Finance

Infrastructural Financing in India And the Landscape of the Last 20 Years’

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(1) Trend and Initiative of the Budgetary Support and Institutional Borrowings –

The managing and financing Page Design Web infrastructural facilities have changed significantly since the mid-eighties. The Eighth Plan (1992-97) envisaged cost recovery to be built into the financing system. This has further been reinforced during the Ninth Plan period (1997-2002) with a substantial reduction in budgetary allocations for infrastructure development. A strong case has been made for making public agencies accountable and financially viable. Most infrastructure projects must be undertaken through institutional finance rather than budgetary support.

The state-level organizations are responsible for providing infrastructural services, and metropolitan and other urban development agencies are expected to make capital investment financing on their own, besides covering the operational costs for their infrastructural services. The borrowing costs have increased significantly for all these agencies over the years. This has come in their way of taking up socially desirable schemes but is financially less or non-remunerative. Projects for the provision of water, sewerage and sanitation facilities, etc., which generally have a long gestation period and require a substantial subsidy component, have received a low priority in this changed policy perspective.

Landscape

Housing and Urban Development Corporation (HUDCO), set up in the sixties by the Government of India to support urban development schemes, had tried to give an impetus to financing projects by opening a special window in the late eighties. Availability of loans from this window, generally at less than the market rate, was expected to make state and city-level agencies, including the municipalities, borrow from Housing and Urban Development Corporation. This was more so for projects in cities and towns with less than a million populations since their capacity to draw upon internal resources was limited.

Housing and Urban Development Corporation finances up to 70 percent of public utility projects and social infrastructure costs. The share ranges from 50 percent for private agencies to 80 percent for public agencies for economic and commercial infrastructure. The loan will be repaid quarterly for 10 to 15 years, except for the shorter repayment period of the private agencies. The interest rates for the borrowings from Housing and Urban Development Corporation vary from 15 percent for financing public agencies’ utility infrastructure to 19.5 percent for the private sector’s commercial infrastructure. The range is much less than what used to be when opening the infrastructure window by Housing and Urban Development Corporation. This increase in the average interest rate and reduction in the range is because its average borrowing cost has increased from about 7 percent to 14 percent during the last two and a half-decade.

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Importantly, Housing and Urban Development Corporation loans were available to upgrade and improve the basic services in slums at a rate lower than the normal schemes in the early nineties. These were much cheaper than under similar projects of the World Bank. However, such loans are no longer available. The Corporation was also charging differential interest rates from local financing bodies in towns and cities depending upon their population size. The rate for urban centers with less than half a million population was 14.5 percent; for cities with a population between half to one million, it was 17 percent; and for a huge number of cities, it was 18 percent. However, as discussed above, no special concessional rate was charged for the towns with less than a hundred or fifty thousand financing population in dire need of infrastructural improvement.

However, it is unfortunate that even this small bias in favor of smaller cities has been given up. Further, the Housing and Urban Development Corporation was financing up to 90 percent of the project cost in the case of infrastructural schemes for ‘economically financing weaker sections,’ which, too, has been discontinued in recent years. Housing and Urban Development Corporation continued to be the premier financial institution for disbursing loans under the Integrated Low-Cost Sanitation Scheme of the government. The loans and the subsidy components for different beneficiary categories under the scheme are released through the Corporation. The number of funds available through this channel decreased drastically in the nineties.

Given the stoppage of equity support from the government, increased cost of resource mobilization, and pressure from international agencies to make infrastructural financing commercially viable, the Housing and Urban Development Corporation has responded by increasing the average interest rate and bringing down the amounts advanced to the social sectors. Most significantly, there has been a reduction in the interest rate differentiation designed for achieving social equity.

An analysis of infrastructural finances disbursed through the Housing and Urban Development Corporation shows that the development authorities and municipal corporations that exist only in larger urban centers have received more than half of the total amount. The agencies like Water Supply and Sewerage Boards and Housing Boards, which have the entire state within their jurisdiction, on the other hand, have received less than one-third of the total loans altogether.

