Crunch Time

Interest rates are marching upwards. Financiers are shying away from infrastructure development projects. With no let-up in sight, developers have no choice but to seek alternate sources of funds and apply financial management skills to tide over the situation, finds Charu BahriAconundrum of sorts seems to be afflicting the Indian infrastructure development sector. During the slowdown, government measures to boost the industry and hence the economy were evident, as a result of which the industry did not suffer as much as expected. More recently, however, both the pace of award of projects as well as their execution has dropped. This new slowdown, as it were, bodes badly for the industry. For starters, developers with orders in hand are finding it difficult to get finance.Funds: In short supply?This begs the question: are funds in short supply? If so, is the shortage afflicting the industry overall or are some sectors or companies better off than others?“The current environment for raising project debt is challenging for sectors like power primarily owing to concerns on availability of fuel, long-term power purchase agreements, exposure limits of banks and financial institutions, etc,” remarks Sanjay Divakar Joshi, Chief Operating Officer, Lanco Infratech Ltd. “With regard to other infrastructure sectors like road and ports, the funding is not difficult for well-structured projects demonstrating healthy cash flows to service debt.” To this, Paresh Mehta, CFO, Ashoka Buildcon, adds, “Project finance is more challenging when the developer cannot establish the credibility of the company, show sufficient cash flows or when the certainty of revenue generation is not high enough.” On the availability of funds, Joy Saxena, Group CFO, Era Infra Engineering Ltd, comments, “We have seen a marked change in the availability of funds in the past one year. Last year, when we entered into a financing agreement with Axis Bank for our Rs 691-crore Muzaffarnagar-Haridwar national highway project, tying up funds was not at all a challenge. Banks were proactively approaching companies that had been awarded such prestigious road projects. Thus, the companies had options to bargain for better terms and be choosy. At the time, banks would even ‘down-sell’ project loans to other banks.” Since then, Era Infra Engineering Ltd has tied up for funds with a consortium of banks for its Rs 1951-crore Bareilly-Sitapur road project in Uttar Pradesh. Saxena has observed a slight change in the keenness of banks to come forward to support projects: “They are still interested but companies now need to negotiate harder, though, established developers would find the going easier.”For his part, Dipak Ashar, CFO Partner, Super CFO Services, observes, “Lenders across the board are not comfortable lending to infrastructure companies because the sector is not perceived to be doing as well as expected owing to various associated risk factors. Projects are taking longer to get executed because of delays on account of land clearances and other reasons. It is only projects that are relatively immune to procedural delays (such as in the power sector) that are finding it easier to get funding. Banks especially have grown choosy about their clients. Just established companies with strong balance sheets have it easier, although funds are not cheap for them either.” On the one hand, funds are harder to come by. On the other hand, as Ashar observes, money is becoming more expensive because of persisting inflationary trends. “Borrowing has become costly nowadays,” he says. “I would put interest rates in the 12 to 15 per cent range as reasonable. Anything more than that is expensive.”Coping with high interest rates In the present situation, companies bidding for infrastructure projects need to be vigilant with regard to interest rate trends because a lot dep-ends on the rates factored into project costs. While BOT project tenures run to 20 to 25 years, project debt must be repaid over 10 to 15 years. The only silver lining is that interest rates fluctuate in this period and tend towards an average figure over the long run. This evens out losses on account of higher than estimated paybacks during inflationary periods. Still, developers must factor interest rates into the cost of the project. Mehta says, “Interest on project finance may be divided into interest payable over the construction period and during the operational period. To cite the example of road projects, there are two kinds of projects in the PPP scenario: toll-based and annuity projects. Annuity projects are more sensitive to changes in interest rates. Toll-based projects have the advantage of having toll rate revisions tied to the WPI. Changes in the latter owing to inflation mandate toll rate revisions. In a sense, then, interest payme-nts tend to be compensated by increases in revenue. Developers must establish an average debt service coverage ratio of 1.4 to 1.5 times.”