Contributed by: Meera Siva
In his talk to the Chennai chapter of IAIP on July 25 titled “Is Infra financing a success in India?” Venkataraman Rajaraman (Venkat), Director of Infrastructure and Project Finance, India Ratings & Research, gives an emphatic answer – in the negative. Venkat has been with India Ratings (a Fitch Group Company) since 2007. Earlier, he was a Sub Sovereign Fund – Municipal Finance Specialist at International Finance Corporation. Prior to that, he was Vice President – Resources at TN Urban Infrastructure Financial Services for over five years. Venkat is a Chartered Account, Cost Accountant and holds a Master of Science in Consultancy Management from BITS Pilani and a Bachelor of Commerce degree from D G Vaishnav College.
Venkat points out a few key problems that continue to plague the road development sector ever since the National Highway Authority of India (NHAI) started giving out contracts in a big way in 2004-05. For one, there are ownerships issues in the structure of the entity created. The winning contractors form a special purpose vehicle that was debt funded to the tune of 75 per cent; but the other portion held by the promoter also had substantial promoter-level borrowing. So effectively the promoter stake was only 10-15 per cent. And after earning their mark-up, they had less incentive to remain committed.
Second, project completions have not been easy due to land acquisition issues. Nearly 75 per cent of the projects – originally set to complete in three years – are stuck due to various approval delays. So the carefully laid out cash flows from tolls have not come to pass, impacting debt servicing.
Three, toll revenue estimates for the projects were very optimistic. For instance, traffic growth was projected at 13 per cent annually – a very high rate. And importantly, this was not based on any measured data but only on wishful thinking.
Four, the bidding process for many of the road projects were very aggressive. One way to measure competition in bidding is seeing the spread between the lowest and highest bid. In many projects, the difference was several times wider – indicating bidders undercutting prices.
Five, the winning bids gave up a large share of revenue – up to 45 per cent – to NHAI. Add to this the fact that NHAI’s claim on revenue is senior to bank interest payment; this leaves banks in an unenviable situation.
Six, banks are not the best funding source for such long-term projects with an operational life of many decades. The interest rate set by banks was reset every year and in many cases rates shot up from 8 per cent to 15 per cent over an 8-10 year period. This stresses the interest coverage ratio, especially when revenue does not ramp up.
Seven, there are also risks if the borrower tries to tap other funding sources such as bonds. Interest payment on the bonds may not happen on time as the project may not complete on time, or the revenue may be uneven.
So what’s the solution? Venkat suggest that a deep debt market with various instruments – tenors, risk appetite, payment structures – is a must to support the funding needs of the infrastructure sector. And the step taken by NHAI to give banks the priority in revenue claims in select projects should help. Collecting traffic data – similar to the extensive data available for toll roads in countries such as Australia – would help formulate realistic assumptions. Banks can also consider restructuring the debt dues. One option may be to categorize 80 per cent as senior debt and 20 per cent as subordinate. This will help improve the interest coverage from 0.9 times currently for many developers to a more comfortable level of 1.2 times.