (8) new ‘go-to-market’ channels and (9) investment insurance for infrastructure investment projects, in order to restore private interest in the infrastructure sector. Government needs to offer incentives such as reductions and exemptions in taxes (exemption of tax levied on capital good required in the infrastructure sector, fractional VAT reductions when project gets completed, etc.); capped public guarantees (minimum revenue guarantee, guarantee for buyout, etc.); rewards and bonuses (for timely/prompt completion, for avoiding cost over-runs) and compensation for losses arising due to exchange rate movements. It is necessary that incentives or subsidies should be made conditional on social inclusiveness. A set of principal quantifiable impact pointers/indicators should be developed. State also needs to look into diverse models of PPPs such as Design and Build, Finance Only, Operation & Maintenance Contract, Build-Finance, Design-Build-Finance-Maintain, Design-Build-Finance-Maintain-Operate, Build-Own-Operate, Transfer-Operate-Transfer and Build-Lease-Transfer, etc., used across the world, to accelerate infrastructure development in the country.

In several nations, sub-sovereign bonds or municipal bonds constitute a major portion of infrastructure finance. Whereas in India, the municipal bond market is still untapped. It is essential that local governments should act as major drivers in infrastructure development of the country. There is a need to empower the local governments by granting them greater economic autonomy to raise funds for investment in infrastructure projects, with specified ceilings and subject to control measures, making them directly accountable for borrowing and repayment. Local governments use Local Government Financing Vehicles (LGFVs) to circumvent budgetary constraints and leverage their capital base. They can issue ‘revenue bond’ (in this interest is paid out of anticipated cash inflows), ‘common bonds’ (they help in funding non-income-generating capital outlays), ‘direct pay bonds’ (taxable bonds for which interest expense is directly subsidized by the federal government) to finance infrastructure projects. SEBI has set up a framework for issuing and registering of debt instruments by local municipal bodies, but there is a need for fine-tuning those regulations. Combined efforts are obligatory on part of Central Government, State Government and the Municipal Bodies for developing a more reliable municipal bonds market. Measures required to strengthen the municipal bond market in India include (a) revamping of regulatory framework, (b) flexibility in determining interest rate by relating it to a standard market rate, (c) provision for tax-exempt municipal bonds, (d) insulation from interventions, (e) need for credit rating, (f) need for partial or full assurance by Central/State government, (g) requisite for complete disclosure, (h) inbuilt mechanism to hedge risk for the investors and (i) expand the investor base by allowing NBFCs, Pension and Provident Funds and Foreign Portfolio Investors to invest in the securities of Urban Local Bodies and Municipal Bodies.

The depository profile of Insurance Companies, Pension and Provident Funds and Post Offices are more in harmony with the currency requisite of infrastructure. Due to the basic nature of their liabilities, they have the ability to invest for long terms and do not confront the issue of asset–liability mismatch. However, presently these institutions have subdued participation in infrastructure financing. There is a need to suitably modify their exposure limits to the infrastructure sector by approving investment in (a) AA-rated instruments (so-called ‘not permitted’ investments) and (b) infrastructure projects having assurance from state. India has the fastest rising middle class; however, only a small percentage of its population is investing in insurance and pension products. There is a need to announce proper schemes and appropriate incentives in insurance and pension domain, to generate additional long-term funds for infrastructure investments. Privatization of the pension system can be a significant stimulus to the development of the fixed-income securities market. Government needs to announce and promote privatized pension system in the country where contributions to pension funds are made automatically out of the monthly salary and another portion the workers are given stock/bonds in proportion to their contribution to the public system. At the time of retirement, the workers are only allowed partial withdrawal, with a substantial portion of their account to be converted into an annuity indexed to inflation. The annuity requirement, would lead to substantial growth in country’s retirement programme and eventually give way to new fund provisions for infrastructure sector. The savings deposited in the various schemes offered by Post Offices also need to be diverted into the investment in the infrastructure projects.

There is a need for well-developed corporate bond market to provide additional funding to infrastructure companies. It is necessary to design framework to enable lenders convert debt into equity in defaulting companies; reform pay and performance structures; devise innovative rating procedures that reward long-term investment in infrastructure sector; encourage innovative financial instruments; relax new foreign portfolio investors rules by eliminating paperwork for entities regulated by foreign securities market regulation; reduce withholding tax and provide tax shield in infrastructure bonds, for boosting investment in infrastructure. The investment bankers can act as bridge between the state and the private organizations by providing innovative financing solutions. They can do underwriting of the new issues offered by private companies, semi-government entities such as municipal bodies for financing infrastructure projects. There is a need to develop derivatives markets, particularly for interest rates and foreign currency. Indian public utility companies with investment-grade ratings and implicit sovereign guarantees should be allowed to issue foreign currency shares, bonds, ADRs, GDRs and hybrid instruments in overseas markets, but the financial risks will have to be judiciously observed and managed.

Participation of private entities in infrastructure financing will largely depend on the nation’s capability: to develop well-organized debt market, making regulatory transformation which facilitates diversification and removing the hurdles for overseas investors. ECBs for infrastructure are inadequate due to (a) poor balance sheets of infra-companies and absence of creditability, (b) interest rate caps, (c) restriction on foreign participation and (d) limited hedging possibilities. Another impediment in exploiting foreign funds is the absence of adequately profound forwards market in foreign exchange.

Government should promote intra-regional infrastructure development, i.e., regional integration and improved connectivity through creation of corridors between sub-regions. This would accelerate infrastructure development, attract new investment and stimulate economic development. For this, it is essential to create synergies and to ensure policy coherence. It is important that there is some common parlance and linkage between the micro and macro policies; between investment and sustainable development strategies and between national and international investment policies. Partnerships between home countries of investors and host countries, trans-national corporations and development banks can assist in reducing information gaps and create united investments in infrastructure sector.

Conclusion

Despite the theoretic ideal match between enormous source of capital and necessity of investment, the investment in infrastructure has been insufficient to bridge the financing gap. The initiatives have mostly been state-driven, but there is a need for market- and investor-driven initiatives. Governments need to reconsider their approach to support infrastructure financing. Financial markets and intermediaries need to innovate to attract larger funds in response to demand (the search for suitable asset class) and supply (the infrastructure gap).

Footnotes

Declaration of Conflicting Interests

The author declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.

Funding

The author received no financial support for the research, authorship, and/or publication of this article.

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