Infra investment: The key to unlock India’s potential
ECONOMY & POLICY

Infra investment: The key to unlock India’s potential

The path to India’s transition from a developing economy to a developed one during the “Amrit Kaal” is intrinsically tied to robust infrastructure development. In this article, Revati Kasture, Executive Director, CareEdge Ratings, outlines what is needed to foster investment in the...
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The path to India’s transition from a developing economy to a developed one during the “Amrit Kaal” is intrinsically tied to robust infrastructure development. In this article, Revati Kasture, Executive Director, CareEdge Ratings, outlines what is needed to foster investment in the infrastructure segment.Infrastructure development stands as the bedrock of economic progress and assumes a pivotal role as India’s transition from a developing to a developed economy unfolds during the “Amrit Kaal”, signifying the next 25 years from India’s 75th year of Independence in 2021. India’s need for robust infrastructure investment is underscored by the evolving geopolitical landscape, offering the country a unique opportunity to diversify the global supply chain and establish a commanding presence on the global stage. To seize this momentous opportunity, India must not only raise its infrastructure game but also enhance its competitive edge, fostering agility and responsiveness to economic conditions. The failure to expedite investments in infrastructure could result in missing out on this transformative opportunity.According to estimations by CareEdge, India’s journey to becoming a $ 25-30 trillion economy by 2047 will necessitate an additional $ 18-20 trillion in infrastructure investment over the next 25 years. Currently, more than 70 per cent of infrastructure project financing emanates from the government and the public sector. The central government has allocated significant capital expenditure (capex) of Rs 10 trillion for FY24, marking a 37 per cent increase over the revised estimate for FY23. The central government’s capex-to-GDP ratio is poised to rise to 2.7 per cent in FY24 from 2.1 per cent in FY23, surpassing the pre-pandemic FY19 level of 1.1 per cent. With a robust multiplier effect estimated at around 2.5 (as per RBI 2020), central government capex is expected to draw in private investment over an extended period.While the central government’s efforts are commendable, the state governments constitute another critical pillar of infrastructure development. State government capex carries a potent multiplier effect of 2 (as per RBI 2020) and significantly contributes to the nation’s economic advancement. However, states have encountered delays in their capex endeavours due to rising revenue uncertainties amid various fiscal commitments. To complement the central government’s infrastructure thrust, states must prioritise capital expenditure and align their efforts with the broader national vision.Realising the multiplier effect of infrastructure investment, including job creation, heightened productivity, expanded market access, enhanced global competitiveness, and improved living standards for citizens, hinges on the augmentation of private investment in the sector. Given the government’s limited financial flexibility, promoting private investment becomes imperative to bridge the infrastructure investment gap. The private sector’s involvement in India’s infrastructure development has yielded mixed results, with successes in roads, renewable energy, telecom, power transmission, and airports. However, challenges persist in segments such as urban infrastructure, power distribution, and water and waste management.Four tips to encourage investment: Here’s an outline of what is needed to foster investment in the infrastructure segment.1. Diversify sources of capital: Currently, banks are the predominant source of finance for infrastructure projects with total exposure at approximately Rs 12 trillion for FY23. Considering the quantum of investment required in the sector, apart from banks, there is a dire requirement for multiple sources of finance that can be tapped. As infrastructure lending is a long-term play, investors with long-term funds/horizons would be most suited for such financing. Investors such as AIFs/ sovereign funds /Retirement funds should be encouraged to take exposure in under-construction infrastructure projects. Furthermore, while the government has taken steps to incentivize Municipal Bond issuances to a certain extent, the development of the Municipal Bond (Munibond) market remains a work in progress. To unleash the full potential of Munibonds as a financing avenue, empowering Urban Local Bodies is essential. This empowerment should translate into more frequent and substantial capital market issuances. By actively promoting retail participation in Munibond issuances, we can unlock significant resource mobilisation, channelling funds toward infrastructure asset creation.2. Use of expected loss ratings for evaluation of credit risk:  In the current landscape, infrastructure projects secure debt finance based on credit ratings, predominantly employing the Probability of Default (PD) approach. However, there exists an opportunity to enhance the risk assessment of these investments by shifting to