Money Methodology

31 Oct 2017 CW Team

It will take innovative financing to reduce the NPA burden on the infrastructure sector, explains VIJAY AGRAWAL. We have had some significant reforms this year - from demonetisation and RERA to GST - that will have a far-reaching impact on our economy. Further, the government introduced the S4A scheme to tackle non-performing assets (NPAs). Under this scheme, the current debt of the company is divided in two parts: Sustainable and non-sustainable. Generally, the non-sustainable portion is converted into equity or non-interest bearing instrument to give new life to the project. The government has also enacted the Indian Bankruptcy Code (IBC); under its provisions, there is a time-bound process of 270 days with an extension of 90 days. Both lenders and the company have to agree to a resolution plan for revival of a company within the defined period. In case the plan is not agreed upon, the liquidation process is started. In fact, the government recently referred 12 large corporates for debt resolution under IBC; another list of 40 corporates will be announced shortly. Mounting debt crises Indeed, we are all hearing about mounting NPAs related to the infrastructure sector. According to rough estimates, there are currently over 2.5 lakh crore NPAs in this sector. Economists fear that the current NPA problem has taken the Indian banking system back to the era of the 2008 US banking system, where banks stopped lending and general businesses suffered owing to lack of credit. So why are there such huge amount of NPAs in a single sector? And, how did these proposals pass the strict appraisal guidelines framed by the RBI and the internal guidelines of the banks? The fact is, most of these projects are funded in consortium by banks. Hence, many bank boards and committees were involved in appraising these projects and funding them; it is a stringent process. The root cause The crux of the problem lies in the cost and revenue model of any infrastructure project. Generally, these are long gestation projects with a life of 25 to 30 years. Any infrastructure project takes around four to five years to start generating revenue. In most cases, there will be a linear growth in revenue. Hence, as years pass by, the revenue will increase and improve debt-servicing. However, as per our banking norms, after commercial operations start, the project needs to start servicing interest on the entire debt burden and principle payments are staggered to 15 years with a moratorium of three years. Thus, the entire project needs to be repaid within 18 years even though it has a commercial life of 30 years. In case there is a shortfall in interest or principal payment, the account is classified as a NPA. Innovation is the solution So what is the solution? Under innovative financing methodology, the banks will assess interest and debt-servicing during the lifetime of the project with a tail period of three years. They will agree to an internal rate of return (IRR) with the borrower and a longer period of repayment to match the future cash flow from the project. The banks will charge interest at a lower rate for the initial years and then increase it to match their IRR. In case the borrower goes for refinancing, they will have the right to recompense the differential IRR. In this way, the banks do not need to classify such accounts as NPA in the initial years, reducing the NPA burden on our banking system. About the author: Vijay Agrawal, Executive Director, Equirus Capital, has over 20 years of experience across the infra, pharma, healthcare, manufacturing and IT sectors. He heads real estate and is the co-head of the infrastructure practice at Equirus.