Municipality financing with less than a hundred thousand population or local agencies with weak economic base often finds it difficult to approach Housing and Urban Development Corporation for loans. This is so even under the central government schemes like the Integrated Development of Small and Medium Towns, routed through Housing and Urban Development Corporation that carries a subsidy component. These towns generally cannot obtain the state government’s guarantee due to their uncertain financial position. The central government and the Reserve Bank of India have proposed restrictions on many states to guarantee local bodies and para-statal agencies to ensure fiscal discipline.

Also, the states are being persuaded to register a fixed percentage of the amount guaranteed by them as a liability in their accounting system. More importantly, in most states, only the para-statal agencies and municipal corporations have been given state guarantees with the total exclusion of smaller municipal bodies. Understandably, getting a bank guarantee is even more difficult, especially for the urban centers in less developed states and small and medium towns.

The Infrastructure Leasing and Financial Services (ILFS), established in 1989, has been an important financial institution in recent years. It is a private-sector financial intermediary financing wherein the Government of India owns a small equity share. Its activities have more or less remained confined to developing industrial townships, roads, and highways where risks are comparatively less. It undertakes project feasibility studies and provides a variety of financial as well as engineering services. Therefore, its role is that of a merchant banker rather than a mere loan provider so far as infrastructure financing is considered, and its share in the total infrastructural finance in the country remains limited.

Infrastructure Leasing and Financial Services has helped local bodies, para-statal agencies, and private organizations prepare feasibility reports of commercially viable projects, detailing the pricing and cost recovery mechanisms and establishing joint venture companies called Special Purpose Vehicles (SPV). Further, it has become an equity holder in these companies and other public and private agencies, including financing the operator of the BOT project. Thus, the role of Infrastructure Leasing and Financial Services may be seen as a promoter of a new perspective of development and a participatory arrangement for project financing. It is trying to acquire the dominant position to influence the composition of infrastructural projects and their financing system in the country.

The Financial Institutions Reform and Expansion (FIRE) Programme, launched under USAID’s auspices, must be mentioned here. Its basic objective is to enhance resource availability for commercially viable infrastructure projects by developing the domestic debt market. Fifty percent of the project cost is financed from the funds raised in the US capital market under the Housing Guaranty fund. This has been made available for thirty years at an interest rate of 6 percent, thanks to the US-Congress guarantee.

A swapping arrangement mitigates the risk involved in the exchange rate fluctuation due to the long period of capital borrowing through the Grigsby Bradford and Company and Government Financing Officers’ Association, for which they would charge an interest rate of 6 to 7 percent. Thus, the interest rate for the funds from the US market does not work out as much cheaper than that raised internally.

The funds under the program are channeled through Infrastructure Leasing and Financial Services and Housing and Urban Development Corporation, which are expected to raise a matching contribution for the project from the domestic debt market. A long list of agendas for policy reform about urban governance, land management, pricing of services, etc., has been proposed for the two participating institutions. The two agencies should examine the projects’ financial viability or bankability for providing loans under the program. This, it is hoped, would ensure financial discipline on the part of the borrowing agencies like private and public companies, municipal bodies, para-statal agencies, etc., as also the state governments that have to stand guarantee to the projects. The major question here, however, is whether funds from these agencies would be available for social sector schemes that have a long gestation period and low commercial viability.

Institutional funds are also available under the Employees State Insurance Scheme and Employer’s Provident Fund. These have a longer maturity period and are, thus, more suited for infrastructure financing. However, regulations require the investment channeled into government securities and other debt instruments in a ‘socially desirable’ manner. However, the government is seriously considering proposals to relax these stipulations so that the funds can be made available for earning higher returns, as per the principle of commercial profitability.

Several international actors are active in the infrastructure sector, such as the United Kingdom’s Government (through the Department for International Development), Australia, and the Netherlands. These have taken up projects about providing infrastructure and basic amenities under their bilateral cooperation programs. Although very small compared to other agencies discussed below, their financial support has generally gone into projects that are unlikely to be picked up by the private sector and may have cost recovery problems. World Bank, Asian Development Bank, and OECF (Japan), on the other hand, are the agencies that have financed infrastructure projects that are commercially viable and have the potential to be replicated on a large scale.

