In an effort to remove some of the key constraints to sustaining India's high economic growth, the country's government has undertaken an ambitious highway development programme with the aim of constructing thousands of kilometres of roads by March 2014. It is estimated that the total investment required to fund the programme will be in the range of $75bn to $90bn, much of which will come from the private sector.

Navin Wadhwani, managing director at the Indian office of European investment bank Rothschild, says: “The Indian system has sufficient liquidity at the moment to take care of existing road projects and there has been no  delay because of financing issues. But this will not be the case in the next few years, when many more projects will be announced and there will be an urgent need for international investment.”

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Increasing interest

The past few months have seen several international private equity firms take a keen interest in India’s roads and highways sector. In April last year, UK-based private equity firm Actis signed an agreement with India’s Tata Realty & Infrastructure to jointly invest $200m in roads and highways projects. More recently, California-based Norwest Venture Partners, along with Swiss hotel chain Xander Group, jointly invested about $100m in Sadbhav Infrastructure, a private developer of roads and highways in India. Meanwhile, UK-based private equity firm 3i Group, which has a $1.2bn India-focused infrastructure fund, is known to have made a second investment in Hyderabad-based engineering and construction company Soma Enterprises’ roads business. It has also been reported that Morgan Stanley Infrastructure Partners is in talks to invest in three highways and toll road projects jointly promoted by Soma Enterprises and Spanish construction firm Isolux Corsan.   

Declining to comment on the transaction, Gautam Bhandari, head of Morgan Stanley Infrastructure in India, merely says that the firm has invested in the roads sector and that the investments of the fund are expected to generate returns of 15% to 20%. He says: “The public-private partnership [PPP] programme in the roads sector has done well and some international construction firms are already here, bidding for contracts.” Commenting on financing requirements of the roads sector, Mr Bhandari says that while international equity investments are coming into India at a steady pace, international debt funds have stayed away. “The long-term debt financing requirements of the roads sector are solely being met at present by domestic financial institutions which will eventually near their lending limits. Going forward, foreign debt investment will become essential to meet growth targets,” he says.

Domestic help

In the absence of an active corporate bond market, and with exposure limits placed on insurance and pension firms by regulators, domestic commercial banks have played a pivotal role in providing debt financing to India’s infrastructure sector. This has however led to concerns about the creation of systemic risk due to the maturity mismatch created by banks financing long-duration infrastructure projects from the essentially short-term nature of their liabilities.

Saud Siddique, joint managing director at SREI Infrastructure Finance, a non-banking financial company focused on the infrastructure sector, says: “Many domestic banks are funding infrastructure projects, but this is a sub-optimal situation and cannot continue for long. Banks finance long-term projects from short-term debt expecting to recycle the debt. But what happens if liquidity dries up?”

He adds: “In addition to liquidity risk, there is also interest-rate resetting risk, which can substantially increase debt-servicing costs for projects which may not be serviceable. The development of long-term bond markets, therefore, is critical for the sustainable financing of infrastructure projects. Long-term bond markets, however, can only develop if there is adequate secondary market liquidity for such bonds. There is an opportunity for PPP to develop innovative instruments and platforms which can provide secondary market liquidity.” SREI itself is planning to launch a $1bn India-focused infrastructure fund that would raise money from overseas investors.

Roadside attraction

“For foreign investors, India’s roads and highways are an attractive sector to invest in since the long-term trends are encouraging and returns are healthy,” says Anoop Seth, head of infrastructure for Asia at AMP Capital Investors, a specialist investment manager headquartered in Australia. He says: “There is a long-term secular movement of traffic away from railways to roads. Earlier roads only accounted for 25% of traffic in India but that has gone up to about 75%. Additionally, users of roads are willing to pay a fee to use the improved facilities. Finally, traffic, as we know, grows at multiples of GDP.”

AMP has thus far invested about $135m in Indian infrastructure. It invested in the roads sector through its $750m Asian Giants Infrastructure Fund launched in 2008. Despite the inherent attractiveness of the highways sector, Mr Seth notes that foreign institutional investors (FIIs) have to learn to live with the issues such as complicated frameworks and procedures around the execution of road projects in India.  

Mr Wadhwani at Rothschild agrees: “One of the key concerns of international players is managing the domestic environment, right from getting approvals to operating within the regulatory framework and managing  project costs and time. They are also not comfortable providing guarantees to banks which in certain situations are sought for in infrastructure project financing.”  

According to Manish Agarwal, executive director at KPMG, it is India’s low credit rating that will deter international debt investors. The government, he suggests, should set up credit risk enhancement mechanisms. Foreign exchange risk is another sticking point for international investors, who would have dollar deposits but the cash flow would be in Indian rupees. “Hedging of foreign exchange risk isn’t well developed in India,” says Mr Agarwal. Interestingly, he points out that the bigger challenge at present is the persisting turmoil in markets outside India. At an international infrastructure finance conference Mr Agarwal attended recently, the debate, he says, was about ‘where is the money?’ rather than ‘where to invest?’ Mr Agarwal says: “International markets aren’t exactly flush with capital. Europe has been under huge pressure. These markets need to settle down before we can expect to see investors looking to invest in India’s highways sector.”

Smoothing the path

While some experts contend that it could well be 2012 before FIIs look eastwards, the Indian government is continuing with efforts to smoothen bureaucratic procedures and developing products to attract international investors. Recently, India raised the cap on FII investment by $5bn in both government and corporate bonds. FIIs are now allowed to invest an additional $5bn in bonds issued by companies engaged in the infrastructure sector. The roads ministry has also floated the idea of launching a $11bn road debt fund that could attract domestic investors as well as investment  from international pension funds, insurance funds and sovereign wealth funds. The ministry is launching 'mega road projects' each worth about $1bn in an effort to attract leading international construction companies that will hopefully bring along some of their preferred financiers too.

Mr Bhandari says, “The pace of development might be slower than what we expect, but we need to look at the positive side as well. The government is thinking ahead and is extremely helpful to industry players. We also need to look at the current situation of the roads and highways sector and compare it to a few years back – there has been massive progress in recent years.”