“In the current inflationary scenario with interest rates rising, it may seem safer to factor in higher rates in the final bid price,” Saxena explains further. “This would hedge the company’s risk in the absence of availability of cheaper funds on the project being awarded. It will also protect profitability margins. But quoting a higher price reduces the competitiveness of a bid, thereby lessening the chances of being awarded the contract in the first place. Thus, the decision has to be very strategic and forward-looking.”So what makes a strategic decision? “In my opinion, a 10 to 15-year horizon should be considered to factor the interest rate component into the final project bid,” responds Saxena. “As most infrastructure development projects are long-term and with economic conditions constantly changing, the interest rates are bound to fluctuate.  In such a scenario, flexi-interest rates are increasingly taking greater importance for term loans given for such long-term projects. Such loan agreements have in-built clauses wherein the interest rates are cut back when rates are revised downwards. As a result, the companies are not held to high interest rates when the economy improves. This makes it all the more crucial for companies to strategise well and balance costs with competitiveness. Interest rates between 9 per cent and 12 per cent are generally taken. Although interest rates are high at present, I expect to see some correction in the coming three to six months.” Sources of fundsBanks and financial institutions have been the key sources of funds for long gestation period infrastructure development projects. “Banks largely contri-bute to the major debt funding for projects,” observes Joshi. “Financial institutions like IIFCL and PFC. participate along with banks during initial debt funding.” But banks are becoming more selective. Simultaneously, infrastructure loans given by financial institutions are marking a decline; for instance, gross approvals and gross disbursements of infrastructure loans by the largest financer of private infrastructure in the country, IDFC, in the first quarter of the current year declined by over 50 per cent year-on-year with the energy and transportation sector constituting 70 per cent of total exposure. In this scenario, some developers are turning to alternate sources such as private equity funds.According to Ashar, “One visible trend is for companies to approach private equity funds or financial institutions. This comes from a desire to limit their exposure to increasingly selective banks as well as have an alternate source to fill in peak or urgent requirement that, at times, takes a while to get sanctioned from commercial banks. At the same time, as private equity funds and institutions also aim to reduce their exposure to risk, such finance is associated with more secure arrangements and stringent contractual terms.”External commercial borrowings“In a bid to reduce the average cost of funds for regular working capital as well as peak requirements, some companies are relying on external commercial borrowings [ECBs],” observes Ashar. For instance, Reliance Infra resorts to external commercial borrowings (ECBs) and local borrowings for funding its projects. The ECBs can be raised from foreign commercial banks or export credit agencies. Export credit agencies come into play during imports from a certain country. According to a company spokesperson, “ECB funds are 4 to 5 per cent cheaper than rupee funds.” Credit-worthiness reviews conducted prior to sanctioning ECBs or local funds take into account the company’s past performance and a detailed appraisal of the projects. Reliance Infra favours infrastructure development projects that assure high returns on equity, in the range of 15 to 20 per cent. For ins-tance, high-density corridors that have lower gestation period, such as the four or six-laning of existing roads, where revenue generation is immediate, and urban-centric projects associated with higher cash flows and growth potential, are preferred to hinter land projects.Like other sources of funds, ECBs have their pros and cons. Ashar cautions, “ECBs only come cheaper if the borrowing company doesn’t hedge its exposure to foreign currency. One must be aware that movements in currency prices as well as risk premiums could increase the cost of repayment of principal or interest substantially, at times. Calculated risks could work if the company has studied foreign currency movements well and therefore used derivative products to hedge and minimise its risks.” In the wake of rising interest costs, Joshi observes that executing projects within time limit is the key success factor. “Delayed execution means increased cost of interest during construction (IDC) as well as higher project cost due to inflation.” But with many factors out of the control of infrastructure developers, they can only hope that the hazy macro outlook and barriers slowing down the performance of the sector are cleared soon.