The share of these agencies in the total funds in the infrastructure sector is substantial. However, the problem is that the funds have generally been made available when the borrowing agencies can involve private entrepreneurs in the project or mobilize a certain stipulated amount from the capital market. This has proved to be a major bottleneck in the launching of a large number of projects. Several social sector projects have failed at different formulation or implementation stages due to their long payback period and uncertain profit potential. These projects also face serious difficulties in meeting the conditions laid down by international agencies.

(2) Trend and Initiative of the Borrowings by Government and Public Undertakings from Capital Market –

A strong plea has been made for mobilizing resources from the capital market for infrastructural investment. Unfortunately, few projects in the country have been perceived as commercially viable for which funds can easily be lifted from the market. The weak financial position and revenue sources of the state undertakings in this sector make this even more difficult. Consequently, innovative credit instruments have been designed to enable local bodies to tap the capital market.

For example, bonds are being issued through institutional arrangements in such a manner that the borrowing agency is required to pledge or escrow certain buoyant sources of revenue for debt servicing. This is a mechanism by which the debt repayment obligations are prioritized and kept independent of the borrowing agency’s overall financial position. It ensures that a trustee monitors the debt servicing and that the borrowing agency does not have access to the pledged resources until the loan is repaid.

The most important development in the context of investment in infrastructure and amenities is the country’s emergence of credit rating institutions. With the financial markets becoming global and competitive and the borrowers’ base increasingly diversified, investors and regulators prefer to rely on these institutions’ opinions. The rating of the debt instruments of corporate bodies, financial agencies, and banks are currently being done by institutions like the Information and Credit Rating Agency of India (ICRA), Credit Analysis and Research (CARE), and Credit Rating Information Services of India Limited (CRISIL), etc. However, the rating of the urban local bodies has been done so far by only the Information and Credit Rating Agency of India, that too only since 1995-96.

Given the state government’s controls on the borrowing agencies, it is not easy for any institution to assess the ‘functioning and managerial capabilities’ of these agencies in any meaningful manner to give a precise rating. Furthermore, an agency’s ‘present financial position’ does not reflect its strength or managerial efficiency. There could be several reasons for the high revenue income, expenditure, and budgetary surplus other than its administrative efficiency. Large sums received as grants or remuneration for certain services could explain that. The rent or capital account surplus is not a basis for cross-sectional or temporal comparison since the state governments’ user charges may vary.

More important than obtaining the relevant information, there is the problem of choosing a development perspective. The rating institutions would have difficulties deciding whether to go to measures of financial performance like total revenue, including grants or build appropriate indicators to reflect managerial efficiency. One can justify that for debt servicing; one needs high income, irrespective of source or organizational efficiency. This would, however, imply taking a very short-term view of the situation. Instead, if the rating agency considers a level of administrative efficiency, a structure of governance, or economic strength in the long term, it would support the projects that may have debt repayment problems in the short run but would succeed in the long run.

The indicators it may then consider would pertain to the provisions in state legislation regarding decentralization, government stability in the city and the state, per capita income of the population, industrial and commercial activity, etc. All these directly impact the prospect of increasing user charges in the long run. For example, the body could generate higher revenues through periodic revision of user charges if its residents’ per capita income levels are high.

The rating agencies have taken a medium or long-term view, as may be noted from the Rating Reports of various public undertakings in the recent past. These have generally based their rating on a host of quantitative and qualitative factors, including the policy perspective at the state or local level and not simply a few measurable indicators. The only problem is that it has neither detailed all these factors nor specified the procedures by which the qualitative dimensions have been brought within the credit rating framework without much ambiguity. Recently, India has made significant progress in mobilizing private investment for infrastructure. Infrastructure finance nearly doubled in the last decade and is expected to grow further under the government’s 12th Plan (2012-17), which calls for investments in the sector of about US$ 1 trillion, with a contribution from the private sector of at least half.

Still, it is not enough to conclude due to the following reasons:

(1) Meeting the ambitious targets fully will be challenging in the long run,
(2) Major changes are needed in the way banks appraise and finance projects,
(3) The government has taken several recent initiatives to expand private investment in infrastructure, but their impact has not yet been felt.

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