India: What to build and where to build it

As markets and confidence stabilize post-GFC, reports indicate that investment sentiment in the sector is, if anything, improving. However, infrastructure industry professionals and investors alike are not slow to recognize the problems as well as the promise of this great opportunity.

Blue skies… in theory

The case for India’s infrastructure sector is straightforward. “Despite its being one of the most exciting emerging markets, India’s poor infrastructure has been major constraint in achieving double digit growth,” as Rajiv Mishra, Managing Director of CLP Power India, points out. “The government and policymakers are increasingly realizing that for India to achieve its ambitious GDP growth targets of 8-10% p.a. for the next decade, the state of Indian infrastructure has to be improved greatly.”

The current stage of India’s developmental cycle, with sustained private-sector growth, makes this an especially critical time for improving infrastructure. “India is entering maturity in its development process, and an infrastructure gap has begun to open up across all the core sectors that threatens to derail achievement of true potential whilst it remains unresolved,” avers Alwyn Bowden, CEO of Essar Projects Ltd.

India’s Planning Commission calculates some $500 billion needed for infrastructure development over the next five years alone. And “over 25% of this is expected to be funded by the private sector – which is a marked shift from the earlier years,” notes Bowden. The deficit in electricity supply alone is estimated at some 11-17%. Infrastructure accounted for 13.3% of all investment during 2009.

However, the great India infrastructure opportunity can be all too disappointing when translated to reality. “The sector presents a dichotomy to the investor,” Bowden cautions. “The needs are huge, the opportunity is massive, the will is there; but the number of project opportunities actually coming to the market lags significantly behind the sentiment.” Infrastructure accounted for 13.3% of all investment during 2009.

Key themes for infrastructure

India’s infrastructure deficit ranges across many sub-sectors, and embraces many diverse asset types. Raja Parthasarathy, Senior Managing Director at IDFC Private Equity, sees roads, renewable energy and urban infrastructure – particularly water and waste management – as the key investment themes for the next few years.

The Indian infrastructure opportunity, however vast, can also be subject to differences of interpretation. For example, India’s Ministry of Statistics and Programme Implementation (MOSPI) lists the expected infrastructure sectors in its statistical reports – power, roads, railways, cargo and ports, civil aviation and telecoms – but also includes some industrial and resources sectors, such as coal, steel, cement, fertilizers and petrochemicals. Conversely, it excludes so-called social infrastructure in areas such as education and healthcare, as well as utilities such as water and sewerage.

“In the next five years, investments over $100 billion are expected in both the power and roads sector,” notes Bowden. “BOT projects in roads are expected to pick up momentum. So also in the power sector, generation capacity addition is expected to bolster growth. Opportunities are also emerging in O&M, as developers are looking forward to recycling their invested capital.”

Naveen Munjal, Director of Business Development at CLP Power India, sees a welcome “greater focus on, and investments in, profitable sectors such as energy, transport and telecom,” as well as “a gradual growth in infrastructure projects in areas of electricity, water supply and sanitation.”

Bowden also highlights India’s parlous urban fabric. “Large-scale investments are expected in the urban infrastructure sector in the next five years – led by key programs like Jawaharlal Nehru National Urban Renewal Mission (JNNURM) and Urban Infrastructure Development Scheme for Small & Medium Towns (UIDSSMT).” He also sees these as underpinned by “a substantial investment in the water and sanitation segment (including solid waste management) – over $20 billion,” as well as a similar amount invested into urban transport, particularly for metro projects in cities such as Delhi, Bengaluru, Mumbai and Hyderabad

Ports, Bowden continues, are also a significant sector, where “expansion plans are being focused on container terminals, LNG terminals, addition of berths, port connectivity, dredging, equipment upgrades and port-based Special Economic Zones.” In this sector, he adds, “private players are making huge investments in developing dry bulk and liquid bulk terminals, multi-purpose berths, greenfield ports & dredging,” with over $7.5 billion due for major ports and slightly more for minor ports, “80-90% of which is expected to come from the private sector.”

Private money, public win

With government making policy favorable to private investment in infrastructure, investors could be forgiven for thinking that trends are moving their way. “The government has already moved to streamline its policy framework to allow a bigger role for private investment in the infrastructure sector,” notes Mishra.

