Thursday, 18 July 2019

Building blocks

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  • Workers walk past a coal port at Mundra in the western Indian state of Gujarat.

Bringing more project financing into the capital markets will be key to overcoming constraints in the banking sector and delivering Modi’s ambitious infrastructure targets.

There are two main challenges to Prime Minister Narendra Modi’s grand infrastructure ambitions. First, domestic banks, traditionally the biggest lenders to the infrastructure sector, are sitting on a mountain of bad debt and are in need of capital. Second, India’s homegrown infrastructure sponsors are also nursing damaged balance sheets, constraining their ability to develop new projects.

The government is acting with a sense of urgency to address both, creating a significant opportunity for the international finance community. However, while greater roles for overseas investors and capital markets can help bridge the gap, the backdrop is challenging.

The Modi administration, which has staked its reputation on the infrastructure “story”, needs to address the problems with non-performing assets at the domestic banks. Local rating agency ICRA estimates that there is a requirement for Additional Tier 1 funding of Rs400bn (US$6.2bn) between now and the end of the fiscal year to March 2016, while Indian banks will need as much as Rs2trn in Basel III-compliant capital over the next three years.

The sense of urgency surrounding the need to kick-start domestic bank lending has led to the recent instigation of a seven-point plan aimed at transforming the country’s public-sector lenders. This includes establishing a bank board bureau, creating a capitalisation plan, reducing bad debt, limiting government oversight and rationalising corporate governance.

Still, a real change may require greater foreign participation.

“Much as is the case in say Thailand or Malaysia, Indian infrastructure has always been funded by local banks with international lenders cherry picking their projects and not really providing the critical mass that India’s infrastructure need requires,” said a Mumbai-based head of syndicated lending.

The traditional focus on coal-fired power plants has contributed to an array of delayed projects as supply problems, price swings and broken off-take agreements have left sponsors high and dry.

Given this backdrop, it is not surprising that renewable energy has become the nirvana of the Indian infrastructure story.

Lead-in times for the construction of either a wind-farm or a solar plant are only around six to nine months versus around four years for a coal-fired power project and, given its relative infancy as a sector, the issue of leverage is not hanging over the renewable energy segment as it does over the traditional coal or gas-fired power sector.

“In the traditional power production sector there are legacy problems with over-leverage and there were cancellations of coal allocations. The coal issue has been dealt with via a fresh round of auctions. As for the leverage issue, there was too much debt taken on and a lot of the projects couldn’t get up and running. Declining power prices also hurt the weaker players,” said Rakesh Garg, head of global finance for Barclays in India.

“But the dynamic now is for the weaker players to get taken out by stronger counterparts. For example JSW Energy is acquiring power assets from stressed companies like Jaypee Group and Monnet Power and Adani Power acquired a stressed power asset from Lanco. This consolidation will enable the projects to complete the last mile.”

In a recent report, Deutsche Bank estimates that, within the next seven years, India will become one of the biggest producers of renewable energy, with the growth momentum anchored in ambitious targets of Premier Modi. He is targeting wind-generated power of 100 gigawatts by 2022, from the current 22.5GW, while the country is aiming to generate the same power output through solar technology with a similar deadline.

Still, the backdrop is challenging in light of the financial weakness of India’s power distribution companies and reluctance of local and international lenders to take the regulatory risks.

Private-equity sponsors, small-scale promoters and blue-chip corporations, both domestic and foreign, dominate India’s renewable energy sector, where mezzanine financing, rolled out with internal rates of return of as much as 19%, has become the norm.

Non-recourse project financing was almost unheard of in the Indian infrastructure sector until 2012, when Techno Electric’s Simran Wind borrowed from Standard Chartered, the International Finance Corporation and DBS with the use of an innovative structure. That set the benchmark high, but wind-turbine manufacturer Suzlon’s US$200m convertible bond default that year left a bad taste, which has yet to dissipate.

Also, the smaller sponsors have faced strains from excessive leverage on mezzanine funding and have been taken out in some cases with fresh equity injected from cash-rich foreign entities, such as Singapore sovereign wealth fund GIC and Hong Kong’s CLP.

“As the renewable energy sector has boomed, the bidding process has driven down the IRRs and now the model is more towards limiting the equity portion of funding to around 15%-25% and also look to sell on the equity when the project is up and running. This sale of equity is ideally to a sovereign wealth fund or a fund located in the green energy sector, where there is a willingness to book lower IRRs, say in the 13%-15% range,” said Garg.

The great hope, as far as Mr Modi and the Indian infrastructure community are concerned, is disintermediation away from non-recourse project finance lending or sponsors’ use of balance sheets towards bond-market funding.

The benchmark in issuance of domestic currency project bonds is a multi-tranche Rs4bn issue from wind-power company ReNew Power Ventures. The issue was split into six tranches with funds raised to increase capacity at a 84.65MW wind-power plant in Maharashtra and contained a 10-year tranche with credit support from state-owned India Infrastructure Finance Co and the Asian Development Bank.

Credit wraps and public-private partnerships are on the way to becoming the standard in the Indian project bond market. Another a dozen-or-so infra companies are said to be looking to issue project bonds and, in July, ReNew was back again with IFC and ADB wraps and maturities of as long as 18 years. That is significant given that India’s illiquid domestic bond market can rarely stomach maturities longer than five years for standalone locally rated Double A issuance.

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