an Expected Loss (EL) matrix instead.The EL Ratings framework represents a specialized rating system meticulously developed to cater to the unique demands of operational infrastructure projects, addressing a critical requirement within India’s infrastructure sector. This development stemmed from extensive collaboration between credit rating agencies and the Ministry of Finance (MoF) following the February 2016 budget speech. In this speech, the then Finance Minister emphasised the necessity of establishing a new credit rating system tailored specifically for infrastructure projects. Such a system would prioritize the diverse built-in credit enhancement structures characteristic of infrastructure projects. Departing from conventional practice, which often results in mispriced loans, this approach recognises that infrastructure projects possess distinct attributes that distinguish them from typical manufacturing or trading concerns.These unique characteristics encompass contractual arrangements ensuring long-term revenue visibility, often sourced from government or quasi-government entities. These attributes are further reinforced by structural features such as cash flow ring-fencing, well-defined waterfall mechanisms, termination payments, low incremental capital expenditure risk, monopolistic market positions, minimal pricing risk, and low technological obsolescence risk.The EL rating system integrates these distinctive characteristics, offering an alternative to the conventional PD methodology, where default is typically declared upon a missed payment. This framework extends beyond the PD-based ratings by introducing an additional parameter, Loss Given Default (LGD), which factors in the recovery prospects following a project’s default. Expected Loss, under this system, signifies the anticipated credit loss that may arise throughout a project’s debt lifecycle in the event of a default.The Securities and Exchange Board of India (SEBI) standardized the EL rating scale in July 2021. In January 2021, the Insurance Regulatory and Development Authority (IRDAI) recognized the EL scale, with the Pension Fund Regulatory and Development Authority (PFRDA) following suit in July 2021.The mandatory adoption of EL ratings for operational infrastructure projects holds immense potential, expanding the pool of eligible projects available for monetization and refinancing. This shift can liberate capital from the banking system, redirecting it toward the continued development of infrastructure assets. Long-term investors, such as pension funds, insurance companies, and participants in capital markets, can leverage EL ratings for risk-based pricing, thus fostering a more diversified bond market. This transition encourages investors to explore opportunities in ‘A’ or ‘BBB’ rated paper issued by operational infrastructure entities boasting high EL ratings, further enhancing the depth and inclusivity of the bond market.3. Credit enhancement for debt of infrastructure project companies: The credit profile of infrastructure assets can be strengthened using partial credit enhancements from multilateral funding agencies/large financial institutions/infrastructure finance institutions which can give a fillip to its credit rating and open the asset to a wider set of investors. For this to happen, there has to be wider stakeholder engagement to provide a first-loss absolute guarantee to the investors in infrastructure projects which cover their losses. This will greatly increase the comfort level of investors and also reduce the cost of funding for infrastructure projects. Currently, Obligor-Coobligor structures are not permitted as valid support mechanisms for credit enhancement by the Reserve Bank of India. These structures in many cases are legally enforceable and were specifically used by infrastructure SPVs leading to a better cost of borrowing. This route of financing may be allowed as a valid support mechanism for credit enhancement.4. Stricter legal frameworks: There is room for improvement in the enforceability of contractual agreements and speedy resolution of disputes. The legal protection framework needs to be enhanced to avoid long-winded litigations and provide clarity in ascertaining cash flows and investment returns. This becomes very important as the developers assume significant risk when disputes arise with sponsors or authorities. Summing up In conclusion, the path to India’s transition from a developing economy to a developed one during the “Amrit Kaal” is intrinsically tied to robust infrastructure development. While there are significant strides taken by the country in the right direction, there is always scope to expedite and capitalise on this transformative opportunity. About the author:Revati Kasture currently serves as an Executive Director at CareEdge Ratings. She has over two decades of experience in ratings and research. At the organisation, she has developed a reputation for excellence and has handled diverse functions. An all-India merit-holder Chartered Accountant and Cost Accountant, she was bestowed with the Professional Achiever-Woman award by the Institute of Chartered Accountants of India in December 2011 and recognised as one of India’s top 100 “Women in Finance” in the Leading Category in March 2019. 

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