Parthasarathy does have some concerns over the level of risk awareness among private equity and infrastructure funds. “Financial investors will need to have a greater appreciation of the risks inherent in emerging sectors … risks such as evolving regulatory environments and the possible tensions between the centre and the states,” he cautions.

“The pipeline of greenfield projects along with the increasing opportunities for investment in O&M of assets – as developers look forward to recycling their investment – presents significant opportunities for creation of diverse portfolios in the infrastructure sector,” confirms Bowden. But, he adds, ‘the question still remains: who is best placed to shoulder the risk of project delivery and of surety of revenue stream?”

Bowden also emphasizes the execution risks. “While much progress has been made, the Indian infrastructure sector still presents significant challenges. To enter at the project delivery stage remains a relatively risky proposition. The solution lies in finding the right delivery partners, and there is evidence that investors are entering into strategic relationships with competent delivery vehicles.”

Even the best partners, however, do not guarantee success, and infrastructure practitioners are aware of the disadvantages of India’s unique position as an investment destination. According to Parthasarathy, India’s advantages include “the obvious need for new infrastructure,” as well as “the fact this is mostly being developed by private sector entrepreneurs – unlike in many other countries, where infrastructure development is government-led, somewhat restricting the opportunity to PPPs. He also cites the need for growth capital that “these entrepreneurs require in order to diversify their sources of funding,” as well as “an attractive exit environment in the equity markets for infrastructure companies – most of the large IPOs in recent years have emerged from this sector.”

However, the commensurate drawbacks include the pace of regulatory reform, challenges around land acquisition, frequent implementation delays and the absence of long-term debt markets to fund projects.

Bowden also points to distinctive regulatory risks as a result of India’s political structure and great size. “Currently, there is a division of power between the central government and the state governments. Some areas are reserved exclusively for central governance, while there are a few sectors that are subject to joint governance. As a result, there is often an ad hoc approach, which is enhanced by the overlapping power of the central and state governments.”

Regulatory development?

India’s recent initiatives to encourage private sector involvement in infrastructure investment and development have certainly attracted plaudits; but these are frequently qualified by assertions that these could be more broadly and systematically pursued. As Bowden remarks, “in times of regulatory development, the potential investor can be forgiven for believing that he is standing on shifting sands. Going forward, the government needs to establish regulatory entities that are unaffected by political changes and can operate autonomously.” The success of the TRAI regime, and the growth of the domestic telecoms sector, he points out, are good precedents.

“The regulatory environment is more advanced in certain sectors than in others,” avers Parthasarathy. “Telecoms, - among the first sectors to undertake large-scale privatization and witness open competition, beginning in the late 1990s – has served as a useful template for reform.  Power is another sector where major reforms began once the Electricity Act was introduced in 2003, and considerable progress has been made since then, even though there is still scope for further refinement.”

Not all sectors have seen such encouraging progress, he adds. “In other sectors, such as roads and airports, much work still needs to be done to bring these up to a reasonable level of discipline.  Over time, we believe that regulatory reforms will be implemented in a consistent manner across infrastructure sectors, keeping their contexts in mind, but the political will to drive such [initiatives] will ultimately determine the pace of their implementation.”

All the same, the challenges that investors have often faced – in the form of delay in getting approvals, complex regulatory environment, delays in the financial closure of projects, long gestation periods of the infrastructure projects and a non-transparent bidding process – are expected to ease off gradually, making the sector more attractive.

Finally, there are legitimate concerns as to whether certain types of project funding and investment are appropriate for the Indian situation at all. “In these tough times, there is a growing feeling in countries such as the UK that the recurring bill for all the infrastructure developed under the PPP mode (particularly schools and hospitals) is unsustainable and an unaffordable burden on the economy,”  Bowden points out. “A headlong rush to PPP/BOOT is not necessarily the answer to the India Infrastructure problem. India needs key infrastructure today, not tomorrow.” 

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• Topics
• Infrastructure
• Infrastructure
• Infrastructure
• South Asia
• IDFC Private Equity
• Raja Parthasarathy